Author Topic: Question about Mega Backdoor Roth - Read Newbie alert  (Read 4147 times)

Fire2025

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Question about Mega Backdoor Roth - Read Newbie alert
« on: January 02, 2016, 11:46:00 AM »
I think I put this in the wrong section before.  I was in the Ask a Mustachian, maybe the mods can fix my blunder and delete the other one, sorry and thank you.

My Corp allows post tax contributions and will assist with in-service withdrawals, so I would like to take this approach to adding to my Roth. 

I see a couple of advantages:
1.) as a newbie anything I can do to automate this system seems like the best approach for me, at this time.
2.) greater contribution amount that includes the tax advantages on gains.

My questions:
1.) Do I set up the pre-tax to run the whole 18,000 and then have the post tax go?  The reason would be to limit possible pre withdrawal gains and to limit the amount of withdrawals I make each year, for simplicities sake.  When I talked to the 401k admin I'm not sure they totally understood what I was asking(in their defense this could be me not knowing exactly what I'm talking about either) and so I would like to just do a one time transfer at the end of the year with gains going to IRA and post tax contributions going to the Roth. We are not looking at huge sums, I'm a median income earner, so gains should be tiny.
 
2.) or do I split the pre-tax and post-tax for each check and do the transfers quarterly, weather the admin is confident about this or not?

please forgive me if my use of terms and lingo is totally off, I'm very new to all of this.
« Last Edit: January 03, 2016, 12:50:18 PM by Fire2025 »

Yankuba

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Re: Question about back door Roth - Read Newbie alert
« Reply #1 on: January 02, 2016, 04:45:20 PM »
Yeah - I think you're off base. Or you're trying to do something I'm unfamiliar with.

A backdoor Roth is when high income people put $5500 into a non deductable traditional IRA and then exchange those assets into a Roth IRA the next day.

From what I skimmed in your message I think you're referring to the Roth 401k. I don't really understand what you're trying to do - either pick the Roth 401k, the traditional 401k, or do 50-50 (that's what I do). I don't know what transfers you plan on making.
« Last Edit: January 02, 2016, 04:49:21 PM by Yankuba »

MonkeyJenga

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Re: Question about back door Roth - Read Newbie alert
« Reply #2 on: January 02, 2016, 05:58:56 PM »
I don't know about the mechanics, since I don't have this option at work, but I think you first fill up pre-tax, then switch to after-tax. I don't think there's a lot of opportunity to automate, since, as you discovered, not many people are familiar with it. Even retirement plan administrators.

This is the article where I first read about it: http://www.madfientist.com/after-tax-contributions/

Boglehead's thread: https://www.bogleheads.org/forum/viewtopic.php?t=137366

Those links might have helpful info.

People tend to refer to this strategy as a Mega Backdoor Roth to distinguish it from the process Yankuba mentioned.

Yankuba

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Re: Question about back door Roth - Read Newbie alert
« Reply #3 on: January 02, 2016, 06:14:36 PM »
I don't know about the mechanics, since I don't have this option at work, but I think you first fill up pre-tax, then switch to after-tax. I don't think there's a lot of opportunity to automate, since, as you discovered, not many people are familiar with it. Even retirement plan administrators.

This is the article where I first read about it: http://www.madfientist.com/after-tax-contributions/

Boglehead's thread: https://www.bogleheads.org/forum/viewtopic.php?t=137366

Those links might have helpful info.

People tend to refer to this strategy as a Mega Backdoor Roth to distinguish it from the process Yankuba mentioned.

Ah, now it makes sense.

I'm not allowed to do the Mega Backdoor Roth so it wasn't in my wheelhouse.

Fire2025

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Re: Question about Mega Backdoor Roth - Read Newbie alert
« Reply #4 on: January 02, 2016, 06:53:25 PM »
Thank you both so much.  I learned about it on the Mad FIentist also, maybe I'll go back and re-read all the comments and see if this was answered.

My work has the option to contribute both Pre-Tax and Post- Tax percentages at the same time, or I can set the Pre-Tax amount and when the Pre-Tax maxes out it will automatically switch to post tax.  So I just got curious, if one way was better than the other.

