Author Topic: Mega Backdoor Roth implementation question  (Read 5619 times)

Mister Fancypants

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Mega Backdoor Roth implementation question
« on: November 14, 2014, 01:48:21 PM »
I original posted this in "Ask a Mustachian"  http://forum.mrmoneymustache.com/ask-a-mustachian/mega-backdoor-roth-mplementation-question/

No one replied so I thought maybe it belongs here... so I thought I would repost and give it another shot...

So my company allows "Employee Voluntary Contributions" of up to 10% of your salary with a cap of $25k. They allow in-service distributions as frequently as daily and since the money is after tax it is 100% vested upon contribution.

My 401(k) is managed by Fidelity and my Roth IRA is also at Fidelity, I spoke with Fidelity, they can't automate the transfer from the "After Tax Account" to my Roth it requires a phone call.

So here are my questions, first since the "After Tax Account" will look just like my 401(k) the deposit will have to be invested it can't remain in cash, so there will be at least a single days change in value Gain/Lose between the pay day when it id deposited and assuming I call Fidelity every pay day and instruct them to transfer the funds, how are those G/L going to impact the rollover? And there will times it takes longer than a day vacations, business trips... Just life getting in the way etc..

My second question, since the Fidelity website restricts the percent to 10% and they only see net pay the amount that can actually get contributed gets skewed by other withholdings like medical deductions, 401(k) and taxes etc... Now taxes is the only one that is really controllable lets say for argument sake a gross pay check is $5,000 and after all deductions net pay becomes $3,500 the after tax contribution allowable would only be $350, Could you adjust your withholdings so your net paycheck is now $4,000 you can contribute $400 and pay an additional $500 per paycheck quarterly to prevent the IRS from penalizing you. Would that work?

I have to look at the Fidelity interface and see if there is a flat dollar amount per paycheck that can be contributed, that would solve problem number 2, then the employer payroll would cut it off at 10% of gross is my guess which would be higher and most bang for your buck. I need to speak to HR/Payroll about that. The difference between 10% of net vs. 10% of gross is a lot.

Thanks in advance,
-Mister FancyPants

brooklynguy

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Re: Mega Backdoor Roth implementation question
« Reply #1 on: November 14, 2014, 03:12:58 PM »
With respect to your first question, the short term change in value should not be a deterrent.  If there is a small gain, that tiny amount of earnings will be subject to tax/penalties.  No big deal.  (If there is a small loss, there won't be any earnings, and it's no different than a rollover of all contributions/principal.)

But what do you mean "will look just like my 401(k)"?  Does your 401(k) plan have a segregated subaccount for the after-tax portion?  It is possible that you have the option of electing a different investment method for the after-tax portion, in which case you could elect a money market fund to avoid gains (but there's really no reason to -- you still come out ahead with some small gains that are taxed/penalized).

With respect to your second question, are you sure the 10% cap applies on a per-paycheck basis (rather than an aggregate cap of 10% of your annual salary)?

brooklynguy

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Re: Mega Backdoor Roth implementation question
« Reply #2 on: November 14, 2014, 03:22:34 PM »
For the sake of comprehensiveness, I should have also noted that the new IRS guidance also allows you to separately roll the earnings into a traditional IRA instead of a Roth IRA (which would allow you to continue to defer taxes on the earnings).  But that's really only worth doing if you don't have the ability to do near-immediate in-service rollovers, when earnings can build up to a meaningful amount.  (Plus your 401(k) administrator may not have implemented the guidance yet.)

sol

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Re: Mega Backdoor Roth implementation question
« Reply #3 on: November 14, 2014, 03:25:00 PM »
I haven't actually done this, so take my advice with a grain of salt.

My understanding is that short term gains or losses on after-tax 401k contributions incurred between payday and rollover day are pretty easy to manage.  Gains would have to get transferred to a traditional IRA instea of a Roth.  Losses are losses, they're gone.  I'd consider checking the share prices for whatever investment you have so that you can be sure to only transfer out the amount equal to that paycheck's after-tax contribution.

