Author Topic: Continue after tax 401k contributions or funnel the money to a taxable account?  (Read 2186 times)

ZiziPB

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Hello fellow investors, given the recent IRS guidance on "mega backdoor Roth" and the interesting discussions here and elswhere on this topic, I would appreciate your input on my particular situation.

I have a good 401k plan at work with inexpensive investment options.  The plan allows after-tax contributions and in-service distributions but with a twist: the after tax money has to stay in the 401k account for at least 2 years before it can be rolled over or converted to Roth 401k.  I am 3.5 years away from early-ish retirement (will be 50.5 years old then) and am wondering if it makes sense to continue after-tax 401k contributions (I just started them last year after learning of the possibility of Roth conversion) or if I should just put the money in the taxable account and not bother with the "mega backdoor Roth" given the waiting period imposed by my plan.  I already invest significant amounts in the taxable account.  My savings this year are projected to be as follows: $17.5K (before tax 401k), employer contributions/match $20.7K, $13.5K after tax 401k (so these three add up to approximately $52K), taxable account $95K.  I also max an HSA account. I don't do normal backdoor Roth contributions because I have a couple of sizeable traditional IRAs. I expect to be able to save about the same in 2015 and hopefully every year until I retire in 2018.
I project to have sufficient taxable investments to last me until at least 65 and I am planning to start a Roth pipeline as soon as I retire.  I have no pension but expect SS of at least $2500 per month at 70 (if the system is still around at the current terms).  Planning to stay in 15% tax bracket throughout retirement.

So what do you think?  Is it worth the trouble or should I keep things simple and just put the money into the taxable account?

brooklynguy

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If I were you, I would continue with maxing out the after-tax contributions.  If you have sufficient taxable investments to last until age 65, what would be the point of directing these funds to taxable accounts instead of after-tax 401k?  And even if you didn't have sufficient taxable investments, you would still be able to access all of these contributions immediately upon retirement (after they've been rolled into the Roth IRA).  So the only downside for you is the headache of keeping track of all this, but for that effort you will gain the benefit of sheltering at least $13.5k per year from taxes forever (and probably more, because you can get the earnings on those $13.5k after the 2-year waiting period into the Roth, and I think you can also eventually get the pre-2-year waiting period earnings into your Roth conversion pipeline too -- see my latest post in the main thread on this topic).

ZiziPB

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What about tax consequences at death?  I think the investments in the taxable account would get a step up in basis, but I don't think that happens for investments sitting in a Roth.  I may be wrong though...

brooklynguy

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I don't think a step-up in basis is really needed because as a general rule I think Roth IRAs can be accessed by your heirs tax-free and stretch out distributions over their lifetimes if they follow the rules.  But you are right that my original response did not tax consequences upon death and estate planning considerations into account, so if those are important to you you need to consider those factors as well.

Another trap to avoid with the mega back door Roth is that if you have an existing Roth that has any funds from an earlier conversion in it, the ordering rules will force you to distribute those funds before you can access the mega back door Roth contributions.  So anyone who has been doing normal back door Roth conversions will have to wait at least five years from the last of those conversions to access the mega back door Roth contributions if they want to avoid penalties on the withdrawals of the normal back door amounts.

ZiziPB

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Thanks Brooklynguy, looks like I need to read up on Roths and how they are treated upon death. 

As to your other remark, I don't have any existing Roth accounts, so I think I am in the clear on that issue.  The plan is to start a Roth pipeline as soon as I retire.