Author Topic: Isn't one point of the backdoor roth to get around maximums?  (Read 6653 times)

catccc

  • Handlebar Stache
  • *****
  • Posts: 1684
  • Location: SE PA
catccc, you can't have both a Roth and a backdoor roth in the same year.  They are both IRA's, and each person can contribute a max of $5,500 to one IRA a year.

I just saw this response to my post in another topic that is kinda old now (from Jan 2014).  Thought I'd start a new topic to address it since the aforementioned thread is so old.

Background, this was a "2014 Financial Goals" topic in the Gauntlet section of the forums.  I was saying that one of my 2014 financial goals was to max out my retirement funds (Roth and 401K) and also get as much into the backdoor roth as possible. 

I don't understand this response, I thought the 401K after-tax contribution and rollover to a roth (the backdoor) was a strategy specifically designed to circumvent the max?

I can't actually put anything new in the backdoor anymore.  My new employer (started in March) doesn't allow after-tax 401K contributions.  But with my previous employer, I got a piddly amount of after tax contributions in before leaving.  The plan is to roll over the pre-tax portion of the old 401K into a traditional roth, and roll the after-tax portion of the old 401K into a Roth. 

I haven't actually gotten around to doing this yet, but was going to give Vanguard a call next week to get this done.  I'm going to hold off until I get more feedback.  Everything I've read points to this being a go, but I want additional feedback that I've got it all straight before I pull the trigger.
« Last Edit: June 27, 2014, 07:59:51 PM by catccc »

MDM

  • Walrus Stache
  • *******
  • Posts: 9791
Re: Isn't one point of the backdoor roth to get around maximums?
« Reply #1 on: June 27, 2014, 08:16:24 PM »
There are multiple maximums at play.  See http://www.bogleheads.org/wiki/Backdoor_Roth_IRA: "A Backdoor Roth IRA is a technique for contributing to a Roth IRA when your income exceeds the contribution limit."

For IRAs, you still have the maximum total annual amount you can contribute, $5500.

The above limits refer to adding new money to IRAs.  401k rollovers to IRAs, and whatever Roth conversions you may want to do with those, are separate - except the tax treatment of any conversions looks at all your tIRA holdings.  Clear?  Clear as mud?  If the latter, try posting a specific "what if...?" including numbers (you can use real or fake), along with your best guess at the answer.

catccc

  • Handlebar Stache
  • *****
  • Posts: 1684
  • Location: SE PA
Re: Isn't one point of the backdoor roth to get around maximums?
« Reply #2 on: June 27, 2014, 08:21:37 PM »
I think it's clear.  My conclusion is that I can do what I'm planning because it's a rollover, not a contribution to a Roth.

I guess Zaga thought I was contributing over 5.5K to IRA, but the reality is I'm only contribution 5.5K to the Roth.  I'm contributing in excess of that to a 401k that I'm rolling over into a Roth.  So I'm good.  I think.

milesdividendmd

  • Handlebar Stache
  • *****
  • Posts: 1913
  • Location: Portlandia
    • Miles Dividend MD
Isn't one point of the backdoor roth to get around maximums?
« Reply #3 on: June 27, 2014, 08:39:44 PM »
I believe you're confusing a couple of things here.

If you max out your contribution to your 401(k), you were still allowed to contribute an additional $5500 post tax to an IRA.

If you're below the income limit you can contribute this $5500 directly to a Roth IRA.

If you're above the income limit you can only contribute your $5500 plus tax to a traditional IRA.

But you can then convert your conventional IRA to a Roth IRA by paying taxes on your appreciation. If there is no appreciation then you pay no taxes. This is a "backdoor" Roth IRA.

You generally cannot contribute 401(k) money to a Roth IRA or any IRA for that fact until you leave your job.

catccc

  • Handlebar Stache
  • *****
  • Posts: 1684
  • Location: SE PA
Re: Isn't one point of the backdoor roth to get around maximums?
« Reply #4 on: June 27, 2014, 09:32:45 PM »
I believe you're confusing a couple of things here.

If you max out your contribution to your 401(k), you were still allowed to contribute an additional $5500 post tax to an IRA.

If you're below the income limit you can contribute this $5500 directly to a Roth IRA.

