| Scenario | Discussion | Image |
| I can take in-service distributions, or I will leave my company within a few years | In 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 free | http://i.imgur.com/cuY1FfF.png |
| I will remain at my company for a long time still, and can't take in service distributions | In 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 |
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?
The principle you rollover into a Roth IRA, and the earnings a traditional IRA.
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.
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.
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.
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.
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?
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.
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.
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.
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.
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.
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.
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...
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.
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...
(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.)
(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.
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)?
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)?
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 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.
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?
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
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.
Called HR, no extra contributions allowed as of now and no word on if they will be for 2015.
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?
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).
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!
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).
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!
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.
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).
401k Plan Guy: Hello, and thanks for contacting us. How can I help you?
Me: Hi. I just learned that our plan has after-tax contributions available. I currently max out the before tax contributions at $17,500 per year. Can I then also max out the after tax contribution at 20% of my salary?
Me: Are there any income limits on maxing this out?
401k Plan Guy: Hi, one moment while I confirm this information for you today.
401k Plan Guy: You can continue to make after tax contributions to your 401k from 1%-20%.
Me: Another question...
401k Plan Guy: Yes
Me: I read that I can also do an in-service distribution for this after-tax contribution every 6 months. Did I understand correctly? Can this be rolled over to a Roth IRA?
401k Plan Guy: You must be 59 1/2 to process an in-service distribution.
Me: Hold on let me see the page in the benefits book
401k Plan Guy: Ok
Me: Withdrawals of after-tax contributions
You may elect to withdraw all or any portion of your account attributable to your after-tax contributions. You may
not take more than one after-tax withdrawal in any six-month period. Like withdrawals of rollover amounts, the
minimum amount you may take is $200.
401k Plan Guy: Correct, once you have reached the age of 59 1/2.
Me: OK. I had read about a new IRS rule that might allow it. Maybe it's about to take effect. I will have to read on that. I know the before tax isn't allowed to be transferred while in service, but I thought the after tax was treated differently.
401k Plan Guy: My apologies, yes you can withdraw your after-tax funds without an age restriction.
Me: Yes, this is a complicated issue. Probably why I hadn't heard about it before.
Me: So there is also no in-service limitation either?
Me: If I am still employed I can withdraw the after tax funds and roll into a Roth IRA?
401k Plan Guy: The funds must be rolled over to an eligible employer plan or traditional IRA.
Me: OK, but I can withdraw while still employed...just one last verification.
Me: (taxes are confusing)
401k Plan Guy: Yes, after-tax no restriction (age 59 1/2 everything but employer contributions).
Me: Perfect, thanks.
401k Plan Guy: You're welcome.
One of the benefits I see in the Roth IRA vs. traditional IRA is that you can trade within it (yes, I know it's a no-no) without worrying about capital gains. So then you don't have to worry whether you are below the 15% tax bracket as much while FIRE'd. And you can control your income a little better for ACA purposes.
I figure while FIRE'd I could first use my taxable accounts, then start withdrawing tax-free and income-worry free whatever contributions/rollovers I have made from my Roth IRA. All the while each year transferring from my traditional IRA to a Roth IRA every year to keep that pipeline going, and being able to withdraw those transfers after 5 years. The rollover amount would be my "income" for the year for ACA purposes.
Did I mention my head is exploding right now trying to process all of this?
EDIT: Even if I can't access the after-tax 401k money that has been transferred to a Roth for 5 years, if I start this now and FIRE in two years, I will be able to access the first year's money 3 years after FIREing.
By doing this, I won't have too much income left over to save in a regular taxable account, but I think I have three years worth of savings (at least) there.
One of the benefits I see in the Roth IRA vs. traditional IRA is that you can trade within it (yes, I know it's a no-no) without worrying about capital gains. So then you don't have to worry whether you are below the 15% tax bracket as much while FIRE'd. And you can control your income a little better for ACA purposes.
I figure while FIRE'd I could first use my taxable accounts, then start withdrawing tax-free and income-worry free whatever contributions/rollovers I have made from my Roth IRA. All the while each year transferring from my traditional IRA to a Roth IRA every year to keep that pipeline going, and being able to withdraw those transfers after 5 years. The rollover amount would be my "income" for the year for ACA purposes.
