Author Topic: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?  (Read 50376 times)

Daisy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #50 on: November 03, 2014, 08:36:10 PM »
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?

Here's our discussion:

Quote
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.
« Last Edit: November 03, 2014, 09:37:49 PM by Daisy »

Daisy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #51 on: November 03, 2014, 08:42:02 PM »
One of the benefits I see in the Roth IRA vs. taxable account 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.
« Last Edit: November 03, 2014, 09:54:39 PM by Daisy »

okashira

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #52 on: November 03, 2014, 09:08:39 PM »
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. ;-)

okashira

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #53 on: November 03, 2014, 09:09:35 PM »
I have been doing this for a couple of months. Contributing to my after tax.
For some reason my employer allows only 18% salary to my after tax. :-/

I shouldn't complain, as 18% is way better then zero, and otherwise our 401k is pretty awesome.

act01

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #54 on: November 03, 2014, 09:19:59 PM »
I'm also still wrapping my head around this a bit... my 401k has an after tax option (up to 10%) that I'm not using. I'm maxing a pre-tax 401k and Roth IRA, and saving on my own. Knowing this new info, for 2015, would it make more sense to max the after-tax 401k, not max the pre-tax 401k, and reserve the Roth IRA for a backdoor contribution (like from a SEP IRA to Roth IRA)?

Daisy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #55 on: November 03, 2014, 09:30:30 PM »
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. ;-)

Possibly. ;-)

I'm not saying I will trade or not, but basically that any capital gains obtained in the Roth IRA won't affect my ACA income, so I can confidently calculate what my FIRE taxable income is (whatever I roll over from a traditional IRA to Roth IRA every year while executing the Roth conversion pipeline) without worrying about capital gains influencing my MAGI for ACA.

Although if I choose to trade I will keep that a secret on this forum. ;-)

Man our tax code is weird...

seattlecyclone

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #56 on: November 03, 2014, 09:39:32 PM »
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?
« Last Edit: November 03, 2014, 09:44:23 PM by seattlecyclone »

Daisy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #57 on: November 03, 2014, 09:47:54 PM »
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?

Yes...I think you are saying I can withdraw whatever after-tax portion I had contributed to the 401k then transferred to a Roth IRA (which I do every 6 months) without worrying about a 5 year delay.

PathtoFIRE

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #58 on: November 04, 2014, 08:45:49 AM »
...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!

welliamwallace

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #59 on: November 04, 2014, 08:59:19 AM »
...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.

brooklynguy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #60 on: November 04, 2014, 11:04:14 AM »
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.

Yes this is correct.  The easiest way to think about this is that you can get money into your Roth IRA in a variety of ways (direct contribution, conversion of traditional IRA, rollover from after-tax 401k, etc.), and you can always take money out of your Roth IRA but you have to follow the distribution ordering rules to determine if the withdrawals will be subject to tax or penalty (and you can use seattle's excellent post on that topic (post # 28 above) as a guide).

seattlecyclone

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #61 on: November 04, 2014, 11:06:50 AM »
...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!

The same provision applies to backdoor Roth IRA contributions as well. A penalty is only owed when you withdraw amounts that you paid tax on at the time of conversion from traditional to Roth. When you convert pre-tax amounts from your traditional IRA or 401(k) to a Roth IRA, you have to wait five years before you can withdraw these funds penalty-free. When you convert post-tax amounts from your traditional IRA or 401(k) to a Roth IRA, the money can be taken out immediately without penalty.

Do keep the ordering rules in mind. Conversions are always withdrawn in first-in, first-out order. If you converted pre-tax funds last year and after-tax funds this year, you can't withdraw the after-tax funds until the pre-tax funds have been withdrawn, so you would have to wait until five years from last year's conversion to withdraw without penalty.

welliamwallace

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #62 on: November 04, 2014, 11:09:16 AM »
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.

Abe

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #63 on: November 04, 2014, 07:10:26 PM »
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) ?

Daisy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #64 on: November 04, 2014, 07:21:50 PM »
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 update! It's been very helpful.

Well after considering this through, I figure I am the target market for these after-tax 401k contributions so today I changed my 401k to also take out 20% for after-tax funds. I couldn't see anywhere a way to steer the before and after tax funds into different investments. I'll see what the first contribution looks like. Hopefully it takes for this next paycheck.

I also recalculated my MAGI and I do indeed qualify for regular Roth IRA contributions as well. I haven't seen anything that says I can't contribute to both. I suppose once I start transferring the after-tax 401k contributions over to the Roth every 6 months I will be mixing and matching the types of Roth IRA contributions. It might make it confusing once I start to want to withdraw the contributions pre-59.5. Would it be better to create two different Roths to avoid 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) ?

