Author Topic: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?  (Read 42661 times)

welliamwallace

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It appears that the IRS just announced a clarification that allows after-tax 401(k)s to be rolled over directly into Roth IRAs tax free. If I am not mistaken, this effectively changes after tax 401(k)s from "tax deferred" to truly "tax free" growth, just like a Roth IRA.

http://www.forbes.com/sites/ashleaebeling/2014/10/15/aftertax-401k-rollovers-advanced-version/

Of course, your employer has to offer an after tax 401k option.

EDIT2 This should summarize things:
After tax, non-Roth 401(k)s are different than, and sub-optimal to traditional pre-tax 401(k)'s, traditional IRAs, Roth 401k(s), and Roth IRAs which you should max out before considering contributions to an after-tax 401(k).

The basic 401(k) salary deferral limit of $17,500 applies to pretax and Roth contributions. But you can stuff in aftertax contributions to get up to a total of $52,000 if your company allows [2014 numbers].

Unlike a Roth 401k, in which earnings are never taxed, earnings (but not contributions) in an after-tax 401k will eventually be taxed at withdrawal at your marginal income tax rate. This is true if you withdraw directly, or rollover the earnings to a traditional IRA and later withdraw from that. Your marginal income tax rate at that time will likely be higher than your long-term capital gains tax rate. For this reason many people would rather just invest in normal taxable accounts.

However, if you can quickly roll over your after-tax 401k contributions to a Roth IRA, any earnings it makes there are completely tax free. The IRS announcement (above) makes it easy to roll the contributions portion of an after-tax 401k into a Roth IRA, and the earnings portion in a traditional IRA.
For people that work at companies that allow in-service distributions (even with a short waiting period), or people that are planning to leave their company within a few years, an after-tax 401k may be an easy way to get a lot more money into a Roth IRA where it will continue to grow completely tax free, while only a small amount (the earnings) needs to be rolled over to a traditional IRA

See the following images which better explain the scenario
ScenarioDiscussionImage
I can take in-service distributions, or I will leave my company within a few yearsIn this situation, the after-tax 401(k) didn't accumulate much taxable "earnings" before I could roll it over into a Roth IRA where it will grow completely tax freehttp://i.imgur.com/cuY1FfF.png
I will remain at my company for a long time still, and can't take in service distributionsIn this situation, my money spent a lot of time in the after-tax 401(k) gaining a substantial amount of earnings. When I withdraw the earnings (or roll them over to a traditional IRA and later withdraw it), I will owe my marginal income tax rate on it.http://i.imgur.com/1tN98hz.png


Even if you cannot do in-service distributions and are not leaving your company very soon, there may be some people that would still benefit from after-tax 401(k)s instead of taxable investing. These are people that will have an extremely low marginal income tax rate in retirement (e.g. the Mad Fientist ). Trading a 10% income tax instead of 0% LTCG tax on a big chunk of earnings may be a price worth paying to get a some more money into a Roth IRA above the annual contribution limit.

90% of the confusion in these comments before this edit is about how the earnings made in an after-tax 401(k) are handled when rolled over to a Roth IRA. The whole point of this post and the IRS ruling is that you can roll over those earnings to a traditional IRA while still sending the contributions to a Roth IRA.
« Last Edit: November 04, 2014, 12:48:33 PM by welliamwallace »

ender

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #1 on: October 27, 2014, 12:30:31 PM »
Oooooh neato. Not as meaningful now as I don't max out Roth space but in the future if I am making enough to so with a lower marginal rate might be quite beneficial!

VirginiaBob

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #2 on: October 27, 2014, 12:45:32 PM »
Can someone explain this to idiot me?  From my understanding, if you are still working, you can contribute to a Roth 401K (if you employer offers this) up to 17,500 post taxes.  You can contribute an addional $34,500 into the account, but all increases earned on this $34,500 will be tax-deferred (you pay when you withdraw).  What this does is make all those increases tax free at withdrawal when rolled over to a Roth IRA.  Correct?

sol

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #3 on: October 27, 2014, 12:53:10 PM »
If I'm reading this right, this effectively just increases the Roth IRA contribution limit.  At least for people who have an after-tax contribution option in their 401k.

In a normal Roth IRA, you pay the taxes up front and then never pay taxes again.  With this new rule, you can instead pay the taxes up front (by making after-tax contributions to your 401k) and then roll that after-tax amount over to a Roth IRA.

For most people here, I'm not sure this is going to be very helpful.  Generally speaking the traditional 401k is a better option for the early retiree than the Roth IRA anyway.  Even if you're maxing them both out, the key to super early retirement is gathering enough savings outside of tax-sheltered accounts to live for the first five years during the construction of your 5 year Roth IRA rollover pipeline.   Most of us ER types aren't so wealthy that we have a bunch of extra money in our Roths or 401ks compared to what we have to save in taxable accounts to survive that first five years

But I see one big unanswered question here, for people to whom the above limitation does not apply.  Are your after-tax 401k conversions to a Roth IRA considered typical rollovers that can be withdrawn penalty free after five years?

ender

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #4 on: October 27, 2014, 12:57:21 PM »
Can someone explain this to idiot me?  From my understanding, if you are still working, you can contribute to a Roth 401K (if you employer offers this) up to 17,500 post taxes.  You can contribute an addional $34,500 into the account, but all increases earned on this $34,500 will be tax-deferred (you pay when you withdraw).  What this does is make all those increases tax free at withdrawal when rolled over to a Roth IRA.  Correct?

Some 401k plans allow after tax contributions. If you can contribute more after-tax dollars to your 401k it effectively allows you to add that space to a Roth IRA. The principle you rollover into a Roth IRA, and the earnings a traditional IRA. Previously all was rolled into a traditional IRA, which was less desirable as you paid double taxes on principle and only benefited from tax deferment on the earnings.

If your plan allows in-service distributions you can roll this over much more quickly and minimize the "earnings vs principle" ratio and effectively treat it as a Roth IRA.

welliamwallace

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #5 on: October 27, 2014, 01:03:15 PM »
The principle you rollover into a Roth IRA, and the earnings a traditional IRA.

Are you saying that's still required under the new rule? If so, It's not AS good as a Roth, which has truly tax-free gains. This would just be tax deferred gains.

sol

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #6 on: October 27, 2014, 01:05:57 PM »
The principle you rollover into a Roth IRA, and the earnings a traditional IRA.

Are you saying that's still required under the new rule? If so, It's not AS good as a Roth, which has truly tax-free gains. This would just be tax deferred gains.

It's as good if you can do the conversion immediately, before you incur any gains.

