The Money Mustache Community
Learning, Sharing, and Teaching => Investor Alley => Topic started by: Cornel_Westside on March 16, 2017, 10:03:36 PM
-
Hi guys, it looks like I'll be able to do a Mega Backdoor Roth at my job and therefore have all my investment contributions in tax-advantaged accounts. That's great, but this mega backdoor stuff is complicated and I have questions. The main issue is to do with my Traditional IRA. I have some that is a rollover from a previous 401(k) and I am not sure how it affects this stuff.
From what I understand, the main reason that this guide(http://thecollegeinvestor.com/17561/understanding-the-mega-backdoor-roth-ira/ (http://thecollegeinvestor.com/17561/understanding-the-mega-backdoor-roth-ira/)) suggests eliminating your existing tIRA is to eliminate tax complications. I'm not sure what the issue is or why that is important. From what I understand, I can take my after-tax contributions to my 401(k) and make distributions or roll it over directly to my Roth IRA. The earnings from the time between the contribution and the rollover will need to be taxed to put it into my Roth IRA, but that's fine. I wouldn't want to take the option of putting the earnings into a Traditional IRA to avoid taxes on it as I assume this is where the tax complexities come in.
Does this method avoid the tax complications that the guide references? If my understanding is correct, the Traditional IRA will not be involved at all, so it shouldn't subject those funds to taxation. Is there something I'm missing? From what I understand, paying taxes on the earnings will simply involve getting an additional 1099 from the receiving Roth IRA institution and I simply treat it as income and it is taxed as such. Is that very hard?
If I have to move my tIRA funds into my 401(k) (reverse rollover), is there any tax complications with that as well?
-
FYI that College Investor article is entirely wrong on the mechanics of the mega backdoor Roth. Mad Fientist has a great article about how this works (http://www.madfientist.com/after-tax-contributions/) in an FI context.
A balance in a traditional IRA complicates a normal backdoor Roth contribution (which goes through a traditional IRA and is subject to the pro-rata rule). It does not affect a mega backdoor Roth contribution, which goes through an after-tax non-Roth 401k subaccount. When you roll your after-tax non-Roth 401k contributions over, you can direct your 401k custodian to split the earnings and the contributions into two separate checks. The earnings would go into a Traditional IRA and the contributions into a Roth IRA.
You don't have to do that, however. You can just pay the tax on the earnings when you withdraw from the Roth. If your after-tax non-Roth contributions only sit for a month or a year in a money market fund before you roll them into your Roth IRA then it's no big deal.
-
You don't have to do that, however. You can just pay the tax on the earnings when you withdraw from the Roth. If your after-tax non-Roth contributions only sit for a month or a year in a money market fund before you roll them into your Roth IRA then it's no big deal.
If you don't split the balance, you'll owe tax on the earnings when you move it to the Roth, not when you withdraw from the Roth. But you're right that doing the conversion shortly after you're paid will minimize any such taxable earnings, which minimizes any reason to mess around with splitting it up. It's also true that traditional IRA balances are completely irrelevant for the mega backdoor Roth; you only need to consider this for the non-mega backdoor Roth.
-
Thanks for the responses! So since I am Roth-eligible with my salary, I don't need to do a backdoor roth, just a mega-backdoor. So I should be clear to do that without touching my Traditional IRA. I'm glad I came to you guys.
I may only be able to make one annual distribution so there may be a decent amount of earnings to pay tax on, so it may be worth it to distribute that money to my tIRA separately.