Did I mention my head is exploding right now trying to process all of this?
EDIT: Even if I can't access the after-tax 401k money that has been transferred to a Roth for 5 years, if I start this now and FIRE in two years, I will be able to access the first year's money 3 years after FIREing.
By doing this, I won't have too much income left over to save in a regular taxable account, but I think I have three years worth of savings (at least) there.
Since you're looking to do "trading," you should be more upset that you can't deduct capital losses, either. ;-)
This whole thread is making my head explode. It's times like these I wish pot was legal in my state. JK...not really a pot user...
So...I knew my 401k plan had an after-tax component but I always ignored it since I figured it was best to save in my own taxable account instead. But after reading this thread, I decided to look up my plan's information. We have the after-tax component, can save up to 20% of our income in it, and I can do an in-service withdrawal every 6 months. Woohoo! Now, do I want to do it? I may FIRE in a couple of years so being able to fund my Roth IRA further might be a good thing. I think I am above the income limits right now to be able to fund a Roth IRA with direct contributions so this could be very positive.
I'm still a little confused on whether these after-tax contributions can be accessed before five years (too much back and forth above and I am confused). It sure would help if the Mad FIentist would write an article on this...hint hint.
I think I stumped my plan's adviser when I had this chat with them today. They said I could roll over to a traditional IRA, but you guys are saying I can do it to a Roth IRA. I don't think they knew what I was talking about so maybe you guys are right. What do you think?
This whole thread is making my head explode. It's times like these I wish pot was legal in my state. JK...not really a pot user...
So...I knew my 401k plan had an after-tax component but I always ignored it since I figured it was best to save in my own taxable account instead. But after reading this thread, I decided to look up my plan's information. We have the after-tax component, can save up to 20% of our income in it, and I can do an in-service withdrawal every 6 months. Woohoo! Now, do I want to do it? I may FIRE in a couple of years so being able to fund my Roth IRA further might be a good thing. I think I am above the income limits right now to be able to fund a Roth IRA with direct contributions so this could be very positive.
I'm still a little confused on whether these after-tax contributions can be accessed before five years (too much back and forth above and I am confused). It sure would help if the Mad FIentist would write an article on this...hint hint.
I think I stumped my plan's adviser when I had this chat with them today. They said I could roll over to a traditional IRA, but you guys are saying I can do it to a Roth IRA. I don't think they knew what I was talking about so maybe you guys are right. What do you think?
First of all, you can (and should) convert the after-tax portion to a Roth IRA instead of a traditional IRA. The whole reason to do this is to put more money into your Roth accounts as quickly as possible so that it grows tax-free from now on. Leaving the money in the traditional after-tax 401(k) or IRA is worse than just having the money in a taxable account because your normal tax rate is higher than your capital gains tax rate.
If the after-tax part of your 401(k) has increased in value between your pay deductions and the in-service distribution, you haven't paid tax on the earnings yet. You can choose to either roll the earnings into the Roth IRA along with the contributions, or you can roll the earnings into a traditional IRA. The Roth IRA is probably a bit less paperwork, but you will have to pay tax on the earnings in the year you make the conversion. In addition, if you withdraw the earnings from the Roth IRA within five years, you'll owe a 10% penalty on this portion only. The after-tax portion can always be withdrawn from the Roth IRA tax-free and penalty-free..
Does that clear things up a bit?
...you can roll the contributions (principal) into a Roth IRA (which then become immediately accessible tax- and penalty-free)...
...you can roll the contributions (principal) into a Roth IRA (which then become immediately accessible tax- and penalty-free)...
Just so I understand, unlike a conversion of a traditional IRA to a Roth IRA (such as is used in the backdoor Roth), when you rollover aftertax traditional 401k contributions to a Roth IRA, there is no 5-year seasoning period, and they are treated exactly like true Roth IRA contributions, no tax and no penalty before 59.5years of age? That is awesome! I need the ability to contribution 401k aftertax now!
Almost. My understanding from this thread is that you have to think of your aftertax 401k as being made up of two components: contributions and earnings. When you go to roll it over to IRAs, the contributions portion go go straight to a Roth IRA with no seasoning period. The earnings portion you would have to either roll it over to a traditional IRA (which the new ruling allows you to easily do), or roll it over to a Roth IRA, pay income taxes on it, and have a 5 year seasoning period. (The same as if you first rolled over the earnings to a tIRA then immediately to a Roth IRA.