If you can afford to, I still think the after-tax 401k is better than a regular taxable account because then your money grows tax free once you place it into a Roth IRA. No need to worry about capital gains. And with the ACA lurking out there, you want to be able to control your MAGI well while FIRE'd and not worry about capital gains.

sol

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #65 on: November 05, 2014, 12:31:10 AM »
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) ?

How do you think you are avoiding paying your marginal income tax rate on money you're putting into your taxable account?  The whole point of this megabackdoor Roth idea is that you're going to be paying your marginal tax rate this year either way, but at least if you put the money into your 401k as after tax contributions then you have the option of moving it into a Roth for some tax shelter later on, which your taxable account will never offer.

okashira

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #66 on: November 05, 2014, 12:41:28 PM »
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) ?

Uh, how would you be "avoiding" marginal income tax on deposits into a taxable acct??
If you had a magic wand to make this happen, then, yeah, it would be nice.

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #67 on: November 06, 2014, 09:24:19 AM »
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?

sol

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #68 on: November 06, 2014, 12:06:35 PM »
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?

I also don't have access to in-service distributions, so my plan is very similar.  I will make after-tax contributions that will stay put until I retire, at which point I will convert my 401k using the above methods, which basically break down into three parts.

Part 1 is my normal pre-tax 401k contributions, which will get converted to a traditional IRA (a tax free conversion).  I will then start the annual 5 year pipeline by converting a portion of these traditional IRA funds to a Roth IRA, paying taxes in the year of conversion.

Part 2 is my after-tax contributions to my 401k contribution, which are further subdivided into contributions and earnings.
       a.  contributions can get converted directly to a Roth IRA, since taxes have already been paid on them.  Immediately withdrawable.
       b.  earnings will get converted to a (different) traditional IRA, because they have not yet been taxed.  Must wait 5 years to withdraw.

The downside of this plan is that the after-tax contributions are tied up until you retire, plus however long it takes to convert them and then withdraw them from your Roth.  So I wouldn't do it for ALL of your after tax contributions, in case you discover that you need some of that money before then.  In our case, we'll already have a significant taxable account balance so utilizing the after-tax 401k contributions is just a tiny bit of extra tax shelter on some fraction of our savings.

seattlecyclone

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #69 on: November 06, 2014, 12:20:17 PM »
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. If you're planning to leave your job in the next few years, this may make sense. If you plan to stay with the same employer for the next decade or two, you may be better off investing in a taxable account. The earnings will have a lower tax rate this way and you'll have easier access to the funds if you need them.

brooklynguy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #70 on: November 06, 2014, 12:41:53 PM »
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.

johnhenry

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #71 on: November 06, 2014, 12:59:15 PM »
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.

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Uhh... Hey bud, is you shoe you's from Brooklyn?  I ain't nevva heard nobody from Brooklyn talkin' like that!
</brooklyn accent>

brooklynguy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #72 on: November 06, 2014, 01:11:55 PM »
<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>




brooklynguy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #73 on: November 06, 2014, 01:36:11 PM »
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.

Yes.  In real life I actually do speak with a Brooklyn accent (though not quite the heavy Brooklynese of johnhenry's post), but I am a dying breed in this New Brooklyn of waxed mustaches and artisanal pickle-makers.

seattlecyclone

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #74 on: November 06, 2014, 04:23:09 PM »
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 59˝. 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 59˝ 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

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #75 on: November 06, 2014, 07:31:24 PM »
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 59˝. 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 59˝ 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.

By definition, anyone who is a good candidate for the Roth conversion pipeline strategy won't get much (or any) benefit out of having funds inside a Roth instead of a taxable account post-retirement, so getting earlier access to the funds arguably outweighs the minimal to non-existent tax benefits of sheltering the earnings inside the Roth.  And since the after-tax 401k mega backdoor Roth strategy is an alternative to investing in taxable accounts, many aspiring early retirees who use it could build up large stashes composed entirely (or almost entirely) of tax-advantaged accounts with little to no taxable component.  Maybe it was too strong of a statement to say that this will be the optimal strategy for the typical early retiree, but it will definitely be true for some subset of us.