If you're above the income limit you can only contribute your $5500 plus tax to a traditional IRA.

But you can then convert your conventional IRA to a Roth IRA by paying taxes on your appreciation. If there is no appreciation then you pay no taxes. This is a "backdoor" Roth IRA.

You generally cannot contribute 401(k) money to a Roth IRA or any IRA for that fact until you leave your job.

I already understood the 1st 3 points. 

And yes, that's one "backdoor" roth, as a strategy to circumvent the income limits. 

Another strategy that is sometimes referred to as a backdoor Roth is to contribute after-tax money to your 401K, and if your company's plan allows in-service distributions, you can roll it over into a Roth (in the same year you've already contributed 5.5K to your roth and $17.5K pre-tax to your 401K!) w/o leaving the company.  I happen to have left my company, so that caveat doesn't apply.

And lastly (as I have learned here to be very careful with word selection) in your last statement, I suppose you mean "rollover" and not "contribute."
« Last Edit: June 27, 2014, 09:39:21 PM by catccc »

milesdividendmd

  • Handlebar Stache
  • *****
  • Posts: 1913
  • Location: Portlandia
    • Miles Dividend MD
Isn't one point of the backdoor roth to get around maximums?
« Reply #5 on: June 27, 2014, 09:41:10 PM »
ah then you are referring to the mega backdoor Roth.

That's a different (and unique) animal.

You should probably retitle the thread.

MDM

  • Walrus Stache
  • *******
  • Posts: 9791
Re: Isn't one point of the backdoor roth to get around maximums?
« Reply #6 on: June 27, 2014, 10:55:46 PM »
I don't understand this response, I thought the 401K after-tax contribution and rollover to a roth (the backdoor) was a strategy specifically designed to circumvent the max?
  Above is the question addressed in reply #1.

Quote
I can't actually put anything new in the backdoor anymore.  My new employer (started in March) doesn't allow after-tax 401K contributions.  But with my previous employer, I got a piddly amount of after tax contributions in before leaving.  The plan is to roll over the pre-tax portion of the old 401K into a traditional [rothIRA], and roll the after-tax portion of the old 401K into a Roth. 
I haven't actually gotten around to doing this yet, but was going to give Vanguard a call next week to get this done.  I'm going to hold off until I get more feedback.  Everything I've read points to this being a go, but I want additional feedback that I've got it all straight before I pull the trigger.
But now that I look closer, it seems the real question lies in the bolded statements above (with bracketed edit) - correct?  If so, then...the answer really does seem clear as mud.  See
http://moneyover55.about.com/od/401ks/fl/Can-I-Roll-After-Tax-401k-Funds-to-a-Roth-IRA.htm, and
http://www.marketwatch.com/story/rolling-after-tax-401k-money-into-a-roth-ira-2013-12-27, and from as recent as 1 week ago,
http://online.wsj.com/articles/what-to-do-when-your-401-k-includes-pretax-and-after-tax-contributions-1403470487

Unless something has transpired in the last week....

Undecided

  • Handlebar Stache
  • *****
  • Posts: 1088
Re: Isn't one point of the backdoor roth to get around maximums?
« Reply #7 on: June 27, 2014, 11:12:34 PM »
I believe you're confusing a couple of things here.

You generally cannot contribute 401(k) money to a Roth IRA or any IRA for that fact until you leave your job.

401(k) plans may permit in-service withdrawals. It may not be more common than not, but it's not unheard off, so I wouldn't write it off without checking the relevant plan.

milesdividendmd

  • Handlebar Stache
  • *****
  • Posts: 1913
  • Location: Portlandia
    • Miles Dividend MD
Re: Isn't one point of the backdoor roth to get around maximums?
« Reply #8 on: June 27, 2014, 11:28:08 PM »

I believe you're confusing a couple of things here.

You generally cannot contribute 401(k) money to a Roth IRA or any IRA for that fact until you leave your job.

401(k) plans may permit in-service withdrawals. It may not be more common than not, but it's not unheard off, so I wouldn't write it off without checking the relevant plan.

True, but you generally would not want to do this as you would have to pay taxes on the conversion.