...you can roll the contributions (principal) into a Roth IRA (which then become immediately accessible tax- and penalty-free)...
Just so I understand, unlike a conversion of a traditional IRA to a Roth IRA (such as is used in the backdoor Roth), when you rollover aftertax traditional 401k contributions to a Roth IRA, there is no 5-year seasoning period, and they are treated exactly like true Roth IRA contributions, no tax and no penalty before 59.5years of age? That is awesome! I need the ability to contribution 401k aftertax now!
I've made a significant update to the original post, hopefully clarifying things. 90% of the confusion in these comments 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 earning to a traditional IRA now, avoiding the confusion.
Thanks for the clarification. Per your update and the diagrams, in most cases it would still be better to put the excess above $17.5k into a taxable account to avoid the marginal income tax rate on earnings and pay just the long-term capital gains (assuming one only withdraws earnings to fund retirement) ?
in most cases it would still be better to put the excess above $17.5k into a taxable account to avoid the marginal income tax rate on earnings and pay just the long-term capital gains (assuming one only withdraws earnings to fund retirement) ?
Thanks for the clarification. Per your update and the diagrams, in most cases it would still be better to put the excess above $17.5k into a taxable account to avoid the marginal income tax rate on earnings and pay just the long-term capital gains (assuming one only withdraws earnings to fund retirement) ?
I just called Fidelity and found that while my employer offers after tax contributions, they do not offer in service distributions. Would it still be beneficial to do 25% Pre-tax (18k max), and then 5% after-tax (My 401k plan has a 30% max) and when I leave the company convert contributions to Roth IRA and earnings to Traditional IRA? Is there anything I should be aware of in doing this?
Basically, the sooner you can get the after-tax contributions out of the 401(k) where earnings are pre-tax into the Roth IRA where the earnings are tax-free, the better.
Basically, the sooner you can get the after-tax contributions out of the 401(k) where earnings are pre-tax into the Roth IRA where the earnings are tax-free, the better.
Not necessarily. I'd say that for the average aspiring extremely-early retiree, forgoing in-service withdrawals is the better plan (assuming there are good investment options in the 401k plan). Keeping the after-tax contributions in the 401k allows you to defer taxes on the earnings during your high income earning years, but allows you to access those earnings sooner (on a tax- and penalty-free basis) than if you rolled the contributions immediately to a Roth IRA using in-service withdrawals (because when you retire, you can roll the earnings to a tIRA and access them five years thereafter). The fact that those earnings are at that point taxable upon withdrawal/conversion from the tIRA is of little consequence, because you will then be in a low enough bracket not to have to pay taxes (which is the same reason the Roth conversion pipeline idea makes sense). Doing it this way (essentially folding the earnings into your Roth conversion pipeline) also gives you additional "dry powder" in your tIRA to play around with if, for example, you are struggling to find enough income to hit the minimum for Affordable Care Act subsidies.
In my view, the biggest trade-off of doing it this way is the lost insulation against future changes in tax laws that may change the analysis.
<brooklyn accent>
Uhh... Hey bud, is you shoe you's from Brooklyn? I ain't nevva heard nobody from Brooklyn talkin' like that!
</brooklyn accent>
You must have missed THE NYC story of the last 20 years: Brooklyn is now officially gentrified. I hear very few NYC accents here any more. Actually, I hear more of them in my hometown in the NYC burbs. Every second elderly person there grew up in Brooklyn.
Basically, the sooner you can get the after-tax contributions out of the 401(k) where earnings are pre-tax into the Roth IRA where the earnings are tax-free, the better.
Not necessarily. I'd say that for the average aspiring extremely-early retiree, forgoing in-service withdrawals is the better plan (assuming there are good investment options in the 401k plan). Keeping the after-tax contributions in the 401k allows you to defer taxes on the earnings during your high income earning years, but allows you to access those earnings sooner (on a tax- and penalty-free basis) than if you rolled the contributions immediately to a Roth IRA using in-service withdrawals (because when you retire, you can roll the earnings to a tIRA and access them five years thereafter). The fact that those earnings are at that point taxable upon withdrawal/conversion from the tIRA is of little consequence, because you will then be in a low enough bracket not to have to pay taxes (which is the same reason the Roth conversion pipeline idea makes sense). Doing it this way (essentially folding the earnings into your Roth conversion pipeline) also gives you additional "dry powder" in your tIRA to play around with if, for example, you are struggling to find enough income to hit the minimum for Affordable Care Act subsidies.