It also allows you to stuff your Roth in a way that you couldn't before.  That probably appeals to some small subset of this audience.

brooklynguy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #7 on: October 27, 2014, 01:16:16 PM »
This strategy (sometimes referred to as the "mega backdoor roth") has been around for a while, but its legitimacy wasn't 100% free from doubt.  See the discussion here:

http://forum.mrmoneymustache.com/investor-alley/mega-backdoor-roth/msg325458/?topicseen#msg325458

But with this latest guidance, it appears that the IRS has now blessed it.

ender

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #8 on: October 27, 2014, 01:21:51 PM »
The principle you rollover into a Roth IRA, and the earnings a traditional IRA.

Are you saying that's still required under the new rule? If so, It's not AS good as a Roth, which has truly tax-free gains. This would just be tax deferred gains.

It's as good if you can do the conversion immediately, before you incur any gains.

It also allows you to stuff your Roth in a way that you couldn't before.  That probably appeals to some small subset of this audience.

Yup.

This is probably primarily useful for a family with high income and lots of kids - so a lower federal tax - but living a MMM lifestyle.

sirdoug007

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #9 on: October 27, 2014, 01:25:22 PM »
Damn, my 401(k) does not allow "after-tax" contributions.  So I'm still stuck with the $18,000 limit for 2015.

I'll have to start lobbying to get them to add this to the plan!  Having $52,000/year worth of room in your 401(k) is great stuff!


brooklynguy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #10 on: October 27, 2014, 01:48:22 PM »
This is probably primarily useful for a family with high income and lots of kids - so a lower federal tax - but living a MMM lifestyle.

Having a current lower federal tax isn't relevant.  Sol nailed it above -- this is useful to anyone who is already maxing out their 401k and who has enough taxable investments to get them through the first five years of a Roth conversion pipeline.  (Your current tax bracket doesn't matter, because this is simply allowing you to take after-tax funds and send them to a Roth IRA instead of a taxable account; either way, you're paying whatever taxes you're paying.)

For me, like most early retirement types, the benefit of having the extra funds in a Roth IRA instead of a taxable account is marginal at best, because I plan to pay zero taxes in retirement and my investments will be tax efficient until then.  But, if this option is available to you, there's not really any downside in doing it, and it does insulate you against future changes in tax laws (and if current political headwinds are any indication, the current tax laws that allow early retirees to live off their investments without paying taxes are ripe for change).

To answer Sol's question above, I don't think there is any reason to doubt that the after-tax 401k conversions to a Roth IRA can be withdrawn penalty-free after five years.

ZiziPB

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #11 on: October 27, 2014, 01:55:41 PM »
My plan allows after-tax contributions but the after-tax money has to be "seasoned" for 2 years before in-service distributions (rollovers) are allowed.  As I understand the new guidance, I will now be able to split the after-tax contributions from the earnings that accummulated over the 2 years and do a "forked" rollover: contributions to Roth IRA and earnings on those contributions to a traditional IRA. 

Does anyone know if an in-plan conversion may be easier now too?  Would I be able to convert the contributions to Roth 401k and lump the earnings with the rest of the before-tax money?  My plan generally allows in-plan conversions under the same conditions as in-service rollovers but as I understood it before, I would have pay tax on the converted earnings.  Now it looks like maybe I can just consolidate the earnings with the rest of the traditional 401k?

sol

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #12 on: October 27, 2014, 02:02:40 PM »
this is simply allowing you to take after-tax funds and send them to a Roth IRA instead of a taxable account; either way, you're paying whatever taxes you're paying.

As long as you have enough money in your taxable accounts to survive that first five years, I think the conversion to Roth is still a slightly better deal than investing in a taxable account, especially if you have tax inefficient investments like dividend paying stocks or bonds that throw off a lot of taxable interest.  Why incur extra tax liability if you don't have to?  Milesdividend made this point clearly in an earlier discussion, even a slight marginal benefit is still a benefit.

The flip side, of course, is that ALL funds in a taxable account are available to you on a moment's notice.  Once you convert to a Roth, only the amount of the conversion is available before age 59.5 and the interest it earns will have to wait.  In my case, the interest has to wait so long that I'll probably never need it because by the time it is available to me I'll be about ready to live off of my pension and SS anyway.

minimalist

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #13 on: October 27, 2014, 02:05:46 PM »
I currently contribute the annual maximum split between my 401k and Roth 401k accounts. So now I can lower my tax liability by maxing out the pre-tax contributions and making after-tax contributions instead of the Roth 401k contributions?

ZiziPB

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #14 on: October 27, 2014, 02:16:18 PM »
I currently contribute the annual maximum split between my 401k and Roth 401k accounts. So now I can lower my tax liability by maxing out the pre-tax contributions and making after-tax contributions instead of the Roth 401k contributions?

Yes, provided your plan allows after-tax contributions and in-service distributions or conversions.  And provided you want and can make contributions in excess of the $17,500 ($18K for 2015) limit.

brooklynguy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #15 on: October 27, 2014, 02:19:27 PM »
As long as you have enough money in your taxable accounts to survive that first five years, I think the conversion to Roth is still a slightly better deal than investing in a taxable account, especially if you have tax inefficient investments like dividend paying stocks or bonds that throw off a lot of taxable interest.  Why incur extra tax liability if you don't have to?  Milesdividend made this point clearly in an earlier discussion, even a slight marginal benefit is still a benefit.

The flip side, of course, is that ALL funds in a taxable account are available to you on a moment's notice.  Once you convert to a Roth, only the amount of the conversion is available before age 59.5 and the interest it earns will have to wait.  In my case, the interest has to wait so long that I'll probably never need it because by the time it is available to me I'll be about ready to live off of my pension and SS anyway.

Yes, this thread immediately reminded me of your heated discussion with miles on the "roth horserace" topic from a while back.

Agree that even a slight marginal benefit is still better than no benefit, which is why I'm going to do this.  Previously, the only reason I hesitated was the lingering doubts about the tax treatment in the absence of explicit IRS guidance (but I had decided to do it anyway).

With all of my taxable account space occupied by tax efficient investments, the upfront tax benefits of this strategy to me are very small, so I view the insulation from future tax law changes as the more important benefit.

sol

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #16 on: October 27, 2014, 02:31:19 PM »
With all of my taxable account space occupied by tax efficient investments, the upfront tax benefits of this strategy to me are very small, so I view the insulation from future tax law changes as the more important benefit.

That's an interesting statement.  Why do you think your taxable account space is limited?  If you had the income, couldn't you invest a million dollars per year in taxable investments?  Did you just mean "what I can afford to invest in taxable accounts"?