Regarding the 10% penalty, I'd call your department to verify.  Most places, percent caps on contributions are based on gross pay per paycheck, not annual pay and not net pay after withholdings.  Failing that, I'd ask for the fixed dollar amount contribution per paycheck and if it's an annual cap (unlikely) you can always fine tune the amount towards the end of the year to hit your cap without going over.


Mister Fancypants

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Re: Mega Backdoor Roth implementation question
« Reply #4 on: November 14, 2014, 03:33:33 PM »
With respect to your first question, the short term change in value should not be a deterrent.  If there is a small gain, that tiny amount of earnings will be subject to tax/penalties.  No big deal.  (If there is a small loss, there won't be any earnings, and it's no different than a rollover of all contributions/principal.)

But what do you mean "will look just like my 401(k)"?  Does your 401(k) plan have a segregated subaccount for the after-tax portion?  It is possible that you have the option of electing a different investment method for the after-tax portion, in which case you could elect a money market fund to avoid gains (but there's really no reason to -- you still come out ahead with some small gains that are taxed/penalized).

With respect to your second question, are you sure the 10% cap applies on a per-paycheck basis (rather than an aggregate cap of 10% of your annual salary)?

By no means is the gains/lose a deterrent, I just wasn't sure what the implications were... The biggest deterrent is the twice a month phone call to Fidelity to roll over the funds. But that won't be a that big a deal all things being a equal.

So basically treat any gains as a short term  gain and apply the 10% early withdrawal penalty on the gains which of course will be minimal.

As far as looking like my 401(k), I meant the investment options will match my 401(k) investment options so I will have to invest in something, I just checked there is a money market fund so I can avoid G/L by directing the investments there for that account, I can pretty much leave the money there and do rollover when the money accrues monthly avoid the G/L and make 12 rollovers a year instead of 24.

I spoke with HR, the 10% cap is tied to eligible pay, but the math is fuzzy, however if you do a $ amount contribution it is just tied to the plan limit and not percent of salary. So I can do the full $25k regardless of percent of salary. Payroll will just cut it off if you get to that limit. In 2015 the limit is going up to $30k.

I'm excited about being able to put a lot more money in a Roth... this has been cut off to us for a while...  Not sure how much I am going to put... but this will be a nice bump up in the tax free savings accounts.

Mister Fancypants

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Re: Mega Backdoor Roth implementation question
« Reply #5 on: November 14, 2014, 03:37:23 PM »
For the sake of comprehensiveness, I should have also noted that the new IRS guidance also allows you to separately roll the earnings into a traditional IRA instead of a Roth IRA (which would allow you to continue to defer taxes on the earnings).  But that's really only worth doing if you don't have the ability to do near-immediate in-service rollovers, when earnings can build up to a meaningful amount.  (Plus your 401(k) administrator may not have implemented the guidance yet.)

Everything is handled by Fidelity all my accounts are there... the 401(k) TIRA and Roth IRA so they could do a split between earnings and contributions if that makes sense, perhaps I will let the money sit in the account and do rollovers every 3 or 6 months and just split the earnings and contributions between both IRA's.

Mister Fancypants

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Re: Mega Backdoor Roth implementation question
« Reply #6 on: November 14, 2014, 03:41:43 PM »
I haven't actually done this, so take my advice with a grain of salt.

My understanding is that short term gains or losses on after-tax 401k contributions incurred between payday and rollover day are pretty easy to manage.  Gains would have to get transferred to a traditional IRA instea of a Roth.  Losses are losses, they're gone.  I'd consider checking the share prices for whatever investment you have so that you can be sure to only transfer out the amount equal to that paycheck's after-tax contribution.

Regarding the 10% penalty, I'd call your department to verify.  Most places, percent caps on contributions are based on gross pay per paycheck, not annual pay and not net pay after withholdings.  Failing that, I'd ask for the fixed dollar amount contribution per paycheck and if it's an annual cap (unlikely) you can always fine tune the amount towards the end of the year to hit your cap without going over.

