Author Topic: To Mega Backdoor Roth or not...  (Read 1365 times)

Arbitrage

  • Bristles
  • ***
  • Posts: 481
To Mega Backdoor Roth or not...
« on: December 11, 2018, 04:33:53 PM »
I have the Mega Backdoor Roth available to me next year for the first time.  I was a bit daunted at first by how to implement it, but I think I'm close.  Here's the situation:

$56k IRS limit -
$19k 401k contribution -
$16k company match

= $21k available space. 

However, it appears that I am capped on the percentage I can contribute after tax, so I really will have $16k available space.  Contributions go in weekly.

I currently have no Traditional IRAs, and make use of the Backdoor Roth IRA. 

To implement this most efficiently, here is what I believe I need to do:

1. 12/XX/2018 Elect for maximum after-tax contribution allowed.
2. 1/02/2019 (or close to that date): Contribute $6000 to (nondeductible) Traditional IRA. 
3. 1/03/2019, or after funds clear: Convert $6000 to Roth IRA
4. 1/XX/2019 - 12/XX/2019: In-service distribution of entire balance of 401k to Traditional (pre-tax bucket) and Roth IRA (after-tax bucket).  Perform as regularly as is convenient.  Will need to pay income taxes on growth of after-tax bucket between contribution and distribution.
5. ~12/29/2019: Rollover entire Traditional IRA balance back to 401k plan to zero it out for Form 8606 and the Backdoor Roth IRA.
6. Would have to skip either the regular or Mega Backdoor if I don't believe I'll be employed on 12/31 of that year.  Of course, income would probably be low enough for direct Roth IRA contributions in that case.

I believe that I still need to confirm that in-service distributions are unlimited.

Any corrections or hints out there? 

jacoavluha

  • Bristles
  • ***
  • Posts: 266
Re: To Mega Backdoor Roth or not...
« Reply #1 on: December 11, 2018, 05:03:46 PM »
It is important to know whether 1) in plan roth rollover of after tax contributions is possible, 2) in service non hardship withdrawal of after tax contributions is possible, 3) allowed frequency of 1 and/or 2, 4) any fees involved in 1 and/or 2, 5) whether split rollover is possible, ie whether earnings on after tax contributions can be separately directed to traditional IRA, or whether entirety of after tax sub account (contributions plus earnings) go via rollover to Roth IRA

if 1) in plan Roth rollover is allowed then everything is easy. Some plans even automate this, ie automatically convert after tax contributions to Roth at some regular interval. Then you don't have to worry about any IRA rollovers

some plans will charge fees for these maneuvers, so you'll want to know that, and balance frequency of your moves versus the fees

if split rollover is allowed, things are pretty easy, the after tax contributions go to Roth IRA, earnings go to traditional IRA, and then you rollover the traditional IRA back to the 401k (make sure the plan accepts IRA rollovers)

alternatively you may be able to direct the entire after tax subaccount to Roth IRA if you choose, and you would pay income tax on the conversion of the after tax sub account earnings

note, you're not moving the "entire balance of 401k", only funds in the after tax sub account. Salary deferral is not distributable. Employer match may be distributable but you would not want to do this I assume, because these funds are pretax, so a conversion would be fully taxable

if you're doing backdoor Roth, and if you end up with rollover funds in traditional IRA via an above maneuver, do not wait until late in the year to do a rollover back into the 401k. There's no sense waiting to do this. Rollover those funds back to the 401k as soon as you can. Or, you could convert the balance to Roth if the amount is small and you don't mind paying the tax.

Now none of this really has anything to do with the backdoor Roth. You'll just want to make sure that in any year you do a backdoor Roth conversion, that your pretax balance in all IRAs is $0 on 12/31.

terran

  • Handlebar Stache
  • *****
  • Posts: 2145
Re: To Mega Backdoor Roth or not...
« Reply #2 on: December 11, 2018, 05:23:09 PM »
Unless it's some peculiarity of your plan you shouldn't need to roll your entire balance out to an IRA. You would just roll out the after tax balance. If you want (and your plan allows) you can roll the after tax contributions out to Roth and any gains out to traditional to avoid paying tax on the gains now. As you point out you'll need to roll the traditional back into the 401(k) if allowed to avoid prorata taxation when you do a regular backdoor Roth, but you can also just roll the whole after tax balance over to Roth and pay tax on the gains, which might be pretty minimal depending on how often you do the rollovers.