I corrected the Subject, i hope, to say Mega.  I always wondered what the difference was. 

tjrssibelle

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Re: Question about back door Roth - Read Newbie alert
« Reply #5 on: January 02, 2016, 08:28:35 PM »
My work allow this with unlimited rollover withdrawals. Fidelity manages the plan so I opened a Roth IRA there to make the process easier. Last year I frontloaded the pre-tax portion since I didn't find out about the money market find until later. My contributions go to that fund, then every other week I'll make the withdrawal; so far, my gains have been about $0.01 out of one withdrawal because i wasn't fast enough to move the money. So look for a similar fund that would help minimize gains.

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Fire2025

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Re: Question about back door Roth - Read Newbie alert
« Reply #6 on: January 02, 2016, 08:39:49 PM »
My contributions go to that fund, then every other week I'll make the withdrawal; so far, my gains have been about $0.01 out of one withdrawal because i wasn't fast enough to move the money. So look for a similar fund that would help minimize gains.

The 401k admin I spoke to said I had to have two separate IRAs.  They would move the contribution to my Roth, but they would have to move the gains to a regular IRA.  Did you have to move your $.01 to a different account or did they let you but it in the Roth?

tjrssibelle

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Re: Question about back door Roth - Read Newbie alert
« Reply #7 on: January 03, 2016, 06:44:58 AM »
It went to the Roth, I chose to pay taxes on it

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Fire2025

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Re: Question about back door Roth - Read Newbie alert
« Reply #8 on: January 03, 2016, 10:35:04 AM »
It went to the Roth, I chose to pay taxes on it

Thanks.  I appreciate the info. 

I'd love to hear from someone who does it the other way (takes the pre-tax and post-tax at the same time) and why.  Just to get another take on this.

But I noticed I can't actually change the subject header on my thread, so maybe I need to start a new thread, asking about the "Mega Backdoor Roth".  poop.

Paul der Krake

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Re: Question about back door Roth - Read Newbie alert
« Reply #9 on: January 03, 2016, 10:48:25 AM »
I let the gains go to a traditional IRA, following the Mad Fientist's general advice that deferring taxes is better than paying them now. That's not the case for everyone, but it works for me. I intend on having rock bottom income in future years.

I will worry about converting in retirement when I have full control over my income and more time to iron out the tax details.

Fire2025

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Re: Question about back door Roth - Read Newbie alert
« Reply #10 on: January 03, 2016, 11:25:05 AM »
I let the gains go to a traditional IRA, following the Mad Fientist's general advice that deferring taxes is better than paying them now. That's not the case for everyone, but it works for me. I intend on having rock bottom income in future years.

I will worry about converting in retirement when I have full control over my income and more time to iron out the tax details.
Thanks Paul, I'm assuming a very very low tax rate in FIRE also so I think I will go with the tIRA also.  If you don't mind my asking, do you do all your Pre-tax first or to you do both types of contributions at the same time?

Paul der Krake

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Re: Question about back door Roth - Read Newbie alert
« Reply #11 on: January 03, 2016, 12:25:29 PM »
I let the gains go to a traditional IRA, following the Mad Fientist's general advice that deferring taxes is better than paying them now. That's not the case for everyone, but it works for me. I intend on having rock bottom income in future years.

I will worry about converting in retirement when I have full control over my income and more time to iron out the tax details.
Thanks Paul, I'm assuming a very very low tax rate in FIRE also so I think I will go with the tIRA also.  If you don't mind my asking, do you do all your Pre-tax first or to you do both types of contributions at the same time?
2016 is special for me because I am planning on leaving my employer around March, so this year I am putting everything in the after-tax portion to maximize this benefit that I am unlikely to have at my next job. I will fill up the $18,000 pre-tax bucket after switching jobs.

Last year however (2015), I did both contributions at the same time, up to the percentage of my paycheck that I am allowed to contribute. Note that I have it setup to have both types of contributions go into the same investment, a Vanguard target date fund. Front-loading one over the other doesn't offer any advantage unless you intend on jumping ship sometime during the year.

Paul der Krake

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Re: Question about back door Roth - Read Newbie alert
« Reply #12 on: January 03, 2016, 12:30:06 PM »
BTW, I outlined my front-loading strategy for 2016 in another thread a few months back. You may find it of interest:

http://forum.mrmoneymustache.com/taxes/timing-of-mega-backdoor-roth/

Paul | pdgessler

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Re: Question about back door Roth - Read Newbie alert
« Reply #13 on: January 03, 2016, 12:39:23 PM »
But I noticed I can't actually change the subject header on my thread, so maybe I need to start a new thread, asking about the "Mega Backdoor Roth".  poop.