In my view, the biggest trade-off of doing it this way is the lost insulation against future changes in tax laws that may change the analysis.
I disagree that this would be an optimal strategy for many early retirees. I'm assuming that someone will max out their pre-tax 401(k) before doing the after-tax contributions. Even someone who retires very early will then have a sizable amount in their pre-tax 401(k), enough to fund a Roth pipeline maxing out the 0-10% tax brackets for quite a few years. The later you retire, the smaller this number of years needs to be in order to reach age 59½. The earlier you're able to retire, the more likely it is that you had to do some taxable saving in addition to your 401(k) and IRAs in order to get a big enough stash to retire. That taxable account will supplement the Roth pipeline, again making it quite likely that you get to 59½ before you need to even think about touching the earnings in your Roth.
I'm really having a hard time envisioning a scenario where someone both has enough money to sustain them for the rest of their life, but that money is all in the form of Roth earnings that they're too young to withdraw. Maybe if there was extremely high inflation that devalued the Roth principal in nominal terms. Beyond that, I don't think that's something most of us will need to worry about.
brooklynguy, I like your example.
" If this person split off the earnings on the after-tax contributions into a traditional 401k [Or IRA?] instead of doing immediate in-service withdrawals, they can access the entire portfolio (including the 170k) during those three decades, which brings the withdrawal rate back into safe territory (4%)."
This person will pay marginal income tax rates on those earnings though. If this person were to instead not put anything into an after tax 401k and put $34.5k per year into taxable accounts, they would only pay Long term capital gains tax on the earnings, most of which would probably be 0% for this low spender. THAT's the alternative you have to assess. (the downside of course is that income taxes are owed on any interest/dividends each year on the principal).
But my point is that this frugal person will probably be paying zero taxes on those earnings in retirement either way (just like with the rest of funds in the Roth conversion pipeline). Once starting the pipeline, he or she should be converting an amount each year right up to the total amount of available deductions (for this frugal retiree, probably the standard deduction and exemptions), and tap the Roth contributions for any shortfall.
You only pay zero tax on Roth conversions to the extent that they are less than the standard deduction and personal exemption ($10k single/$20k married). In your example ($260k pre-tax growing at 8% annually), the earnings in the account each year ($20.8k) are more than enough to max out that space for a married couple. If you leave your $170k of after-tax earnings in a tax-deferred status, that amount will accumulate another $13.6k of tax-deferred earnings each year. So you either have to withdraw more than the earnings each year and pay some tax or stick to the 0% bracket and just let your pre-tax money grow indefinitely. In this case, you would have been better off putting your post-tax funds in a taxable account because you really would pay 0% tax on this $13.6k during retirement.
Having money in a traditional after-tax 401(k) during retirement is almost never a better idea than keeping that money in a taxable account. If you have the after-tax option available, it should only be used as a way to stuff your Roth with more money than you would otherwise be able to contribute. If you're worried about having access to enough money during pre-59½ retirement, use a taxable account instead so that the earnings are taxed at a lower rate when you sell.
You only pay zero tax on Roth conversions to the extent that they are less than the standard deduction and personal exemption ($10k single/$20k married). In your example ($260k pre-tax growing at 8% annually), the earnings in the account each year ($20.8k) are more than enough to max out that space for a married couple. If you leave your $170k of after-tax earnings in a tax-deferred status, that amount will accumulate another $13.6k of tax-deferred earnings each year. So you either have to withdraw more than the earnings each year and pay some tax or stick to the 0% bracket and just let your pre-tax money grow indefinitely. In this case, you would have been better off putting your post-tax funds in a taxable account because you really would pay 0% tax on this $13.6k during retirement.
Having money in a traditional after-tax 401(k) during retirement is almost never a better idea than keeping that money in a taxable account. If you have the after-tax option available, it should only be used as a way to stuff your Roth with more money than you would otherwise be able to contribute. If you're worried about having access to enough money during pre-59½ retirement, use a taxable account instead so that the earnings are taxed at a lower rate when you sell.