After reaching out to HR I realized the $ amount makes more sense as it is plan year based and not salary based. The Fidelity rep is who told me they use net pay since it is after tax for the 10% calc, my guess is that was wrong, I think payroll would use gross... However the percentage is more limiting and has become moot.

I am going to start this in 2015... so I have a month to plan out my exact amounts...

seattlecyclone

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Re: Mega Backdoor Roth implementation question
« Reply #7 on: November 14, 2014, 03:43:42 PM »
So here are my questions, first since the "After Tax Account" will look just like my 401(k) the deposit will have to be invested it can't remain in cash, so there will be at least a single days change in value Gain/Lose between the pay day when it id deposited and assuming I call Fidelity every pay day and instruct them to transfer the funds, how are those G/L going to impact the rollover? And there will times it takes longer than a day vacations, business trips... Just life getting in the way etc..

You should be able to roll over the entire amount in the after-tax sub-account, contributions and earnings alike. Vanguard does this for me and Fidelity should be able to as well.

This is my first year doing these after-tax-to-Roth conversions, so I haven't gotten the tax forms yet. The way it's supposed to work is that Fidelity should keep track of the total amount rolled over throughout the year, as well as what portion of that rollover was after-tax contributions versus earnings. They will send you a Form 1099-R early next year. Box 1 (gross distribution) should be equal to the sum of all your rollovers throughout the year. Box 5 should be equal to the after-tax contribution portion of your rollover, and Box 2a (taxable amount) should be equal to the taxable earnings portion of the rollover. Box 2a should also be equal to the difference between Box 1 and Box 5.

On your tax return, you report the amount in Box 1 on Line 16a of Form 1040, and the taxable amount is reported on Line 16b (source: page 30-31 of Publication 575).

brooklynguy

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Re: Mega Backdoor Roth implementation question
« Reply #8 on: November 14, 2014, 03:47:54 PM »
Everything is handled by Fidelity all my accounts are there... the 401(k) TIRA and Roth IRA so they could do a split between earnings and contributions if that makes sense, perhaps I will let the money sit in the account and do rollovers every 3 or 6 months and just split the earnings and contributions between both IRA's.

You may want to read through the extended discussion in the main post on this topic for the pros and cons of letting the money sit in the account and doing split rollovers vs. getting it into the Roth immediately (the link is below; look at all the most recent back-and-forth near the end).  If you are going to continue to lead a Fancypants lifestyle post-retirement, you're probably better off getting the funds into the Roth as fast as you can.

http://forum.mrmoneymustache.com/investor-alley/did-the-irs-just-give-an-extra-$35kyr-of-tax-free-growth-saving-space/50/


medinme

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Re: Mega Backdoor Roth implementation question
« Reply #9 on: November 16, 2014, 10:43:24 AM »
I haven't actually done this, so take my advice with a grain of salt.

My understanding is that short term gains or losses on after-tax 401k contributions incurred between payday and rollover day are pretty easy to manage.  Gains would have to get transferred to a traditional IRA instea of a Roth.  Losses are losses, they're gone.  I'd consider checking the share prices for whatever investment you have so that you can be sure to only transfer out the amount equal to that paycheck's after-tax contribution.


I did this about a month ago - Fidelity transferred the after tax contributions to Roth IRA and the Gains to Traditional IRA.  Unlike Trad IRA to Roth conversions there are no recharacterizations so there is no way to undo if you transfer and it loses value.  Truthfully it only makes sense to do this after maxing out IRA and 401K though. 1st half of the year I frontloaded the  401K leaving enough in 401K to take advantage of the company match. Then maxed 1RA and spouse Sep IRA's.  I am now using the last 1/2 year to max out after tax contributions- performing a conversion every 3 months- keep in mind the 52K maximum also includes company match in addition to 401K contributions.

It is best to check with your 401K plan administrator to see if there is a cap on in service rollovers per year.  My company only allows 2/year so I split it up in 3month increments to limit the impact of gains.. 