The only real exception to this rule, is in the case of the mega backdoor Roth IRA, which is only possible if you have a 401(k) that allows you to

1. contribute after tax dollars after you have maxed out your pretax contributions (Ie you can contribute more than $17,500 in 2014).

And

2.  Allows in-service withdrawals.

In this case you could withdraw only your after-tax contributions and roll them into a Roth without having to pay tax.

This is a very rare combination of attributes for a 401(k) plan.

And to define terms this maneuver is known as the mega backdoor Roth IRA.

This is not a simple backdoor Roth IRA, in which you rollover post tax contributions from an IRA, directly into a Roth IRA.



Undecided

  • Handlebar Stache
  • *****
  • Posts: 1088
Re: Isn't one point of the backdoor roth to get around maximums?
« Reply #9 on: June 28, 2014, 09:32:13 AM »

I believe you're confusing a couple of things here.

You generally cannot contribute 401(k) money to a Roth IRA or any IRA for that fact until you leave your job.

401(k) plans may permit in-service withdrawals. It may not be more common than not, but it's not unheard off, so I wouldn't write it off without checking the relevant plan.

True, but you generally would not want to do this as you would have to pay taxes on the conversion.

The only real exception to this rule, is in the case of the mega backdoor Roth IRA, which is only possible if you have a 401(k) that allows you to

1. contribute after tax dollars after you have maxed out your pretax contributions (Ie you can contribute more than $17,500 in 2014).

And

2.  Allows in-service withdrawals.

In this case you could withdraw only your after-tax contributions and roll them into a Roth without having to pay tax.

This is a very rare combination of attributes for a 401(k) plan.

And to define terms this maneuver is known as the mega backdoor Roth IRA.

This is not a simple backdoor Roth IRA, in which you rollover post tax contributions from an IRA, directly into a Roth IRA.

Yes, I have these features in my 401(k) and have done this (and previously described my process here), and I value it, which is why I suggest that others check their plans rather than assume that they "generally cannot contribute 401(k) money to a Roth IRA or any IRA for that fact until you leave your job." I have never seen data on how common in-service withdrawals are (although I have seen that about 40% of plans permit after-tax contributions, in a Vanguard paper, I think).

catccc

  • Handlebar Stache
  • *****
  • Posts: 1684
  • Location: SE PA
Re: Isn't one point of the backdoor roth to get around maximums?
« Reply #10 on: June 28, 2014, 01:09:57 PM »
I have only heard it referred to as "mega backdoor roth" very recently, but the strategy had been discussed previously without this label... I guess I didn't know what to call it.  Or, I suppose there's a rollover backdoor to the roth...

I don't want to get too caught up in semantics here, but yes, essentially the moves I'm making match the "mega backdoor" method. 

IDK, I still think it is a reasonably advantageous method for most that plan on retiring early, esp. if the additional info from the vanguard rep I recently spoke to is correct.  I was told that when I roll this over into IRA, the after-tax contributions will go to the Roth IRA, and the pre-tax contributions and earnings AND the earnings on the after-tax contributions will roll into a traditional IRA...  If she is correct, than I've essentially circumvented both the IRA max (by the amount of the after tax contributions) and the 401K max (by the amount of earnings on the after tax contributions).  All in all it's a win-win.  Wish I had know about this strategy prior to Jan 2014, though, I would have dumped way more into that 401K.

milesdividendmd

  • Handlebar Stache
  • *****
  • Posts: 1913
  • Location: Portlandia
    • Miles Dividend MD
Re: Isn't one point of the backdoor roth to get around maximums?
« Reply #11 on: June 28, 2014, 04:26:31 PM »
You are absolutely right. It's a great strategy. I would use it too if I could!

rpr

  • Guest
Re: Isn't one point of the backdoor roth to get around maximums?
« Reply #12 on: June 28, 2014, 04:38:19 PM »

I have only heard it referred to as "mega backdoor roth" very recently, but the strategy had been discussed previously without this label... I guess I didn't know what to call it.  Or, I suppose there's a rollover backdoor to the roth...

I don't want to get too caught up in semantics here, but yes, essentially the moves I'm making match the "mega backdoor" method. 