The earnings in the pre-tax account would not outpace the available space for non-taxable Roth conversions, because the standard deduction and personal exemption are increased each year at a rate approximating the inflation rate. (Your numbers incorrectly assume that the annual amount that can be converted tax-free in the Roth pipeline remains constant, unadjusted for inflation, for thirty years.) Cfiresim tells me that historically, during those thirty years this hypothetical married couple would completely exhaust the $260k pre-tax account 83 out of 115 times if we continue to assume a constant 8% return (and 85 out of 115 times if we use actual historical performance) (in either case, using cfiresim's default settings for the other variables, including a 75/25 stock/bond allocation). This couple is going to need to access the $170k of after-tax earnings in tax-deferred status during those thirty years too.
Are we using inflation in this scenario or not? I figured we were ignoring it because of the assumption of constant $17.5k/$34.5k contributions to the 401(k) (these limits are indexed to inflation as well). But if we're ignoring inflation, 8% return on investments is a bit higher than I would assume, so I concede that the earnings on the pre-tax account would probably not actually be higher than the 0% tax bracket most years for a married couple.
I will also concede that the couple in your example would probably be better off leaving their money in their after-tax 401(k) than converting to Roth. They would even be better off doing this than having the money in a taxable account because they wouldn't need to pay tax on dividends/capital gains during their working years.
However, I would also argue that this is pretty much the most extreme possible scenario.
If the worker had earned any more each year, they would have had some money left over to save in a taxable account, increasing the fraction of their money that isn't earnings on after-tax contributions.
If the worker had earned any less each year, they would have been unable to max out the after-tax 401(k). This would have also increased the fraction of their money that isn't earnings on after-tax contributions.
If the worker had an employer match in their 401(k), they would have more pre-tax money going in there each year, which would have reduced their after-tax contribution limit, which would have also increased the fraction of their money that isn't earnings on after-tax contributions.
If the worker's spouse also worked for a company offering a 401(k), each earning $50k instead of one earning $100k, the couple would have doubled their pre-tax contributions and the after-tax contributions would have been cut roughly in half, which would once again increase the fraction of their money that isn't earnings on after-tax contributions.
Basically any variable you tweak in your scenario increases the probability that the couple would be able to make it to age 59½ without touching the earnings on their after-tax contributions. There may be many real-life couples who are similar enough to your hypothetical couple that they would benefit from making after-tax 401(k) contributions and not converting them to Roth right away. However, I stand by my statement that this is a sub-optimal strategy for the majority of early retirees. Most would be better off either saving in a taxable account or making after-tax 401(k) contributions and regularly converting them to Roth.
Since this thread has just been bumped, in case anyone hasn't seen it, yesterday the Mad Fientist did a nice write-up of the mega backdoor Roth option available here (http://www.madfientist.com/after-tax-contributions/). It doesn't contain any information not available in this thread, but in typical Mad Fientist fashion it presents the information in an easy-to-follow, clear and concise manner (it is actually missing some of the nuances discussed in this thread, but that's the price of clarity and concision, and the details and nuances will get fleshed out in the comments).Thanks for sharing the link. That is helpful. I think I'll pass that along to our HR dept. in the hopes that they might see the advantage of allowing this in our 401(k) plan.
Bumping this with a question as my company has the trifecta of after tax 401k, allowing in service withdrawals and subaccounting of the different accounts.
One complication is we have an employer match on the after tax portion. I would assume that would be considered pre tax money for the purposes of rolling it over to a Roth IRA?
In the madfientist article that was linked above there was a description of moving the earnings amount on the after tax portion $8,700 in his example to the Roth as well and not incurring any penalty or taxable event. This seems contradicting to this thread from his explanation: "You can see that the gains on the after-tax contributions that would have been taxed in the initial scenario are now protected in the Roth IRA and will be tax free whenever we decide to withdraw the money!"
So according to the above quote these gains that were originally tax deferred gains generated in the after tax 401k will now not be taxed ever in the Roth, no matter when you withdraw them..... then why would you even consider putting them in a traditional IRA?