Mister Fancypants

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Re: Mega Backdoor Roth implementation question
« Reply #10 on: November 17, 2014, 10:55:21 AM »
Everything is handled by Fidelity all my accounts are there... the 401(k) TIRA and Roth IRA so they could do a split between earnings and contributions if that makes sense, perhaps I will let the money sit in the account and do rollovers every 3 or 6 months and just split the earnings and contributions between both IRA's.

You may want to read through the extended discussion in the main post on this topic for the pros and cons of letting the money sit in the account and doing split rollovers vs. getting it into the Roth immediately (the link is below; look at all the most recent back-and-forth near the end).  If you are going to continue to lead a Fancypants lifestyle post-retirement, you're probably better off getting the funds into the Roth as fast as you can.

http://forum.mrmoneymustache.com/investor-alley/did-the-irs-just-give-an-extra-$35kyr-of-tax-free-growth-saving-space/50/

@brooklynguy thanks for the link... I read every post in the thread this weekend :)

Lots of good info.

@seattlecyclone thanks for the IRS Publication info, always good to be able to the source of the information.

So here are a few questions for you guys and anyone else reading...

I have just over half a million in TIRA/401k's now (wife and I combined), I max out my annual pre-tax contributions annually plus I get and employer match of 25% of my contributions (amd 2/3rds vested, last 1/3 vests in June). My wife gets about $6k annually deposited in a 403(b) from an insurance payment, the account is fully vested so we roll it over to a TIRA annually. I am able to make an annual spousal contribution in my wife's name to her TIRA since the insurance contribution is not reported as a plan participation and she is considered a non-working spouse. So in total annually we put add about $35k to tax deferred accounts.

Based on how my company pays out bonuses sometimes it is 12/31, other years it is 1/31 of the next year depending on what is more advantageous tax wise (generally to them, although with the fiscal cliff they paid early in favor of the employees). So on years where my bonus doubles in one year and I don't get one in another year I can make a Roth Contribution.... That doesn't happen too often...

We have a combined total of about $50k in Roth IRA savings and several hundred thousand in taxable accounts.

I can contribute flat dollar amounts (up to $30k in plan year 2015, not sure to what extent I will contribute) after tax into my 401(k) invest it into a money market fund, and immediately roll them over to a Roth IRA every pay check with no limits or fees (I can do the roll over online so it doesn't even require a phone call). I will have no G/L, I will have already maxed out the pre-tax investing options available to me, I have substantial taxable accounts already.

I do not have access to traditional back door Roth funding since I have substantial TIRA assets and am in a high tax bracket.

I am 38 and I plan on retiring somewhere between 48 and 50, I am more concerned with having the ability to roll over all of my TIRA to Roth before RMD's then I am with funding any years of retirement.

To me this seems like a great opportunity to load up the Roth instead of further loading taxable accounts (I will still invest here as well over time).

Am I missing something that should make me want to invest in taxable accounts vs. the Roth mega back door? Based on my account dynamics would you suggest a different rollover strategy then immediate etc..

Thanks,
-Mister FancyPants

brooklynguy

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Re: Mega Backdoor Roth implementation question
« Reply #11 on: November 17, 2014, 12:53:49 PM »
The only downside to doing the mega backdoor Roth instead of taxable investing is the loss of unfettered access to the earnings.  But of course with the mega backdoor Roth you get the benefit of tax avoidance on the earnings.  So it's purely a trade-off between those two factors.  Unless you need to access the earnings before traditional retirement age (and it sounds like you don't), I don't see any reason not to do the mega back door Roth.  (And even someone who does need to access the earnings before traditional retirement age could still be better off using the mega back door Roth to shelter the earnings from taxes between now and retirement (and paying penalties on the withdrawals), depending on the tax efficiency of their investments and on the difference between their tax bracket between pre- and post-retirement.)

Personally, I'm doing the mega backdoor Roth even though I don't expect it to have much of a benefit for me (at least at the federal tax level -- it may be worth my while for state and city tax purposes, and since you are also in NYC, that's another big factor to consider -- plus there's the protection it provides against changes in tax laws), because I don't see any reason not to do it over taxable investing if you don't need access to the earnings immediately upon retirement.  Like the Mad Fientist, my rule of thumb philosophy is to take whatever upfront tax breaks I can get, and then I'll figure out how to access the money later.