IDK, I still think it is a reasonably advantageous method for most that plan on retiring early, esp. if the additional info from the vanguard rep I recently spoke to is correct.  I was told that when I roll this over into IRA, the after-tax contributions will go to the Roth IRA, and the pre-tax contributions and earnings AND the earnings on the after-tax contributions will roll into a traditional IRA...  If she is correct, than I've essentially circumvented both the IRA max (by the amount of the after tax contributions) and the 401K max (by the amount of earnings on the after tax contributions).  All in all it's a win-win.  Wish I had know about this strategy prior to Jan 2014, though, I would have dumped way more into that 401K.

If there is considerable accumulation in the pre tax 401k then it is better to keep it in the 401k or roll it over into the new employers 401k plan. This is because it will allow you to make regular back door Roth IRA contributions. This is my understanding.

catccc

  • Handlebar Stache
  • *****
  • Posts: 1684
  • Location: SE PA
Re: Isn't one point of the backdoor roth to get around maximums?
« Reply #13 on: June 29, 2014, 04:31:10 PM »
If there is considerable accumulation in the pre tax 401k then it is better to keep it in the 401k or roll it over into the new employers 401k plan. This is because it will allow you to make regular back door Roth IRA contributions. This is my understanding.

Not sure I follow on this one.  I'm planning on rolling the pre-tax 401K into a traditional IRA.  I want some of my investments to give me a tax benefit now (or, it did when I contributed pre-tax), and be taxable later, since essentially at very low income levels, you needn't pay taxes.  (at least at a federal level, there's a small "free pass" with the standard deduction and personal exemption.)  Am I missing something?

milesdividendmd

  • Handlebar Stache
  • *****
  • Posts: 1913
  • Location: Portlandia
    • Miles Dividend MD
Re: Isn't one point of the backdoor roth to get around maximums?
« Reply #14 on: June 29, 2014, 04:45:54 PM »
If there is considerable accumulation in the pre tax 401k then it is better to keep it in the 401k or roll it over into the new employers 401k plan. This is because it will allow you to make regular back door Roth IRA contributions. This is my understanding.

Not sure I follow on this one.  I'm planning on rolling the pre-tax 401K into a traditional IRA.  I want some of my investments to give me a tax benefit now (or, it did when I contributed pre-tax), and be taxable later, since essentially at very low income levels, you needn't pay taxes.  (at least at a federal level, there's a small "free pass" with the standard deduction and personal exemption.)  Am I missing something?

The point that RPR is making is that if for your mega backdoor IRA maneuver you roll over only your post-tax 401K contribution to a roth IRA instead of rolling over both your post tax 401K contribution into a Roth IRA AND your pretax 401K contribution into a traditional IRA, then you will still potentially be able to contribute an additional 5500/year into a backdoor Roth without triggering the pro-rata rule.


rpr

  • Guest
Re: Isn't one point of the backdoor roth to get around maximums?
« Reply #15 on: June 29, 2014, 07:51:59 PM »
Milesdividendmd -- thanks. You explained better.

Catccc -- The bottom line is that having assets in a traditional  IRA can complicate the back door Roth IRA due to the pro-rata rule.

catccc

  • Handlebar Stache
  • *****
  • Posts: 1684
  • Location: SE PA
Re: Isn't one point of the backdoor roth to get around maximums?
« Reply #16 on: June 30, 2014, 08:23:54 AM »
Milesdividendmd -- thanks. You explained better.

Catccc -- The bottom line is that having assets in a traditional  IRA can complicate the back door Roth IRA due to the pro-rata rule.

Well, thank you fellow forum members for pointing out this kind of stuff!  I had to google the pro-rata rule.  (Can you believe I'm a CPA?  But my career has been in corporate accounting...)

It sounds like it doesn't apply to my current scenario, but having a traditional IRA could affect me in the future, if I ever choose to convert from a traditional IRA to a Roth?  Have I got this right?

So far I only have my Roth IRA and my workplace 401K.  If I make this move I'm proposing, I'll have a traditional IRA, which could trigger pro-rata rules in the future.  If I'm going to do something like a Roth Pipeline in the future, would the pro-rata rule come into play?

I am hesitant to roll my old employer 401K to the new employer, because the old is with Vanguard, and the new is with Fidelity.  I could just leave it there, but (I realize this is kinda lame), but I want to move it so the unvested portion isn't shown in my balance.  There's about 7K unvested right now and I hate to see the number and know part of it isn't really mine...  Maybe I should just get over that...

