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Learning, Sharing, and Teaching => Investor Alley => Topic started by: icyappraiser on March 01, 2019, 01:58:22 PM

Title: Investment Order Question---mega backdoor Roth
Post by: icyappraiser on March 01, 2019, 01:58:22 PM
Doing some reading on MadFientist about this...but not sure I'm 100% understanding.

Currently, I'm investing in the following order...

1. 401k to Match
2. Max HSA
3. Max ROTH IRA (MAGI too high for traditional deduction, but below ROTH limits)
4. Max 401k
5. Taxable

My question is on Mega Backdoor Roth...can/should I do this? Here's some language from my company's benefits handbook...

"You may elect to contribute up to 100% of your eligible monthly salary, after legally required deductions, into the
Plan through payroll deductions only. You may change your contribution rate at any time. Your contributions may
be made on an after-tax basis (Regular Savings), a pre-tax basis (Deferred Savings), or an after-tax Roth basis (Roth
Savings) or any combination of Regular, Deferred or Roth Savings." --> So I can make after-tax contributions after maxing out pre-tax 401k...right?

And here's the part I don't quite follow...

"Roth In-Plan Conversion
This option allows you to convert all or a portion of your eligible RSP pre-tax contributions and non-Roth assets
(including after-tax contributions, rollovers and matching contributions, if any) to Roth assets within the RSP.
The benefit of holding converted Roth assets is that they may qualify to be distributed tax free (including
earnings), similar to distributions of qualified Roth IRA assets. The amount that may be converted is the amount
that may otherwise be withdrawn or distributed from the Plan.
Special tax rules apply to an In-Plan Roth Conversion and are an important consideration in determining whether
to do such a conversion. Generally, the taxable amount of a conversion is determined as if the converted assets
were distributed to you from the Plan as a taxable distribution, although the assets will only be transferred to the
Roth portion of your account and no amount will be actually distributed to you, therefore no penalty would apply
for an In-Plan Roth Conversion prior to age 59½. The taxable amount (determined as if actually distributed to you)
is taxable to you in the year of the conversion, and should be reported on your income tax return for that year.
For more information related to the tax consequences of a conversion, you should review the Savings Plan
Participant Guide and consult with your tax or financial advisor."

Can someone help me decipher this and how it relates to a mega backdoor roth and if I can/should use that?

Thanks!
Title: Re: Investment Order Question---mega backdoor Roth
Post by: MDM on March 01, 2019, 08:51:26 PM
Can someone help me decipher this and how it relates to a mega backdoor roth and if I can/should use that?
That describes a mega backdoor Roth.  See also Investment Order (https://forum.mrmoneymustache.com/investor-alley/investment-order/msg1333153/#msg1333153) and links therein.
Title: Re: Investment Order Question---mega backdoor Roth
Post by: starguru on March 02, 2019, 07:21:21 AM
You should call your plan administrators.  It seems you can do it.  You contribute after tax dollars and then fill out a form to convert those after tax dollars to a Roth.  You pay taxes on any gains those after tax dollars might have between when you contribute and when you convert.   Thereafter in the Roth you won’t pay taxes again barring changes to tax law. 

Would need more details to see if it makes sense but in general It’s a great tool if you have it available.  I love mine; it’s been a year since my last conversion so it’s about time for me. 


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Title: Re: Investment Order Question---mega backdoor Roth
Post by: terran on March 02, 2019, 07:27:47 AM
Agreed, this sounds like the in-plan version of a mega backdoor Roth. This is only slightly less good than the version that allows in-service withdrawal of after tax as you can't separate the earnings from basis (earnings into traditional, basis into Roth) with an in plan conversion, but it's still pretty great. You'll just pay tax on earnings but that can be pretty small if you do it regularly.

But, yes you should check with you administrator to confirm that they'll let you roll your after-tax contributions over to the Roth part of the plan.
Title: Re: Investment Order Question---mega backdoor Roth
Post by: icyappraiser on May 30, 2019, 12:38:11 PM
Thanks for all the replies. Following back up on this. I talked to my plan administrator and asked if I could do in-service withdrawals of after-tax money. Here is what they said:

me: Does my 401(k) plan allow me to take in-service withdrawals of after-tax contributions?
them: I do show that your plan does allow for an in-service withdrawal which would pull from after-tax funds. This in-service withdrawal allows for up to one-transaction be permitted per day. This same withdraw is allowing you to pull from the funds you had rolled into this account as well. If you wanted to elect for only the after-tax balance to be removed, it would require a call for that withdrawal processing. As if you were to initiate this transaction online, it is going to pull from both your roll-in source, as well as any after-tax funds you have.

So this seems to mean to me that I can make after-tax 401(k) contributions and roll them over into my ROTH IRA, with the only caveat being any gains made between the contributions and when I roll-over the monies are taxable, correct? I can also roll it over into ROTH within the plan, but my understanding is that is inferior to rolling it into my ROTH IRA, correct?

Thanks for the help, this is all getting a bit complex :)
Title: Re: Investment Order Question---mega backdoor Roth
Post by: DeepEllumStache on May 30, 2019, 01:30:13 PM
Yes, you could take those after tax contributions and roll them into a Roth IRA.