But you've also highlighted another potential benefit, tax-efficient asset allocation.  If your problem is that you've already crammed your tax-deferred accounts with investments that generate taxable income (like you're 100% bonds in your 401k and Roth) while keeping your stocks or index funds in taxable accounts, and you wanted to buy even more bonds but would have to put them in your taxable account, this new strategy would help you out.  It lets you fit more tax-inefficient investments into a tax shelter.

Though if you're maxing out $18k in 401k +$5k in Roth space with 100% bonds, you're probably already very close to retirement and have a very conservative asset allocation.  That or you have a TON of taxable investments to balance out a more typical asset allocation, and you need to tell me what you do for a living.

sirdoug007

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #17 on: October 27, 2014, 02:50:20 PM »
The flip side, of course, is that ALL funds in a taxable account are available to you on a moment's notice.  Once you convert to a Roth, only the amount of the conversion is available before age 59.5 and the interest it earns will have to wait.  In my case, the interest has to wait so long that I'll probably never need it because by the time it is available to me I'll be about ready to live off of my pension and SS anyway.

This is a good point.  Right now 100% of my retirement funds are in 401(k) or IRAs.  I'm thinking it would be more advantageous for me to start building my 5 year bridge fund with taxable investments now while still maxing out the traditional 401(k) for the tax benefits.

brooklynguy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #18 on: October 27, 2014, 03:01:23 PM »
That's an interesting statement.  Why do you think your taxable account space is limited?  If you had the income, couldn't you invest a million dollars per year in taxable investments?  Did you just mean "what I can afford to invest in taxable accounts"?

But you've also highlighted another potential benefit, tax-efficient asset allocation.  If your problem is that you've already crammed your tax-deferred accounts with investments that generate taxable income (like you're 100% bonds in your 401k and Roth) while keeping your stocks or index funds in taxable accounts, and you wanted to buy even more bonds but would have to put them in your taxable account, this new strategy would help you out.  It lets you fit more tax-inefficient investments into a tax shelter.

Though if you're maxing out $18k in 401k +$5k in Roth space with 100% bonds, you're probably already very close to retirement and have a very conservative asset allocation.  That or you have a TON of taxable investments to balance out a more typical asset allocation, and you need to tell me what you do for a living.

Yes, by "taxable account space," I really meant everything left over after using up my tax-advantaged account space.  My asset allocation is pretty close to 100% equities, so I can easily stick my tax-inefficient bond funds in my tax-advantaged accounts.

Not sure if your last paragraph was directed at me or the hypothetical person in the scenario you described.  I'm maxing out my 17.5k of 401k space (I can't use the 5k of ordinary backdoor roth because of an existing roth IRA rolled over from a previous employer's roth 401k) and will have enough taxable funds (plus "ripe" contributions from my existing rolled-over roth IRA) to get me through the first five years of the pipeline, but only by a hair.  My plan is to stuff the Roth using this strategy only with excess dollars above the amount needed to fund the first five years (plus a cushion).  I'm a lawyer (but not a tax lawyer); nothing I say on this board constitutes legal advice.

This is a good point.  Right now 100% of my retirement funds are in 401(k) or IRAs.  I'm thinking it would be more advantageous for me to start building my 5 year bridge fund with taxable investments now while still maxing out the traditional 401(k) for the tax benefits.

I worry a bit about having such a large concentration of my portfolio "tied up" in tax-advantaged accounts that were designed to be accessed at traditional retirement age, because changes in the law could restrict or eliminate the strategies available today to access those funds in early retirement.  But the tax benefits are too great, and the risk of not being able to access the money in one way or another too small, to really worry too much about this.

ender

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #19 on: October 27, 2014, 03:32:06 PM »
Quote
I worry a bit about having such a large concentration of my portfolio "tied up" in tax-advantaged accounts that were designed to be accessed at traditional retirement age, because changes in the law could restrict or eliminate the strategies available today to access those funds in early retirement.  But the tax benefits are too great, and the risk of not being able to access the money in one way or another too small, to really worry too much about this.

Don't forget that even money "tied up" into a Roth IRA isn't necessarily locked. You can withdraw your principle, too, immediately for a Roth IRA and after 5 years for rollovers/conversions.

By the time most of us invest for 5-10 years that's a good sum of money, especially if you started the Mustachian journey early.

gimp

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #20 on: October 27, 2014, 03:32:34 PM »
Let me make sure I am understanding this.

If my employer supports this, I can contribute extra post-tax money to a roth 401k, which can be rolled over to a roth IRA. That's it. Basically, I can fund my roth IRA much more than I could before.

Is that right?

If so, this might be quite meaningful - my income is too high for a traditional IRA, and I have a bunch in taxable accounts...

sol

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #21 on: October 27, 2014, 03:42:14 PM »
If my employer supports this, I can contribute extra post-tax money to a roth 401k, which can be rolled over to a roth IRA. That's it. Basically, I can fund my roth IRA much more than I could before.

It looks to me like the existing limitations on eligibility are still in place.  The idea here is that your pre-tax contributions can be rolled over into a traditional IRA (and then to a Roth IRA if you pay taxes), just like before, and your post-tax contributions can be rolled over directly into a Roth IRA.  You still need to be able to take a distribution and you still need to qualify to hold all types of accounts involved. 

More details here:  http://fairmark.com/retirement/roth-accounts/roth-conversions/isolating-basis-for-roth-conversion/

seattlecyclone

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #22 on: October 27, 2014, 03:45:55 PM »
Let me make sure I am understanding this.

If my employer supports this, I can contribute extra post-tax money to a roth 401k, which can be rolled over to a roth IRA. That's it. Basically, I can fund my roth IRA much more than I could before.

Is that right?

If so, this might be quite meaningful - my income is too high for a traditional IRA, and I have a bunch in taxable accounts...

Yes, that's all there is to it.

The total amount of money that can be put into your 401(k) this year is $52k ($53k next year). This amount minus your deductible contribution limit minus any employer match is the amount you can put in the after-tax bucket.

The best situation is where your employer allows you to take in-service withdrawals of the after-tax amount. This way you can roll over the amount to a Roth IRA soon after the initial contribution so that you allow the earnings to compound in the Roth account.

The amount rolled over can be withdrawn completely tax-free and penalty-free after five years in every case. Even before five years, only the amount that was taxable at the time of rollover (i.e. any earnings on the after-tax amount before the rollover) is subject to a penalty. When you do the rollovers relatively soon after the initial contribution, the taxable portion is minimal. Even that can be avoided if you utilize this new guidance that allows you to split the earnings off into a traditional IRA.

brooklynguy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #23 on: October 27, 2014, 03:52:24 PM »
Don't forget that even money "tied up" into a Roth IRA isn't necessarily locked. You can withdraw your principle, too, immediately for a Roth IRA and after 5 years for rollovers/conversions.

