Author Topic: Taking full advantage of the tax code to maximize Roth IRA contributions  (Read 3089 times)

Emanonrog

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I recently learned that if your 401(k) plan has certain provisions, it's likely that you could be contributing an extra 20-30K to your Roth IRA each year.

As long as your 401(k) plan allows after-tax contributions (which are tracked separately from pre-tax/roth 401k contributions) and allows in-service distributions, you can take advantage of this strategy. 

The pre-tax/roth 401k contribution limit for 2014 is $17,500, but the total DC contribution limit is $52,000.  The total DC limit includes your company's match, so the amount of money you can convert into your Roth will depend on your salary as well as your match formula.  Assuming you are making the maximum pre-tax contribution of $17,500 and your company is matching $7,500, you can still make an additional $27,000 of after-tax contributions.  Once the money is in, you request an in-service distribution (for the full amount of your after-tax balance) and a rollover into your Roth IRA.  This is already post-tax money, so the only taxes you'll owe are from gains realized during the year. 

The Pension Protection Act (PPA), which also opened the door to back-door Roth IRA contributions by removing the pay limit on Roth Conversions, made this maneuver legal.  It's unclear if this was the IRS's intention, or if it was an unforeseen consequence.  It's certainly possible that this opportunity could be taken away at any time.

Note, I am not a tax or an investment professional, so you may want to seek advice from someone who is.  This article has more information - http://www.napa-net.org/news/technical-competence/case-of-the-week/case-of-the-week-converting-401k-plan-after-tax-accounts-to-roth-iras/

Badass by 41

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I approached my benefits team about this and they gave me some run-around about after-tax contributions and in-service distributions not being possible.  I did a bit of research and showed them the IRS rules.  Now they're bringing it up with the benefits committee for consideration for 2015.

This is an amazing opportunity if your company provides these options.  I'm hoping that most 401k plans don't offer these options out of ignorance and not because they add significant cost to administration.

Anyone else gone through something similar with their employer?  Or have real world experience executing this strategy?

Edit: typos
« Last Edit: May 09, 2014, 02:11:55 PM by Badass by 41 »

Wile E. Coyote

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Be careful with this. There is not clear guidance that this works. It is possible that the in service distributions will be seemed to come pro-rata from pre-tax and after-tax dollars.

A quick google turned up this, but it is a bit old. Not sure if there has been any more guidance on this, but I will do some digging.

http://m.kiplinger.com/article/retirement/T046-C000-S002-a-sweet-deal-on-roth-ira-conversions.html

Badass by 41

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Good point Wile W. Coyote, and in fact all of the research I've read says that the IRS is aware of the loophole and that a precedent hasn't been set that this strategy is or isn't "legal".

Re: pro-rata - the versions of this strategy I've seen pair it with reverse 401k rollovers.  This allows you to move your IRA assets out of the pro-rata classification when you do your Roth conversion.  Obviously in order to make that work you'll need to get the timing just right, which may be too risky/labor intensive for most people.

Trirod

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I'm a CPA and looked into this for a client recently who wanted to try the same thing.  My conclusion was that it was pretty risky and if the IRS looked at it they would have a good argument to treat the distribution as coming from pre and post tax contributions pro-rata.  My research on this is all at work and since it's Friday evening and I don't feel inclined to log in to my work system, I can't post the links.

There was no definitive conclusion - it's definitely a grey area.

Badass by 41

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I would be very interested in any additional info you have from your research.  Just so I'm clear, your conclusion is that even if the funds are in a 401k in different account (pre-tax, post-tax) that they could still treat it all as pro-rata contributions?


Left

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I thought about this before or something similar, I worked PRN at another company as well as a full time job. Anyways, I'm able to max 401k at full time job but also put money into PRN's 401k. This allowed me to put in over the IRA max since I contributed to both. I was told that I shouldn't do this since I got taxed for the extra amount that went over the limit then I got taxed again when I took the money out, so taxed twice. But I went ahead and did it. Anyways since I stopped the PRN job due to current job taking so much of my time, I just rolled PRN 401k into my roth.

A round about way of saying this, but isn't this thread just the same as what I did when I worked 2 jobs and put money into both 401ks? If so, the IRS didn't really care that I over-contributed just as long as I paid my taxes on the amount over their deferred limit.

edit:@wile's link, in my case above with over contribution, and paying the taxes for it, isn't this the same as that option 3 in his link? And if it works that way, I might just pick up seasonal jobs or other PRN jobs and then each time I'm done, I can "quit" and roll it over into a roth, pay the taxes on it, then apply for job again next season. It's fairly easy to justify the PRN job "quitting" too, at least for me. I helped out when someone is off for maternity/family leave which is normally a few months. After they come back, I'm "no longer needed" so I let the PRN spot go. This could be the same for temp agencies too?

edit: it might depend on how much you over contribute too? I just worked twice a month but even then I made about $8,000/year with about $5,000 into the 2nd 401k. Maybe it was so little that it didn't draw IRS's attention?
« Last Edit: May 09, 2014, 10:37:14 PM by eyem »