I’ve been doing this the past few years. I contribute after tax dollars after hitting the annual pretax limit, then call the 401k plan once a year in December to trigger the in plan rollover. I limit my roll overs because my plan charges me $20 per rollover.

Rolling the after tax contributions into a separate Roth account makes them more portable and opens up more fund choices. We have an above average 401k with low fees but I still prefer the flexibility and control of moving the money to a separate Roth.

For the gains, mine are split off into a separate IRA so it doesn’t create a taxable event. You could also choose to pay the taxes (my separate IRA is adorably small so that might have been worth doing).
Title: Re: Investment Order Question---mega backdoor Roth
Post by: terran on June 02, 2019, 07:07:18 AM
So this seems to mean to me that I can make after-tax 401(k) contributions and roll them over into my ROTH IRA, with the only caveat being any gains made between the contributions and when I roll-over the monies are taxable, correct? I can also roll it over into ROTH within the plan, but my understanding is that is inferior to rolling it into my ROTH IRA, correct?

Yes, that's how I read their response.

Doing an in plan rollover isn't necessarily inferior to rolling over to a Roth IRA. If the investment options in your 401(k) are as good or better than what you can get in a Roth IRA, then the in plan rollover would be as good or better, if they're worse then it would be worse. Otherwise it's really just a matter of preference.

However, if you rollover to an external IRA it's possible they'll let you rollover the after-tax basis (what you contribute to after-tax) to Roth IRA and any gains between when you contribute and when you withdraw/rollover to traditional IRA, thereby deferring the tax on those gains. This would be superior if you current marginal tax bracket is higher than your expected future marginal tax bracket in the same way that contributing to traditional/tax-deferred 401(k) may be preferred to contributing to a Roth IRA when you current marginal bracket is higher. If you rollover shortly after contributing you won't have much in gains, so it might not be worth the trouble of splitting the basis and gains even if it is theoretically better. 
Title: Re: Investment Order Question---mega backdoor Roth
Post by: icyappraiser on August 09, 2019, 07:49:23 AM
So I learned that I can set up an automatic in-plan rollover to Roth 401(k) done every pay period to essentially eliminate any tax due (this is through Fidelity). This obviously appeals to me due to it being hands off and simple.

Assuming the investment options are just as attractive within my 401(k) plan, which I feel they are, is there any other downside? Mostly I am wondering about accessing money before 59.5. I understand if I roll it out into my Roth IRA and wait 5 years, the money is accessible--is that correct? Can I also access money out of the Roth 401(k) in the same manner or not?

Thanks again all!
Title: Re: Investment Order Question---mega backdoor Roth
Post by: seattlecyclone on August 09, 2019, 10:27:35 AM
Assuming the investment options are just as attractive within my 401(k) plan, which I feel they are, is there any other downside? Mostly I am wondering about accessing money before 59.5. I understand if I roll it out into my Roth IRA and wait 5 years, the money is accessible--is that correct?

You don't even need to wait five years. The five-year waiting period for withdrawing the principal from Roth conversions only applies to the part you paid tax on at the time of conversion. Any amount that was already post-tax when you converted it comes out free at any time. Especially with your automatic conversions, the pre-tax amount should be trivial and not worth worrying about.

Quote
Can I also access money out of the Roth 401(k) in the same manner or not?

No, you would probably want to roll it into your Roth IRA first before starting early withdrawals.

When you withdraw directly from a Roth 401(k), each withdrawal is prorated between your contributions and your earnings. You'll pay tax at your regular bracket plus 10% for the earnings part.

In a Roth IRA the withdrawals are ordered in a way that is probably more favorable to most early retirees. All the contributions come out first. No tax on these. Roth conversions come out next*, and finally the earnings. This allows you to wait on withdrawing any of the earnings until after you've exhausted all the money that can be withdrawn tax-free at any age. Hopefully this happens after you hit a standard retirement age so you don't pay any tax on this bit either.

* Note that this second bucket (Roth conversions) only applies to amounts that you converted directly from your pre-tax retirement accounts into your Roth IRA. For amounts you converted to Roth within your 401(k) and then later rolled into your Roth IRA, the regulations of 26 CFR § 1.408A-10 (https://www.law.cornell.edu/cfr/text/26/1.408A-10) provide that the full amount of such conversions will go into the contributions bucket of the Roth IRA. Before you think of using this as an end-run around the five-year waiting period for withdrawing Roth conversions of pre-tax funds, don't. There's a special recapture rule (https://www.irs.gov/retirement-plans/retirement-plans-faqs-on-designated-roth-accounts#irr12) designed to prevent this.
Title: Re: Investment Order Question---mega backdoor Roth
Post by: icyappraiser on August 13, 2019, 04:11:24 PM
Thanks for the explanation. So if I just convert it to ROTH 401(k) now, can I later convert it to ROTH IRA and withdraw it without a 10% penalty with no waiting period (at least the contributions?) Or would I have to wait five year from that rollover?
Title: Re: Investment Order Question---mega backdoor Roth
Post by: seattlecyclone on August 13, 2019, 06:12:15 PM
The relevant date is when you do the conversion within your 401(k). The rollover to your IRA doesn't restart that clock.

Again, remember that this five-year waiting period only applies to the amount you paid tax on during the Roth conversion transaction. This amount should be minimal. The bulk of your principal was already post-tax when you converted it and can therefore be freely withdrawn at any time.