By the time most of us invest for 5-10 years that's a good sum of money, especially if you started the Mustachian journey early.

I know, but my point was that these rules can change.  It is possible that in the future the rules will change in a manner that restricts you from withdrawing contributions (extremely unlikely).  Most of us won't actually be stuffing Roth 401ks/IRAs, but traditional 401ks/IRAs, with the intention of constructing a Roth conversion pipeline -- changes in tax laws can cut off the ability to do this (also unlikely, but less so).

Let me make sure I am understanding this.

If my employer supports this, I can contribute extra post-tax money to a roth 401k, which can be rolled over to a roth IRA. That's it. Basically, I can fund my roth IRA much more than I could before.

Is that right?

If so, this might be quite meaningful - my income is too high for a traditional IRA, and I have a bunch in taxable accounts...

Yes, except substitute "voluntary after-tax contribution account" for "roth 401k" in your post.  The limits on Roth 401k contributions haven't changed.  Some employers offer the ability to contribute after-tax dollars above and beyond the 17.5k limit, subject to an overall $52k cap.

Undecided

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #24 on: October 27, 2014, 04:01:50 PM »
(Your current tax bracket doesn't matter, because this is simply allowing you to take after-tax funds and send them to a Roth IRA instead of a taxable account; either way, you're paying whatever taxes you're paying.)

Except for the not paying taxes on dividends or capital gains .... I know you said that in your situation you expect to be in the 0% bracket for (it seems) qualified dividends and capital gains, but that's a key part of being indifferent between the taxable investing and Roth IRA investing. I don't expect to be in that situation (1) because I have a high state tax rate that also applies to dividends and capital gains (and I like it here) and (2) I expect there to be years when I will need to spend extra money for my children's education and for a planned-for one-time expense.

brooklynguy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #25 on: October 27, 2014, 07:33:03 PM »
(Your current tax bracket doesn't matter, because this is simply allowing you to take after-tax funds and send them to a Roth IRA instead of a taxable account; either way, you're paying whatever taxes you're paying.)

Except for the not paying taxes on dividends or capital gains .... I know you said that in your situation you expect to be in the 0% bracket for (it seems) qualified dividends and capital gains, but that's a key part of being indifferent between the taxable investing and Roth IRA investing. I don't expect to be in that situation (1) because I have a high state tax rate that also applies to dividends and capital gains (and I like it here) and (2) I expect there to be years when I will need to spend extra money for my children's education and for a planned-for one-time expense.

I just meant that your current (as opposed to future) tax rate has no bearing on the analysis when deciding between the taxable and backdoor roth alternatives, because either way you are using after-tax funds.

Good point about state taxes, though.  I'm also subject to high state (and local) taxes, so I shouldn't focus exclusively on the federal side when I take these considerations into account.

GlassStash

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #26 on: October 28, 2014, 07:42:45 AM »

Let me make sure I am understanding this.

If my employer supports this, I can contribute extra post-tax money to a roth 401k, which can be rolled over to a roth IRA. That's it. Basically, I can fund my roth IRA much more than I could before.

Is that right?

If so, this might be quite meaningful - my income is too high for a traditional IRA, and I have a bunch in taxable accounts...

The amount rolled over can be withdrawn completely tax-free and penalty-free after five years in every case. Even before five years, only the amount that was taxable at the time of rollover (i.e. any earnings on the after-tax amount before the rollover) is subject to a penalty.

Just to be clear, any rollover portion that is not earnings is only subject to income tax, and not the 10% penalty (if withdrawn before 5 years)?

brooklynguy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #27 on: October 28, 2014, 10:00:06 AM »
Just to be clear, any rollover portion that is not earnings is only subject to income tax, and not the 10% penalty (if withdrawn before 5 years)?

No - as I understand the rules, after you roll over an after-tax 401k account (whether Roth or not) into a Roth IRA, you can withdraw the amount of your contributions immediately with no penalty (and no tax, since tax was already paid upfront on the contributions).  In this scenario, the five year waiting period would only apply to earnings (note that this is a separate and distinct five year rule from the one that applies to Roth conversions -- if a traditional tax-deferred account is converted into a Roth IRA, a five year waiting period applies before you can withdraw the contributions without penalty; however, I don't believe that a rollover of an after-tax (Roth or otherwise) 401k into a Roth IRA is treated as a conversion).

Now that I think about it, I think this means the "mega back door Roth" strategy actually would be helpful for the typical aspiring early retiree.  The problem Sol identified is that the typical aspiring early retiree is (if possible) maxing out both the traditional 401k and the Roth IRA options, but still has to accumulate sufficient savings in taxable accounts in order to bridge the first five years of retirement (after which the first of the Roth conversion pipeline funds become accessible).

However, if your 401k plan allows after-tax contributions beyond the 17.5k of traditional 401k contributions, then you can use the mega back door Roth strategy to stuff your Roth and all of those contributions will be accessible immediately upon retirement.  In other words, any funds that you would have directed to taxable accounts (up to the 52k cap) are instead directed to your Roth IRA (indirectly via the mega back door Roth route).  So you don't need taxable accounts to bridge the gap to the Roth conversion pipeline, because you can access the mega back door Roth contributions right away.

Thoughts?

(Again, none of this constitutes legal advice.)

[EDIT:  Now that I've given additional thought to this, I don't think you can use mega back door Roth contributions as a substitute for taxable accounts to bridge the five year gap to a Roth conversion pipeline.  If you start a Roth conversion pipeline before you've exhausted the mega back door Roth contributions, the ordering rules will force you to withdraw the converted amounts (which are subject to a penalty if withdrawn before five years have elapsed) before you can access the remainder of the mega back door Roth contributions.  So you're always stuck with a five year gap that needs to be bridged by funds in taxable accounts.

To make this concrete, suppose this year you contribute $20k to your after-tax 401k account and immediately roll it over to a Roth IRA.  You do the same thing each year for the next two years, then you retire.  You now have $60k of contributions in your Roth IRA immediately accessible without penalty.  Let's say you also have $500k in a traditional IRA, and zero funds in taxable accounts.  If you start a Roth conversion pipeline using the $500k right away, you're no longer going to be able to access the $60k (because at that point, the ordering rules will treat your withdrawals from the Roth IRA as distributions of the converted amounts from the pipeline).  But if you wait until the $60k is used up to start the pipeline, then you have no funds to bridge the five year gap.

One way around this is to withdraw the entire amount of the mega back door Roth contributions (the $60k in my example) immediately upon retirement and move them to a taxable account.  Then you can start the Roth conversion pipeline of your tax deferred accounts right away.  But this sort of defeats the purpose of doing the mega back door Roth in the first place -- the only benefit you get is the avoidance of taxes on earnings while you are still employed before retirement begins (I suppose this benefit could be substantial, depending on the time horizon and the tax efficiency of your investments, but it is not nearly as beneficial as having those funds sheltered in a Roth account forever).]