FYI, you can edit the first post of the thread (click the "Modify" button) and change the thread title ("Subject" field) there if you want to.

Fire2025

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Re: Question about Mega Backdoor Roth - Read Newbie alert
« Reply #14 on: January 03, 2016, 12:50:56 PM »
FYI, you can edit the first post of the thread (click the "Modify" button) and change the thread title ("Subject" field) there if you want to.
Thanks got it!!!

MM_MG

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Re: Question about Mega Backdoor Roth - Read Newbie alert
« Reply #15 on: January 04, 2016, 10:28:30 AM »
Whether or not to front load to the 401K would depend on whether any Company match is contingent upon having a contribution each paycheck and whether there is a true up provision in the plan.  In my case I get the match on pre- and post- tax contributions and have a true up provision.  Therefore, I intend to front load the pre-tax contribution as much as I can and have the calculated post-tax amount equal throughout the year.  Mine is at Vanguard and the process of doing the conversion is a bit cumbersome, so I plan to do it twice a year or so.

4alpacas

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Re: Question about back door Roth - Read Newbie alert
« Reply #16 on: January 04, 2016, 10:43:09 AM »
It went to the Roth, I chose to pay taxes on it

Thanks.  I appreciate the info. 

I'd love to hear from someone who does it the other way (takes the pre-tax and post-tax at the same time) and why.  Just to get another take on this.
I do the front end max-out, but I could understand someone who would do pre and post at the same time.  The second half of the year (the part with post-tax removal) included paying an extra $800/month in taxes.  If you wanted a more consistent paycheck, the simultaneous contribution could make sense. 

Civex

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Re: Question about Mega Backdoor Roth - Read Newbie alert
« Reply #17 on: January 04, 2016, 03:17:17 PM »
It went to the Roth, I chose to pay taxes on it

Thanks.  I appreciate the info. 

I'd love to hear from someone who does it the other way (takes the pre-tax and post-tax at the same time) and why.  Just to get another take on this.

But I noticed I can't actually change the subject header on my thread, so maybe I need to start a new thread, asking about the "Mega Backdoor Roth".  poop.


You should take a look at the actual mechanics of withdrawing from your after tax account. In my case, the account will not let me withdraw the after tax amount without withdrawing all potential earnings, and when the account is rolled over, the money is not separated into pretax(earnings) and post tax. It is all one check, which is made out to Vanguard FBO Civex. There is a ledger (?) that comes with the check, that breaks down the post and pretax amounts.

I don't think this will be an issue because even though I'm only allowed quarterly withdrawals, my earnings were less than ~$100. I plan on making sure my accountant counts this as taxable investment income come tax time, and would doubt I will pay more than an extra $30 in taxes.

I would definitely read your plan paperwork very thoroughly, and make some calls to your plan. Some phone reps will have no idea what you are talking about, so you may have to try a few times. I also did a test run with ~$3500 after researching and calling Vanguard and my plan admin. Hopefully this is helpful, I think I understand what you are asking, and for me other people's examples help me understand. Good luck, the Mega Roth is a sweet deal!

msilenus

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Re: Question about back door Roth - Read Newbie alert
« Reply #18 on: January 04, 2016, 03:45:20 PM »
Thanks.  I appreciate the info. 

I'd love to hear from someone who does it the other way (takes the pre-tax and post-tax at the same time) and why.  Just to get another take on this.

But I noticed I can't actually change the subject header on my thread, so maybe I need to start a new thread, asking about the "Mega Backdoor Roth".  poop.

It's not clear if by "pretax" above you mean pretax contributions and/or gains, or gains on after-tax contributions.  Let's assume the latter.  (The prior doesn't make much sense for most people.)

Here's how I think it works:
1) You say you want to do an in-service withdrawal of your after-tax amount.  You probably want to do the full amount, and you probably don't want to touch pretax contributions + gains.  (As opposed to your aftertax contributions +gains.)  You are forced to take after-tax gains along with after-tax contributions.

2) You now have a choice of whether that money (which is all after-tax contributions and possibly gains on after-tax contributions) goes all into your Roth IRA creating a tax event for any gains, or if you want to split it up so basis goes into the Roth IRA and any gains go into the traditional IRA, avoiding the tax event.