I've been researching this and came across this article:
http://thefinancebuff.com/after-tax-401k-403b-rollover-to-roth-small-paycheck.html
If you have this "Mega Backdoor Roth" option, and have outside investments already, and won't get
up to the 53k from your annual salary, you can "convert" non-retirement money into Roth. Basically use your outside investments to live off of, and put your whole paycheck to this.
The numbers he uses are not very mustacian, but there's still benefit IMO.
Can I roll over just the after-tax amounts in my account to a Roth IRA and leave the remaining amounts in the plan (i.e., take a partial distribution of just the after-tax amounts)?
No. The guidance provided in Notice 2014-54 does not alter the requirement that each distribution from a plan must include a proportional share of the pretax and after-tax amounts in the account. Accordingly, any partial distribution from the plan must include some of the pretax amounts you have in your account -- you cannot take a distribution of only the after-tax amounts and leave the pretax amounts in the plan. In order to roll over all of your after-tax contributions to a Roth IRA, you could take a distribution of the full amount (all pretax and after-tax amounts) in your account, roll over all the pretax amounts in a direct rollover to a traditional IRA or another eligible retirement plan, and roll over all the aftertax amounts in a direct rollover to a Roth IRA.
QuoteCan I roll over just the after-tax amounts in my account to a Roth IRA and leave the remaining amounts in the plan (i.e., take a partial distribution of just the after-tax amounts)?
No. The guidance provided in Notice 2014-54 does not alter the requirement that each distribution from a plan must include a proportional share of the pretax and after-tax amounts in the account. Accordingly, any partial distribution from the plan must include some of the pretax amounts you have in your account -- you cannot take a distribution of only the after-tax amounts and leave the pretax amounts in the plan. In order to roll over all of your after-tax contributions to a Roth IRA, you could take a distribution of the full amount (all pretax and after-tax amounts) in your account, roll over all the pretax amounts in a direct rollover to a traditional IRA or another eligible retirement plan, and roll over all the aftertax amounts in a direct rollover to a Roth IRA.
At first blush, this seems to run counter to the mega back door roth strategy.
Notably, to the extent a retiree takes out only part of the account, the pro-rata rules under IRC Section 72(e)(8) do still apply to determine how much is coming out in the first place. Thus, for instance, if the 401(k) balance is $100,000 including $20,000 of after-tax funds, and the individual only requests a $20,000 distribution, then the distribution is treated as $16,000 of pre-tax and $4,000 of after-tax; while this could still be split, with the $16,000 of pre-tax to a rollover IRA and $4,000 of after-tax to a Roth, if the account owner wants to get out all $20,000 of after-tax funds into a Roth, he/she will be required to take all $100,000 from the 401(k) plan getting out the whole $20,000 of after-tax and $80,000 of pre-tax and can then allocate the pre-tax funds to a rollover IRA and the after-tax to a Roth.
Ok, I'm sufficiently convinced (for someone who doesn't have to make this decision himself!) that this "separate contract/sub-account" is an actual IRS-allowed thing. It just feels weird that this artificial separation is respected in the 401(k) world, because in the IRA world, the IRS gives zero fucks about whether you have your IRAs in "separate contracts": "nice try, asshole, you thought you could trick me by holding your money in separate accounts? Get the hell out of here, it's all one pot!" But I guess the different treatment of 401(k)-vs.-IRA is just another highlight of what a jury-rigged mess the whole 401(k) concept is!
I just realized that my 401k allows for in-service withdrawals, so I came back to thread to read up on the topic. Last year, I made two months' worth of after-tax contributions after hitting the pre-tax maximum in October.
I just realized that my 401k allows for in-service withdrawals, so I came back to thread to read up on the topic. Last year, I made two months' worth of after-tax contributions after hitting the pre-tax maximum in October. I'm about to contact my plan administrator, and I'm crossing my fingers that I'll be able to withdraw just the after-tax contributions.
Why did you make after-tax 401k contributions without a view towards doing mega backdoor roth rollovers? Simply for the tax deferral on the earnings?
You can't withdraw just the contributions. Any earnings have to come out as well. You are allowed to divert the earnings to a traditional IRA to avoid paying tax on them for now (which could probably be rolled back into your 401(k) if you really felt like it), but you can't just leave that amount in your after-tax 401(k) subaccount.