My understanding with the aftertax contributions is that you can't choose to withdraw JUST the contributions and leave the pretax earnings alone, you have to also transfer them.
I believe this is correct. My understanding is that you can't leave the earnings in the 401(k), you have to take it all out in one form or another.
For most that would mean a traditional rollover IRA, although I guess transfer to another eligible account like another 401k is possible. However, now I will have a tIRA with pretax dollars, which will limit the backdoor Roth benefit.
Yes, if you are averse to paying any tax at the time of the conversion, you would have to split the earnings off into a traditional IRA. Then you would have pre-tax money in your IRA, which would also be a problem for doing a backdoor Roth IRA if you are still averse to paying any tax on the conversion. But if you do these after-tax conversions fairly frequently (quarterly should be more than enough), the amount of accumulated earnings should be relatively minimal (maybe a few percent). Why not just convert the whole thing to your Roth IRA directly and pay a few dollars of extra tax?
Suppose you make $5k of after-tax contributions each quarter. Suppose the stock market is doing great, growing 5% quarter over quarter. When you do your rollover at the end of the quarter, you'll have $5,000 of principal and about $125 of earnings (half of 5% since the average dollar in the account was only in the account for half the quarter). If you're in the 25% tax bracket, you'll pay an extra $125 in taxes over the course of the year (0.6% of the amount rolled over) by just rolling over the whole sum. That's in a really good year for the market. Most years you'll pay less. In exchange, you get an extra $500 of money in your Roth IRA to grow tax-free forever, do less paperwork on your rollovers, and leave the possibility of a backdoor Roth IRA open.
1) You can either go through the hassle of immediately transferring your aftertax contributions to a Roth everytime you make a contribution as brooklynguy suggests
This would work. I do conversions after every paycheck because my employer's plan lets me do these rollovers online with a few clicks. If I had to call someone on the phone or mail in a paper form, I would likely do it no more than quarterly.
2) have the aftertax placed in a money-market type fund that will earn no earnings until you've accumulated enough over several months say to make it worthwhile to transfer.
I guess you could do this, but why? You're giving up potential growth on your money just to avoid the possibility of owing tax on that growth. Unless your marginal tax rate is higher than 100%, this is a bad idea.
A third option would be to get rid of the tIRA the same way many of us do once we discover the backdoor Roth, by rolling it into the 401k. I did that once, was a huge hassle. Does anyone know of have any experience with being able to transfer the pretax earnings from the aftertax "subaccount" directly into your pretax "elective deferral subaccount" of the 401k? In other words, when making a withdrawal of the aftertax portion of your traditional 401k, can you designate that the contribution or basis go to this Roth IRA, and the earnings go back into the 401k but on the pretax side?
My understanding is that the new IRS guidance only applies to 401(k) -> IRA conversions. So you would have to move the money through the traditional IRA and then roll it back into the 401(k). I could be wrong on this point. Again, if you want to go through even more paperwork (to not only split your conversion between two IRAs but then to roll the traditional portion back into the 401(k)) just to save a little bit of tax, be my guest.