If I have self-employment income on the side, can I open a solo 401K and roll the old 401K into that? 
« Last Edit: June 30, 2014, 08:28:04 AM by catccc »

brooklynguy

  • Handlebar Stache
  • *****
  • Posts: 2207
  • Age: 39
Re: Isn't one point of the backdoor roth to get around maximums?
« Reply #17 on: June 30, 2014, 12:09:58 PM »
After extensively researching this, it looks like there have been a few voices saying the tax treatment of this strategy is not entirely free from doubt.

See, for example, this discussion:

http://www.bogleheads.org/forum/viewtopic.php?f=1&t=137366

Does anyone here have any additional light to shed on whether:

(1) there might be a 401k analog to the pro rata rule for regular back door Roth conversions (i.e., if you have traditional 401k funds, the conversion of the after-tax account could be prorated across the entire 401k balance)?

(2) if you structure this as a direct rollover into a private Roth IRA, whether the pro rata rule is a problem if you have existing traditional IRA funds?

Thanks.

[Edit:  I'm posting the same question in the other active thread on this topic.]

4alpacas

  • Handlebar Stache
  • *****
  • Posts: 1896
Re: Isn't one point of the backdoor roth to get around maximums?
« Reply #18 on: June 30, 2014, 01:36:34 PM »
After extensively researching this, it looks like there have been a few voices saying the tax treatment of this strategy is not entirely free from doubt.

See, for example, this discussion:

http://www.bogleheads.org/forum/viewtopic.php?f=1&t=137366

Does anyone here have any additional light to shed on whether:

(1) there might be a 401k analog to the pro rata rule for regular back door Roth conversions (i.e., if you have traditional 401k funds, the conversion of the after-tax account could be prorated across the entire 401k balance)?

(2) if you structure this as a direct rollover into a private Roth IRA, whether the pro rata rule is a problem if you have existing traditional IRA funds?

Thanks.

[Edit:  I'm posting the same question in the other active thread on this topic.]
I've seen mention of it both ways.  Our tax accountant said the tax code isn't clear on the topic, so I'm hesitant. 

catccc

  • Handlebar Stache
  • *****
  • Posts: 1684
  • Location: SE PA
Re: Isn't one point of the backdoor roth to get around maximums?
« Reply #19 on: June 30, 2014, 03:30:53 PM »
Oh, eyes glazing over, the complexities are getting to be too much for me, specifically the pro-rata rule.  I'm going to call Vanguard about rolling over only the after-tax amount.  I'll leave the pre-tax portion where it is until I understand more clearly the ramifications of a move to a traditional roth...

I suppose besides the simplification of eliminating an account, there's no real advantage of putting the old Vanguard 401K into my new Fidelity 401K.

Undecided

  • Handlebar Stache
  • *****
  • Posts: 1088
Re: Isn't one point of the backdoor roth to get around maximums?
« Reply #20 on: June 30, 2014, 03:56:53 PM »
After extensively researching this, it looks like there have been a few voices saying the tax treatment of this strategy is not entirely free from doubt.

See, for example, this discussion:

http://www.bogleheads.org/forum/viewtopic.php?f=1&t=137366

Does anyone here have any additional light to shed on whether:

(1) there might be a 401k analog to the pro rata rule for regular back door Roth conversions (i.e., if you have traditional 401k funds, the conversion of the after-tax account could be prorated across the entire 401k balance)?

(2) if you structure this as a direct rollover into a private Roth IRA, whether the pro rata rule is a problem if you have existing traditional IRA funds?

Thanks.

[Edit:  I'm posting the same question in the other active thread on this topic.]