Also, immediate in-service withdrawals do sound like the best rollover strategy for your situation.

Mister Fancypants

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Re: Mega Backdoor Roth implementation question
« Reply #12 on: November 17, 2014, 01:07:03 PM »
The only downside to doing the mega backdoor Roth instead of taxable investing is the loss of unfettered access to the earnings.  But of course with the mega backdoor Roth you get the benefit of tax avoidance on the earnings.  So it's purely a trade-off between those two factors.  Unless you need to access the earnings before traditional retirement age (and it sounds like you don't), I don't see any reason not to do the mega back door Roth.  (And even someone who does need to access the earnings before traditional retirement age could still be better off using the mega back door Roth to shelter the earnings from taxes between now and retirement (and paying penalties on the withdrawals), depending on the tax efficiency of their investments and on the difference between their tax bracket between pre- and post-retirement.)

That is pretty much how I saw it from the downside perspective as only losing access to the assets until 59 1/2 which is not really a concern. However I do see a lot more upside than just avoiding taxes on the investments between now and retirement.

I do believe I will be in a lower income bracket in the future when I stop working a full time job, however I think my tax bracket will not necessarily be much lower as the government is going to eventually have to deal with their deficits and taxes will go up. I am hopeful that whatever laws are changed will not effect the grandfathered rules of already contributed Roth contributions. So I want as much money in the completely tax free domain as I can get before the government decides to change rules. Now I could be wrong and taxes could stay low, but I wouldn't bet on that. I hope I am wrong. 

Personally, I'm doing the mega backdoor Roth even though I don't expect it to have much of a benefit for me (at least at the federal tax level -- it may be worth my while for state and city tax purposes, and since you are also in NYC, that's another big factor to consider -- plus there's the protection it provides against changes in tax laws), because I don't see any reason not to do it over taxable investing if you don't need access to the earnings immediately upon retirement.  Like the Mad Fientist, my rule of thumb philosophy is to take whatever upfront tax breaks I can get, and then I'll figure out how to access the money later.

NY State here, I work in the city, but don't live there so I don't get hit with the local taxes. My last statements of the last paragraph pretty much fit here too... Take the tax break now and figure out how to use it later.

Also, immediate in-service withdrawals do sound like the best rollover strategy for your situation.

Thanks I thought this made the most sense.

brooklynguy

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Re: Mega Backdoor Roth implementation question
« Reply #13 on: November 17, 2014, 01:20:15 PM »
However I do see a lot more upside than just avoiding taxes on the investments between now and retirement.

Yes, as long as you're not going to access the earnings before traditional retirement age, the tax benefit you get is complete tax avoidance on the earnings.  But my point was that for someone who will be accessing the earnings and paying their marginal tax rate plus the penalty, the only benefit will be tax deferral on the earnings between now and retirement.  And someone who will be paying zero taxes in retirement anyway (like some frugal mustachians) will be in an equivalent situation, because they don't benefit from the tax avoidance beyond the deferral of taxes on the earnings while working.

Mister Fancypants

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Re: Mega Backdoor Roth implementation question
« Reply #14 on: November 17, 2014, 01:39:55 PM »
However I do see a lot more upside than just avoiding taxes on the investments between now and retirement.

Yes, as long as you're not going to access the earnings before traditional retirement age, the tax benefit you get is complete tax avoidance on the earnings.  But my point was that for someone who will be accessing the earnings and paying their marginal tax rate plus the penalty, the only benefit will be tax deferral on the earnings between now and retirement.  And someone who will be paying zero taxes in retirement anyway (like some frugal mustachians) will be in an equivalent situation, because they don't benefit from the tax avoidance beyond the deferral of taxes on the earnings while working.

Touché... I was just thinking of my own particular situation... But yes I agree if you are going to access it early...

We are frugal for our income/net worth, but by no means would most mustachians consider our spending levels or lifestyle frugal.

Thanks again for the feedback!