[SECOND EDIT:  The application of the ordering rules for distributions described in the first edit above is incorrect.  See the additional discussion in the posts below.]
« Last Edit: October 29, 2014, 01:28:02 PM by brooklynguy »

seattlecyclone

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #28 on: October 28, 2014, 11:09:17 AM »

Let me make sure I am understanding this.

If my employer supports this, I can contribute extra post-tax money to a roth 401k, which can be rolled over to a roth IRA. That's it. Basically, I can fund my roth IRA much more than I could before.

Is that right?

If so, this might be quite meaningful - my income is too high for a traditional IRA, and I have a bunch in taxable accounts...

The amount rolled over can be withdrawn completely tax-free and penalty-free after five years in every case. Even before five years, only the amount that was taxable at the time of rollover (i.e. any earnings on the after-tax amount before the rollover) is subject to a penalty.

Just to be clear, any rollover portion that is not earnings is only subject to income tax, and not the 10% penalty (if withdrawn before 5 years)?

When you take money out of a Roth IRA, the taxation depends on exactly which funds you are removing. The tax code specifies a set of ordering rules that determine which funds you are removing and how they are taxed.

The ordering is as follows:
1) Direct contributions to the Roth IRA. These can always be taken out tax-free and penalty free.
2) Conversion/rollover contributions. These include any "backdoor" contributions from a traditional IRA or after-tax 401(k). These come out in first-in, first-out order. Each rollover can potentially be further divided into two parts:
2a) The part that was taxable at the time of the conversion (i.e. earnings on your after-tax 401(k) contribution) comes out first. This part is tax-free at the time of withdrawal (you already paid tax on it when you did the conversion), but is subject to a 10% early withdrawal penalty if withdrawn within five years of the conversion.
2b) The part that was not taxable at the time of the conversion (i.e. your after-tax 401(k) principal) comes out next. This part is always tax-free and penalty-free.
3) Any earnings within the Roth IRA come out last. These are taxed at your normal marginal rate plus a 10% early withdrawal penalty if withdrawn before age 59.

As an example, suppose you have a Roth IRA with $100k in it.
* $10k came from direct contributions over the life of the IRA,
* $20k was converted from a traditional after-tax 401(k) in 2008 ($2k was taxable earnings),
* $30k was converted from a traditional after-tax 401(k) in 2011 ($3k was taxable earnings),
* $15k was converted from a traditional after-tax 401(k) in 2013 (all principal, no taxable earnings),
* the remaining $25k is earnings from investment growth within the IRA.

You could withdraw $30k completely tax-free and penalty-free right now. Contributions come out first irrespective of what year they were made, and they are always withdrawn tax-free and penalty-free. Conversions are tax-free and penalty-free after five years, so that would apply to the 2008 contribution.

You have to pay a 10% penalty on the originally taxable portion of any conversion from the past five years. So after the first $30k, you'll have to pay a 10% penalty on the next $3k you withdraw (since the originally taxable portion of a conversion comes out before the originally tax-free portion).

Then the next $42k (the tax-free portion of your 2011 conversion and the entire 2013 conversion) is tax-free and penalty-free upon withdrawal. So in this example you could withdraw $75k and only owe $300 in tax penalties. Not a terrible deal.

You wouldn't really want to go beyond $75k until age 59. Any non-qualified distributions of earnings count as regular income and have a 10% penalty on top of that. So if you're in the 15% tax bracket during retirement, you'll be paying 25% on every dollar you take out beyond $75k. But if you wait until 59, it's tax-free.
« Last Edit: October 28, 2014, 11:13:33 AM by seattlecyclone »

brooklynguy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #29 on: October 29, 2014, 10:22:59 AM »
I just edited my post above to reflect further thinking on this issue.  Would appreciate it if any of the tax buffs could weigh in with their thoughts (am I thinking about this correctly?) and any creative solutions.

Beric01

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #30 on: October 29, 2014, 11:46:52 AM »
This is great to have the confirmation! I'm following up with my company now to urge them to offer this option in the 401(k) - as well as more Vanguard funds.

seattlecyclone

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #31 on: October 29, 2014, 12:58:46 PM »
I just edited my post above to reflect further thinking on this issue.  Would appreciate it if any of the tax buffs could weigh in with their thoughts (am I thinking about this correctly?) and any creative solutions.

I think the example in your edited section is incorrect. Withdrawals of conversions are ordered by when you made the conversion. My understanding is that pre-tax amounts only come out before post-tax amounts within the context of a single conversion that includes both types of funds. See my example above where the entire amount of the first conversion comes out before the second conversion, and the pre-tax amount in the second conversion comes out before the post-tax amount in the second conversion.

So if you make conversions from your after-tax 401(k) for three years and then start making conversions from your traditional IRA the next year, the after-tax 401(k) contributions will still come out first.

brooklynguy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #32 on: October 29, 2014, 01:26:11 PM »
I just edited my post above to reflect further thinking on this issue.  Would appreciate it if any of the tax buffs could weigh in with their thoughts (am I thinking about this correctly?) and any creative solutions.

I think the example in your edited section is incorrect. Withdrawals of conversions are ordered by when you made the conversion. My understanding is that pre-tax amounts only come out before post-tax amounts within the context of a single conversion that includes both types of funds. See my example above where the entire amount of the first conversion comes out before the second conversion, and the pre-tax amount in the second conversion comes out before the post-tax amount in the second conversion.

So if you make conversions from your after-tax 401(k) for three years and then start making conversions from your traditional IRA the next year, the after-tax 401(k) contributions will still come out first.

I think you're right!  (It was nagging at me that the rules as I described them in my edited section did not make intuitive sense, but I've learned that you can't always count on the tax rules not to be counterintuitive.)

So now I've come back around to my original view that you can use mega back door Roth rollovers in lieu of taxable accounts to bridge the five year gap to a Roth conversion pipeline.  So, if the mega back door Roth option is available to you, there's really no reason not to use it, unless you are counting on the earnings on those funds to help bridge the five year gap (but I don't think that will be true for most of us on a path to extremely early retirement).

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #33 on: October 29, 2014, 01:41:39 PM »
Two questions.