Arbitrage

  • Bristles
  • ***
  • Posts: 481
Re: To Mega Backdoor Roth or not...
« Reply #3 on: December 12, 2018, 08:49:44 AM »
Thanks all.  I was able to get the final pieces of information from my plan's administrator.  I do have both in-plan conversions of after-tax to Roth 401k and in-service withdrawals of only the after-tax account available to me, though I may only do either a maximum of four times per year (no fees). 

I'm thinking of probably going with withdrawals to Roth IRA only, paying the tax on the (likely minimal, with a $2000 average balance) earnings.  It'll avoid the extra hassle of rolling back and forth, managing yet another new account.  In addition, the in-plan conversions require me to call the administrator every time, while the withdrawals to IRA can be done myself through the website. 

Arbitrage

  • Bristles
  • ***
  • Posts: 481
Re: To Mega Backdoor Roth or not...
« Reply #4 on: April 08, 2019, 07:38:44 AM »
I successfully executed the first rollover withdrawal for my Mega Backdoor Roth.  I waited until now due to the 4-transaction-per-year limit.  In doing so, I learned a few things:

1. The ability to perform the rollover myself online is not working as intended.  This was confirmed when I used phone support - the rep insisted that I could do it myself, but in walking me through the process ended up agreeing with me, and took a note to try to work with tech support to get it working.  Here's hoping.

2. This phone rep informed me that the 4-transaction-per-year limit is only on age 59.5+ rollovers, and I should be able to do it as often as I'd like!  That would help minimize taxes, though I certainly don't want to do it too frequently until they get their online system working. 

3. Funds that are in the 401k plan but aren't native to Fidelity won't be transferred in-kind, so I do have to execute a second transaction after the rollover to re-invest the liquidated funds.  Not ideal, but not the end of the world.  I considered investing the after-tax contributions only in Fidelity funds, but my contribution allocation has to be identical for all types of contributions.  Another possible solution is to invest everything into the Fidelity fund, and then reallocate my pre-tax 401k after each rollover.  Either way, it does take a bit of extra work, but I suppose one benefit to doing it the latter way is that the funds don't spend a day out of the market. 

I have to admit, this process feels a bit like cheating.  I don't feel guilty, since the system is broken, and we all certainly take advantage of the opportunities offered to us to minimize our taxes.  Don't hate the player, hate the game. 

SubL stache

  • 5 O'Clock Shadow
  • *
  • Posts: 61
Re: To Mega Backdoor Roth or not...
« Reply #5 on: April 08, 2019, 08:36:51 PM »
That's awesome.  I asked my employer about this and they were researching it but they were getting pretty confused and I didn't have the money to start really doing it...however come 6 months I will have capped my tax-advantaged vehicles and might need to dig into this more.

thesis

  • Stubble
  • **
  • Posts: 185
Re: To Mega Backdoor Roth or not...
« Reply #6 on: April 09, 2019, 03:08:50 PM »
Don't hate the player, hate the game.

The Mega Backdoor Roth has always sounded like cheating, and this is further amplified by the large-scale inability to perform it through most employers (unless I'm mistaken). Pretty awesome it will be available to you, though! I make enough to max out the 401k, Roth IRA, and HSA, the rest goes to cash savings since I'm still a bit early in the game and my brain is happier that way. But I suspect that so few people are taking advantage of this "loophole" that it isn't worth the congressional session required to kill it. How many people outside of the FI community are already maxing their 401k? Yeah, not very many. Far, far fewer are then going beyond that.

Tax avoidance is not the same as tax evasion. Take every legal recourse to keep your money :)
« Last Edit: April 09, 2019, 03:10:44 PM by thesis »