What do you mean, exactly, by "this strategy"? While that Boglehead discussion raises some valid concerns regarding some 401(k)-->Roth IRA transactions, I don't see anything that offers any specific basis to think that after-tax contributions and earnings (in a sub-account, which is how they're tracked at my 401(k)) can't be independently withdrawn. Perhaps the basis can't be isolated from the earnings, but that would be a minor problem if this is used well. For what it's worth, the distribution request form for my plan (managed by a major bank) permits two (non-hardship) in-service withdrawal options, one for anything in the plan, but available only after age 59.5 and the other available for "after-tax contributions and related earnings."

brooklynguy

  • Handlebar Stache
  • *****
  • Posts: 2207
  • Age: 39
Re: Isn't one point of the backdoor roth to get around maximums?
« Reply #21 on: June 30, 2014, 06:42:04 PM »
After extensively researching this, it looks like there have been a few voices saying the tax treatment of this strategy is not entirely free from doubt.

See, for example, this discussion:

http://www.bogleheads.org/forum/viewtopic.php?f=1&t=137366

Does anyone here have any additional light to shed on whether:

(1) there might be a 401k analog to the pro rata rule for regular back door Roth conversions (i.e., if you have traditional 401k funds, the conversion of the after-tax account could be prorated across the entire 401k balance)?

(2) if you structure this as a direct rollover into a private Roth IRA, whether the pro rata rule is a problem if you have existing traditional IRA funds?

Thanks.

[Edit:  I'm posting the same question in the other active thread on this topic.]

What do you mean, exactly, by "this strategy"? While that Boglehead discussion raises some valid concerns regarding some 401(k)-->Roth IRA transactions, I don't see anything that offers any specific basis to think that after-tax contributions and earnings (in a sub-account, which is how they're tracked at my 401(k)) can't be independently withdrawn. Perhaps the basis can't be isolated from the earnings, but that would be a minor problem if this is used well. For what it's worth, the distribution request form for my plan (managed by a major bank) permits two (non-hardship) in-service withdrawal options, one for anything in the plan, but available only after age 59.5 and the other available for "after-tax contributions and related earnings."

By "this strategy" I meant the "mega back door roth" where after-tax contributions to 401k plans meeting certain requirements can be converted into roth.  I originally posted the question in this thread (but pasted it into this one too because the conversation turned in that direction):

http://forum.mrmoneymustache.com/investor-alley/mega-backdoor-roth/

Looks like there are some recent good responses that I haven't had time to dig into yet.

Undecided

  • Handlebar Stache
  • *****
  • Posts: 1088
Re: Isn't one point of the backdoor roth to get around maximums?
« Reply #22 on: June 30, 2014, 07:38:55 PM »
After extensively researching this, it looks like there have been a few voices saying the tax treatment of this strategy is not entirely free from doubt.

See, for example, this discussion:

http://www.bogleheads.org/forum/viewtopic.php?f=1&t=137366

Does anyone here have any additional light to shed on whether:

(1) there might be a 401k analog to the pro rata rule for regular back door Roth conversions (i.e., if you have traditional 401k funds, the conversion of the after-tax account could be prorated across the entire 401k balance)?

(2) if you structure this as a direct rollover into a private Roth IRA, whether the pro rata rule is a problem if you have existing traditional IRA funds?

Thanks.

[Edit:  I'm posting the same question in the other active thread on this topic.]

What do you mean, exactly, by "this strategy"? While that Boglehead discussion raises some valid concerns regarding some 401(k)-->Roth IRA transactions, I don't see anything that offers any specific basis to think that after-tax contributions and earnings (in a sub-account, which is how they're tracked at my 401(k)) can't be independently withdrawn. Perhaps the basis can't be isolated from the earnings, but that would be a minor problem if this is used well. For what it's worth, the distribution request form for my plan (managed by a major bank) permits two (non-hardship) in-service withdrawal options, one for anything in the plan, but available only after age 59.5 and the other available for "after-tax contributions and related earnings."

By "this strategy" I meant the "mega back door roth" where after-tax contributions to 401k plans meeting certain requirements can be converted into roth.  I originally posted the question in this thread (but pasted it into this one too because the conversation turned in that direction):

http://forum.mrmoneymustache.com/investor-alley/mega-backdoor-roth/

Looks like there are some recent good responses that I haven't had time to dig into yet.

There are many variations, though, such that without nailing down those "certain requirements," you're not really talking about one single strategy. At a minimum, does the plan have a separate sub account for the after-tax contributions? Does the "strategy" accept paying taxes on the earnings that are distributed with the after-tax contributions? If "yes" to both of those questions, that's going to be the safest version to pursue.