Let's say someone has annual income of $100k.  They max out their traditional 401k ($17.5k per year) and after-tax 401k ($34.5k per year) (their income is too high to do deductible IRA contributions).  Their annual expenses are about $30k, so after taxes and the traditional and after-tax 401k contributions they have no savings left over for taxable investments.  After ten years, assuming continuous 8% returns (for simplicity's sake), this person will have accumulated about:

 - $260k in their trad 401k; and
 - $515k in their after-tax 401k ($170k of which represents earnings)

So this person's total stash is roughly $775k -- just enough to support $30k of expenses using a 4% withdrawal rate.  But there's only $345k (the total after-tax 401k contributions) immediately available upon retirement, and, if this person did immediate in-service rollovers of the after-tax amounts, only $260k available for the Roth conversion pipeline.  If this person retires at age 30, they need to fund three decades of retirement with only $605k (345 + 260) before gaining free access to the extra $170k; there's not much safety margin in those numbers (close to 5% for that 30 year period).  If this person split off the earnings on the after-tax contributions into a traditional 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%).
« Last Edit: November 07, 2014, 09:27:16 AM by brooklynguy »

welliamwallace

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #76 on: November 07, 2014, 08:36:48 AM »
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).

brooklynguy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #77 on: November 07, 2014, 09:25:29 AM »
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%)."

Oops, I meant to say "traditional IRA" (not traditional 401k) in the spot you quoted.  I edited the post to fix it.


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.

welliamwallace

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #78 on: November 07, 2014, 11:36:10 AM »
Got it, thanks for the clarification. I guess I really still expect my marginal income tax to be non zero, and greater than my LTCG tax in early retirement. For someone (e.g. Madfientist) with truly low expenses, you are probably right!

seattlecyclone

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #79 on: November 07, 2014, 12:01:09 PM »
Quote
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-59˝ retirement, use a taxable account instead so that the earnings are taxed at a lower rate when you sell.
« Last Edit: November 07, 2014, 12:02:41 PM by seattlecyclone »

brooklynguy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #80 on: November 07, 2014, 03:47:56 PM »
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-59˝ 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.

seattlecyclone

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #81 on: November 07, 2014, 05:58:55 PM »
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-59˝ 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 59˝ 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.

sol

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #82 on: November 07, 2014, 06:11:55 PM »
The conversation is far too polite and the participants far too knowledgeable for it to take place on the internet.   Please report to an offline venue or get back on track with the name calling and add hominem attacks.

brooklynguy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #83 on: November 07, 2014, 07:35:14 PM »
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.

Good point about the constant 17.5/34.5k contributions.  It didn't occur to me that inflation adjustments are relevant there too.
 
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 59˝ 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.

I agree with most of this, except the scenario where the worker had earned less each year (which is probably the most common real world scenario, since most people don't have six figure salaries).  It is true that a worker who earns less won't be able to max out the after-tax 401k, which would increase the fraction of their money that isn't earnings on after-tax contributions, but so what?  That person would also be better off leaving their money in their after-tax 401k than doing in-service rollovers to Roth, and possibly better off doing this than doing taxable investing (depending on just how much less they earn), just like the person in the example.

We have also ignored lots of other variables, such as other potential deductions/exemptions available after retirement (what if our worker has kids after he or she retires?), state taxes (if they are high and don't get the same favorable 0% tax treatment for low income brackets as under the federal scheme, like in my home state, then the taxable investment alternative becomes less attractive), etc.

So it's tough to say which is the more common scenario.  Like I said before, it might have been an overstatement to say that keeping the funds in the after-tax 401k approach is the better approach for the "average" or "typical" aspiring early retiree, but I also don't think we can safely say the overwhelming majority of us are definitely better off doing immediate conversions to Roth.

In the interest of full disclosure, personally I am doing immediate in-service withdrawals, both because (i) I already have a sizable taxable account and (ii) I value the protection against changes in tax laws provided by the Roth (all of the analysis we are doing in these discussions could become obsolete if tax laws change).  Also, my example assumes that this worker's situation (annual expenses, absence of other income sources, etc.) are set in stone for at least three decades after retirement, but of course that's not the way it works in real life.  So even if I was in this hypothetical worker's shoes, I might do in-service Roth rollovers as a hedge against the unknown.

Oh, and for Sol's benefit, you're a schmuck!