First, and please correct me if I'm wrong, but in my research today about this topic, it seems like the IRS has always held that aftertax contributions to a traditional 401k are separate from "elective deferrals" which include the employee's typical contribution plus employer match (it all comes from the employer technically. The difference now is that before, if you withdrew anything from that aftertax subaccount, the earnings those contributions had, well, earned were comingled with your contributions, so you couldn't (easily) separate out your original aftertax contributions only to go to a Roth IRA or into your pocket tax free, since you had to pro-rata whatever earning they had also earned. Now you can split the earnings off and put those separately into a traditional IRA or even another 401k that will accept them, and only direct aftertax contributions to the Roth. My question is whether you can do all of this without ever touching the traditional pretax contributions and earnings, and whether I am understanding all of this correctly.

Second, my 401k plan explicitly says that it does not allow aftertax contributions, there is no Roth 401k (not that I'd use it with my high marginal rate), and it allows in-service distributions for hardship type situations but doesn't explicitly allow other types. So obviously I would need to do some lobbying to get these benefits. Does anyone know if there are specific reasons for companies to not include these features? Do aftertax contributions run afoul of the rules for highly compensated employees and such, or is it mostly to protect most employees from overcontributing past the elective deferral limit and also limit withdrawal mistakes, etc?

brooklynguy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #34 on: October 29, 2014, 07:04:03 PM »
Two questions.

First, and please correct me if I'm wrong, but in my research today about this topic, it seems like the IRS has always held that aftertax contributions to a traditional 401k are separate from "elective deferrals" which include the employee's typical contribution plus employer match (it all comes from the employer technically. The difference now is that before, if you withdrew anything from that aftertax subaccount, the earnings those contributions had, well, earned were comingled with your contributions, so you couldn't (easily) separate out your original aftertax contributions only to go to a Roth IRA or into your pocket tax free, since you had to pro-rata whatever earning they had also earned. Now you can split the earnings off and put those separately into a traditional IRA or even another 401k that will accept them, and only direct aftertax contributions to the Roth. My question is whether you can do all of this without ever touching the traditional pretax contributions and earnings, and whether I am understanding all of this correctly.

I think you are understanding this correctly.  On the issue of being able to roll over after-tax 401k contributions into a Roth IRA (the mega back door Roth strategy), this new IRS guidance really just clarifies the position that had already been the general consensus among tax experts, save for a few outliers who questioned/doubted its legitimacy in the absence of explicit IRS guidance.  For plans that allow after-tax contributions and have separate subaccounts for the various contribution types, I think most were already being administered in a manner consistent with this guidance.  If your 401k plan allows after-tax contributions and allows in-service distributions, you can definitely take a distribution of the after-tax portion without touching the traditional pretax portion (and if it doesn't allow in-service distributions, you can still do the same but you have to wait until you leave your employer, so you can't get the funds into the Roth IRA right away to shelter the earnings).

Second, my 401k plan explicitly says that it does not allow aftertax contributions, there is no Roth 401k (not that I'd use it with my high marginal rate), and it allows in-service distributions for hardship type situations but doesn't explicitly allow other types. So obviously I would need to do some lobbying to get these benefits. Does anyone know if there are specific reasons for companies to not include these features? Do aftertax contributions run afoul of the rules for highly compensated employees and such, or is it mostly to protect most employees from overcontributing past the elective deferral limit and also limit withdrawal mistakes, etc?

Yes, the after-tax contribution option has ramifications for the highly compensated employee rules.  I don't know enough about this area to speak intelligently about it, but at the very least it makes the highly compensated employee analysis more complicated.

sol

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #35 on: October 30, 2014, 12:49:39 AM »
So now I've come back around to my original view that you can use mega back door Roth rollovers in lieu of taxable accounts to bridge the five year gap

Only for people who can make in-service or unlimited withdrawals from their 401k, which I gather is not most of us.  Federal employees, for example, are limited to two withdrawals from the TSP.  Ever, in their whole lives.  That's a significant disincentive to play with this kind of tax trickery.

brooklynguy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #36 on: October 30, 2014, 05:08:14 AM »
So now I've come back around to my original view that you can use mega back door Roth rollovers in lieu of taxable accounts to bridge the five year gap

Only for people who can make in-service or unlimited withdrawals from their 401k, which I gather is not most of us.  Federal employees, for example, are limited to two withdrawals from the TSP.  Ever, in their whole lives.  That's a significant disincentive to play with this kind of tax trickery.

Even if you don't have the ability to do in-service withdrawals, you can use the new guidance to split up the rollover of the after-tax 401k account upon leaving your employer to send the contributions (principal) to a Roth IRA and the earnings to a traditional IRA.  You still get immediate, penalty free access to the contributions upon retirement (which you can use to bridge the gap).  You just don't get the benefit of sheltering the earnings in a Roth right away, but there still seems to be no reason not to do it (again, unless you need access to those earnings during the five year gap).  It can't hurt, but it can help.

EDIT:  Thinking out loud, this approach of separately rolling the earnings into a traditional IRA (instead of immediately rolling the contributions into a Roth IRA, if in-service distributions are allowed under your plan) may even be the preferable strategy for the typical aspiring early retiree.  It still shelters the earnings from taxes during your high-income earning years, but allows you to access those earnings starting five years after retirement (because you can roll them into a traditional IRA, then convert that tIRA to a Roth IRA during low-income retirement, and access it five years later, just like the rest of your Roth pipeline).

If you utilize in-service withdrawals to roll the contributions to a Roth IRA right away, you will never be able to access the earnings until traditional retirement age.  (Of course, the benefit of the tradeoff is that you won't ever have to pay taxes on them, but if you're a frugal early retiree you may not have to pay taxes on them in any event.)
« Last Edit: October 30, 2014, 07:21:23 AM by brooklynguy »

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #37 on: October 30, 2014, 12:16:01 PM »
Called HR, no extra contributions allowed as of now and no word on if they will be for 2015.

Beric01

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #38 on: October 30, 2014, 01:46:52 PM »
Called HR, no extra contributions allowed as of now and no word on if they will be for 2015.

I actually sent HR the OP's article and a brief message about how it would be an incredible opportunity for retirement savings for our company's employees. We'll see if that has any better effect. :)

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #39 on: October 31, 2014, 12:48:26 PM »
I figured I would post this here since I didn't get any responses to the thread I made in another section.

I recently switched jobs and rolled over $5000 from a Fidelity Roth 401k to a Vanguard Roth IRA.  My questions are as follows:

  • When can I withdraw the contributions (rollover) from the Roth IRA?  I think anytime, but not sure.
  • If I contribute money to an After-Tax 401k and roll it over to the Roth IRA, when would that money be withdraw-able?

brooklynguy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #40 on: November 01, 2014, 11:58:46 AM »
I figured I would post this here since I didn't get any responses to the thread I made in another section.

I recently switched jobs and rolled over $5000 from a Fidelity Roth 401k to a Vanguard Roth IRA.  My questions are as follows:

  • When can I withdraw the contributions (rollover) from the Roth IRA?  I think anytime, but not sure.
  • If I contribute money to an After-Tax 401k and roll it over to the Roth IRA, when would that money be withdraw-able?