The main reason to put it all in Roth is to keep your traditional IRA space empty.  This is advantageous if you also want to *also* do normal Roth backdoor conversions (with the $5.5k limit,) or might in future years.  If you have any untaxed money in any traditional IRA, then normal Roth backdoor conversions are taxable events.

Otherwise, it's likely optimal to split it up so the pretax money lands in your traditional IRA and you avoid the tax event.

One fine point: you might consider opening *separate* IRA accounts for receiving money from your 401(k).  The reason is that ERISA provides asset/bankruptcy protection to 401(k) money, which follows the money into IRAs.  That isn't a perk for IRA contributions in all states, and if you comingle, how much is protected becomes ambiguous.
« Last Edit: January 04, 2016, 03:48:02 PM by msilenus »

Fire2025

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Re: Question about Mega Backdoor Roth - Read Newbie alert
« Reply #19 on: January 04, 2016, 09:07:20 PM »
4alpacas, Civex, and Msilenus,
Thank you all so much for the information.

Civex, Thank you so much for pointing out the potential tax implications of front loading the pre-tax contributions.  Yes I may want to look at changing things up in the next few weeks to level the pay.  I keep things pretty bear bones so a big change in tax rate at the end of the year could really be unfortunate.  Thank you again for pointing this out!!

Msilenus, Yes I'm talking about pre tax and post tax contributions. 

I plan to move the post tax contributions along with the post tax gains into two separate accounts - The contributions will go to my Roth IRA and the Gains will go to my tIRA.  I spoke to the 401k representative and he got what I was asking, in the end, and said that they can do the inservice transfers but I have to move the whole post tax contribution amount each time and the post tax gains have to go also, but that they can split the gains off into a tIRA.

There is one thing I'm not sure I understand,
The main reason to put it all in Roth is to keep your traditional IRA space empty.  This is advantageous if you also want to *also* do normal Roth backdoor conversions (with the $5.5k limit,) or might in future years.  If you have any untaxed money in any traditional IRA, then normal Roth backdoor conversions are taxable events.

Otherwise, it's likely optimal to split it up so the pretax money lands in your traditional IRA and you avoid the tax event.
I think I'm reading, that I don't want to have any pre-tax money in my tIRA because this will cause trouble down the road or limit my options down the road.  But if I'm moving only the post tax gains to my tIRA I should be okay.  Is that right?  Sorry if I'm being thick it's just all very new to me.

msilenus

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Re: Question about Mega Backdoor Roth - Read Newbie alert
« Reply #20 on: January 04, 2016, 10:03:12 PM »
This thread is titled "Mega Backdoor Roth."  There's another, older, smaller maneuver that is more modestly called the "Backdoor Roth."  (Without the "Mega.")  Limit on that is $5.5k in 2015 and 2016.  And you can still do it for 2015, too.  I forget what the exact deadline is.  Probably the filing deadline.

Anyway, if you read up on Backdoor Roth IRA, you'll find a word of caution about doing one when you have a large untaxed balance in your traditional IRA.  If you do "Mega Backdoor Roths" for long enough while doing basis isolation (that's what you're doing to avoid the tax event), that's exactly what you'll create: a large untaxed balance in a traditional IRA.

So let's say that you do the Mega trick, and in five years you have $3k built up, with a tax basis of $0.  Let's say in five years you're making too much money to do a regular Roth or pretax IRA contribution.  So you decide to do a Roth Backdoor Conversion.  You open up a traditional IRA, stick $6k of post-tax money in it, and roll it over into a Roth IRA.  Viola.

Except you screwed up.  The IRS treats all traditional IRAs for a given individual as one account.  So 66.6% of that rollover was basis from the IRA contribution, and 33.3% was the gains (and earnings on gains) from your previous Mega backdoor operations.  So you owe taxes on $2k more of income.

None of this matters if you never think you'll do a Backdoor Roth.  But it's a really good reason to *not* do basis isolation if you think you might.
« Last Edit: January 04, 2016, 10:08:56 PM by msilenus »

Fire2025

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Re: Question about Mega Backdoor Roth - Read Newbie alert
« Reply #21 on: January 04, 2016, 10:49:23 PM »
Msilenus,  Okay I think I get it, thank you for the info, you never know what the future holds.

There's just sooooo much to learn.  Little bites, little bites.