Money is a Roth IRA is always "with-drawable."  The question is really whether the withdrawals will be subject to tax and/or penalty.  See seattle's post above on the distribution ordering rules for how to determine the answer to that question.  If you have no preexisting Roth IRA, then in your situation the answers to your questions are:

1.  Yes, you can withdraw the contributions anytime tax- and penalty-free.

2.  This depends on whether the amount rolled over represents solely the contributions or a mix of contributions and earnings.  If the entire amount rolled over represents contributions, then you can withdraw the contributions immediately tax- and penalty-free.  And you can subsequently do another after-tax 401k contribution and roll it over and immediately be able to withdraw it tax- and penalty-free, and so on.  If, however the amount rolled over represents a mix of contributions and earnings, then you have to wait five years if you want to access the money without any penalties (because the ordering rules will force you to withdraw the earnings first, which are subject to the 10% penalty for the five years following the rollover).

Undecided

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #41 on: November 02, 2014, 04:54:24 AM »
I figured I would post this here since I didn't get any responses to the thread I made in another section.

I recently switched jobs and rolled over $5000 from a Fidelity Roth 401k to a Vanguard Roth IRA.  My questions are as follows:

  • When can I withdraw the contributions (rollover) from the Roth IRA?  I think anytime, but not sure.
  • If I contribute money to an After-Tax 401k and roll it over to the Roth IRA, when would that money be withdraw-able?

Money is a Roth IRA is always "with-drawable."  The question is really whether the withdrawals will be subject to tax and/or penalty.  See seattle's post above on the distribution ordering rules for how to determine the answer to that question.  If you have no preexisting Roth IRA, then in your situation the answers to your questions are:

1.  Yes, you can withdraw the contributions anytime tax- and penalty-free.

2.  This depends on whether the amount rolled over represents solely the contributions or a mix of contributions and earnings.  If the entire amount rolled over represents contributions, then you can withdraw the contributions immediately tax- and penalty-free.  And you can subsequently do another after-tax 401k contribution and roll it over and immediately be able to withdraw it tax- and penalty-free, and so on.  If, however the amount rolled over represents a mix of contributions and earnings, then you have to wait five years if you want to access the money without any penalties (because the ordering rules will force you to withdraw the earnings first, which are subject to the 10% penalty for the five years following the rollover).

Although applicable time periods and amounts may make this unhelpful for many, consider that you could take SEPP from the Roth, or withdraw all or some aged contributions and take SEPP from remaining contributions and earnings. Under 72(t) you'd then avoid the penalties. For most people, better to bridge the gap, but there may be scenarios where that's the difference between a workable and unworkable plan.

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #42 on: November 02, 2014, 08:14:19 PM »
In the Forbes article they say you can contribute up to $52,000 per year with combined tax-deferred and after-tax contributions, but aren't IRAs only up to $5k per year? Can someone explain this to me? I've put $17,500 into my 401k this year. I have $30,000 left over. What do I do next? Thanks!

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #43 on: November 02, 2014, 08:24:30 PM »

In the Forbes article they say you can contribute up to $52,000 per year with combined tax-deferred and after-tax contributions, but aren't IRAs only up to $5k per year? Can someone explain this to me? I've put $17,500 into my 401k this year. I have $30,000 left over. What do I do next? Thanks!

Did you even read the thread before posting? See above.

RabStache

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #44 on: November 03, 2014, 11:25:08 AM »
I figured I would post this here since I didn't get any responses to the thread I made in another section.

I recently switched jobs and rolled over $5000 from a Fidelity Roth 401k to a Vanguard Roth IRA.  My questions are as follows:

  • When can I withdraw the contributions (rollover) from the Roth IRA?  I think anytime, but not sure.
  • If I contribute money to an After-Tax 401k and roll it over to the Roth IRA, when would that money be withdraw-able?

Money is a Roth IRA is always "with-drawable."  The question is really whether the withdrawals will be subject to tax and/or penalty.  See seattle's post above on the distribution ordering rules for how to determine the answer to that question.  If you have no preexisting Roth IRA, then in your situation the answers to your questions are:

1.  Yes, you can withdraw the contributions anytime tax- and penalty-free.

2.  This depends on whether the amount rolled over represents solely the contributions or a mix of contributions and earnings.  If the entire amount rolled over represents contributions, then you can withdraw the contributions immediately tax- and penalty-free.  And you can subsequently do another after-tax 401k contribution and roll it over and immediately be able to withdraw it tax- and penalty-free, and so on.  If, however the amount rolled over represents a mix of contributions and earnings, then you have to wait five years if you want to access the money without any penalties (because the ordering rules will force you to withdraw the earnings first, which are subject to the 10% penalty for the five years following the rollover).

Does the 5 year rule not come into play for this?  My Roth 401k at my old company was created in 2012.  I shouldn't be able to withdraw the contributions that I moved over until 2017 correct?  I do not plan on withdrawing this money but I just wanted to know if something ever comes up.

seattlecyclone

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #45 on: November 03, 2014, 11:33:36 AM »
Again, it's not a question of being "able" to withdraw the money. You can always withdraw money from an IRA, there are just lots of situations where you'll pay an uncomfortably high amount of tax on it if you do.

I don't know the timing rules for funds that are rolled over from a Roth 401(k) to a Roth IRA.

This thread is mainly about rolling over non-Roth after-tax 401(k) funds to a Roth IRA. The impact of the five-year rule on these conversions is discussed above. The gist of it is that only the earnings you accumulated while the money was still in your after-tax 401(k) will be subject to penalties if it is withdrawn within five years of conversion. The principal, which should make up the bulk of the amount converted, was not subject to tax at the time of the conversion, so it is not subject to penalties if withdrawn within five years.

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #46 on: November 03, 2014, 05:39:57 PM »
I did read the thread but still didn't  understand exactly how to set this up. Do we need  to roll over the money into a Roth if we already have a bridge set up? Can it be kept in the regular 401k and not touched until the criteria is met? If this question is too basic for it to be worth your time to answer, please don't.

Undecided

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #47 on: November 03, 2014, 06:06:25 PM »
In the Forbes article they say you can contribute up to $52,000 per year with combined tax-deferred and after-tax contributions, but aren't IRAs only up to $5k per year? Can someone explain this to me? I've put $17,500 into my 401k this year. I have $30,000 left over. What do I do next? Thanks!

1) Does your 401(k) plan permit after-tax contributions? The numbers your quote are the limits under law, but not all plans permit such contributions, or permit them without limit. Also, this is different from a "Roth 401(k)" option.
2) If the answer to #1 is yes, does your 401(k) plan permit in-service withdrawals?

If so, you may be able to get some use out of this.

3) Does your 401(k) plan administrator hold after-tax contributions and associated earnings as a "separate contract"? That is, does it track them as a separate sub-account?

Assuming the answers those question are yes, you could make after-tax contributions to your 401(k), up to the portion of the annual maximum (currently $52,000 under law, but possibly lower in your plan or circumstances) not used by your elective deferral (the $17,500) and any employer contribution. You could then take an in-service withdrawal of such contributions (together with associated earnings) as a rollover to a traditional IRA, a Roth IRA, or a combination of both (as the IRS has now expressly approved), although it's possible your plan needs to catch up to the recent ruling. Although there is a $5,500 limit for contributions to an IRA, what you are asking about is not a contribution, but rather a "rollover." While you could roll the entire amount of the after-tax contributions and the associated earnings directly to a Roth IRA, the earnings included in that amount would be taxed as income. There are a couple of techniques to isolate the contributions from the earnings, though, and if your 401(k) plan also permits incoming rollover contributions from a traditional IRA, you may be able to both roll the after-tax contributions to a Roth IRA and avoid both (i) paying taxes on the earnings to roll them into the Roth IRA and (ii) creating any continuing balance in a traditional IRA that would have the effect of making future "backdoor Roth IRA contributions" partly taxable.

brooklynguy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #48 on: November 03, 2014, 07:27:11 PM »
In the Forbes article they say you can contribute up to $52,000 per year with combined tax-deferred and after-tax contributions, but aren't IRAs only up to $5k per year? Can someone explain this to me? I've put $17,500 into my 401k this year. I have $30,000 left over. What do I do next? Thanks!

1) Does your 401(k) plan permit after-tax contributions? The numbers your quote are the limits under law, but not all plans permit such contributions, or permit them without limit. Also, this is different from a "Roth 401(k)" option.
2) If the answer to #1 is yes, does your 401(k) plan permit in-service withdrawals?

If so, you may be able to get some use out of this.

3) Does your 401(k) plan administrator hold after-tax contributions and associated earnings as a "separate contract"? That is, does it track them as a separate sub-account?

Assuming the answers those question are yes, you could make after-tax contributions to your 401(k), up to the portion of the annual maximum (currently $52,000 under law, but possibly lower in your plan or circumstances) not used by your elective deferral (the $17,500) and any employer contribution. You could then take an in-service withdrawal of such contributions (together with associated earnings) as a rollover to a traditional IRA, a Roth IRA, or a combination of both (as the IRS has now expressly approved), although it's possible your plan needs to catch up to the recent ruling. Although there is a $5,500 limit for contributions to an IRA, what you are asking about is not a contribution, but rather a "rollover." While you could roll the entire amount of the after-tax contributions and the associated earnings directly to a Roth IRA, the earnings included in that amount would be taxed as income. There are a couple of techniques to isolate the contributions from the earnings, though, and if your 401(k) plan also permits incoming rollover contributions from a traditional IRA, you may be able to both roll the after-tax contributions to a Roth IRA and avoid both (i) paying taxes on the earnings to roll them into the Roth IRA and (ii) creating any continuing balance in a traditional IRA that would have the effect of making future "backdoor Roth IRA contributions" partly taxable.

You may be able to get use out of this even if the answer to #2 is no (and, as I mentioned in post # 36 above, for some of us it may even be preferable not to exercise the right to do in-service distributions even if we have that ability).  After doing the after-tax contributions, if you leave all the funds in the 401k plan until you retire, you can roll the contributions (principal) into a Roth IRA (which then become immediately accessible tax- and penalty-free) and roll the earnings into a traditional IRA.  You can fold this tIRA into the rest of your Roth conversion pipeline, allowing you to gain penalty-free access to those funds five years after conversion (whereas if you had moved the contributions into the Roth IRA right away using in-service distributions, you couldn't access the earnings without penalty until traditional retirement age).

Undecided

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #49 on: November 03, 2014, 08:16:59 PM »
In the Forbes article they say you can contribute up to $52,000 per year with combined tax-deferred and after-tax contributions, but aren't IRAs only up to $5k per year? Can someone explain this to me? I've put $17,500 into my 401k this year. I have $30,000 left over. What do I do next? Thanks!

1) Does your 401(k) plan permit after-tax contributions? The numbers your quote are the limits under law, but not all plans permit such contributions, or permit them without limit. Also, this is different from a "Roth 401(k)" option.
2) If the answer to #1 is yes, does your 401(k) plan permit in-service withdrawals?

If so, you may be able to get some use out of this.

3) Does your 401(k) plan administrator hold after-tax contributions and associated earnings as a "separate contract"? That is, does it track them as a separate sub-account?

Assuming the answers those question are yes, you could make after-tax contributions to your 401(k), up to the portion of the annual maximum (currently $52,000 under law, but possibly lower in your plan or circumstances) not used by your elective deferral (the $17,500) and any employer contribution. You could then take an in-service withdrawal of such contributions (together with associated earnings) as a rollover to a traditional IRA, a Roth IRA, or a combination of both (as the IRS has now expressly approved), although it's possible your plan needs to catch up to the recent ruling. Although there is a $5,500 limit for contributions to an IRA, what you are asking about is not a contribution, but rather a "rollover." While you could roll the entire amount of the after-tax contributions and the associated earnings directly to a Roth IRA, the earnings included in that amount would be taxed as income. There are a couple of techniques to isolate the contributions from the earnings, though, and if your 401(k) plan also permits incoming rollover contributions from a traditional IRA, you may be able to both roll the after-tax contributions to a Roth IRA and avoid both (i) paying taxes on the earnings to roll them into the Roth IRA and (ii) creating any continuing balance in a traditional IRA that would have the effect of making future "backdoor Roth IRA contributions" partly taxable.

You may be able to get use out of this even if the answer to #2 is no (and, as I mentioned in post # 36 above, for some of us it may even be preferable not to exercise the right to do in-service distributions even if we have that ability).  After doing the after-tax contributions, if you leave all the funds in the 401k plan until you retire, you can roll the contributions (principal) into a Roth IRA (which then become immediately accessible tax- and penalty-free) and roll the earnings into a traditional IRA.  You can fold this tIRA into the rest of your Roth conversion pipeline, allowing you to gain penalty-free access to those funds five years after conversion (whereas if you had moved the contributions into the Roth IRA right away using in-service distributions, you couldn't access the earnings without penalty until traditional retirement age).

Yes, I should have noted that. For completeness, in the scenario you describe, you could access the earnings and the rest of the account via SEPP without penalty even before 59.5.