Schaefer Light

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #84 on: November 21, 2014, 12:20:31 PM »
Unfortunately, my 401(k) plan doesn't allow for after-tax contributions OR in-service withdrawals.  I'm lobbying for getting both of these features added.

brooklynguy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #85 on: November 21, 2014, 01:40:24 PM »
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.  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).

panhead

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #86 on: November 21, 2014, 09:34:42 PM »
Good thread.  There is some excellent discussion on this topic at bogleheads.org.  Go there and search the forum for "IRS relents" or "mega backdoor ROTH".  There are several tax experts who have chimed in.
A couple points I haven't seen mentioned:
If you have a 401k that allows 1) after tax contributions, 2) in service withdrawals and 3) separate sub-account for taxable portion, then the mega backdoor ROTH is a possiblility. 
Now, if you are a crazy saver and also want to do your $5500 back door ROTH IRA conversions as you are ineligible due to income, you have to be careful.  If you have any existing traditional IRAs, you will run afoul of the pro-rata rule, making this strategy (the backdoor ROTH IRA) unhelpful.  So if you have earnings on your after tax portion of your 401k and roll the earnings over to a traditional IRA when you do the in-service withdrawal and still want to do the backdoor strategy, you have three options:

1)  Roll the earnings into your ROTH IRA as well.  You will need to pay attention to withdrawal ordering rules and will have to pay penalty if you hit the earnings based on ordering rules (discussed above)
2)  If your original 401k plan allows it, you can roll the earnings back into your original 401k (pre-tax) plan.
3)  If the earniings are small, you could always take the earnings and pay tax and penalty on it and call it a day.

Some have mentioned leaving the after tax portion in the 401k, or doing in service conversions to the company's ROTH 401k plan.   The way the 401k plans work, is there is no way to separately define where after tax money will be invested with respect to pre-tax money.
It has been stressed that the existence of the "after tax subaccount" is one of the requirements in order to be able to do this.  My thinking is that every plan would track it separately, and considering it's just accounting, I'm not sure why all plans who allow after tax contributions wouldn't have the idea of a separate sub-account, but just something to keep in mind.

Lastly, even though you could roll the earnings back into your original 401k plan, you can't leave the earnings there when you do the in service withdrawal, as the earnings have to follow the contributions. 
-Pan


 

Schaefer Light

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #87 on: November 22, 2014, 05:35:52 AM »
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.  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.

Daisy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #88 on: December 14, 2014, 09:28:01 PM »
Assuming you have an after-tax 401k option with the possibility of in-service withdrawals...what would happen if in the 6 month period in which you can do the in-service withdrawal the market goes down? In that case, there will be no taxable gains. In a regular after tax account you would be able to take a capital loss. All of the analysis of this strategy that I've seen just talks about gains that are made while your 6 month contributions are marinating in the company's 401k plan before withdrawing.

Is it even worth worrying about? I haven't done this yet so I don't know how my plan will treat the in-service withdrawals.

brooklynguy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #89 on: December 15, 2014, 06:12:12 AM »
If the value of the investments in the after-tax 401k account is down at the time you do the in-service withdrawal, then there are no gains and you can roll over the entire amount into the Roth IRA on a tax-free basis, which is equivalent to having done the in-service rollover immediately after the contribution was made (before you had a chance to incur any gains).  You are right that you can't take a capital loss, but that's true of any tax-sheltered investing strategy.

WGH

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #90 on: January 07, 2015, 01:35:15 PM »
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?

brooklynguy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #91 on: January 07, 2015, 02:48:41 PM »
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?

Are you sure you get an employer match on the after-tax contributions, above and beyond the employer match on the traditional pre-tax and/or Roth contributions?  That sounds too generous to be true.  But in any event, I believe the employer match is always treated as a pre-tax contribution.

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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?

You seem to be confused about what the Mad Fientist described in his example.  He wasn't describing moving any earnings from the after-tax 401k account to the Roth IRA; instead, he was describing moving the contributions from the after-tax 401k account to the Roth IRA immediately (before any earnings had a chance to accrue).  So the $8700 of earnings in his example was not transferred from the 401k to the Roth IRA--at the time of the rollover, the 8700 didn't exist yet.  It accrued later on in the year, inside the Roth IRA.  If, instead, the rollover was delayed and occurred after those earnings had accrued inside the 401k after-tax account, those earnings would be subject to tax if rolled into a Roth IRA (or they could be segregated off and rolled into a traditional IRA and maintain their pre-tax status).

Emanonrog

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #92 on: January 07, 2015, 03:04:16 PM »
Quick followup question to your last comment, Brooklynguy...

Assuming you did move the your after-tax contributions with some gains, and you moved everything into your Roth, the taxes you owe on the gains are just normal income taxes (no penalty).  I assume this is the case since your rolling over your balance into a Roth IRA, not withdrawing them. 

brooklynguy

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #93 on: January 07, 2015, 03:23:47 PM »
Correct.  Penalties only come into the picture when you are making withdrawals from the Roth IRA.  Any earnings in the after-tax 401k account that are rolled into the Roth IRA will be subject to tax (but not penalty) at the time of the rollover, and will be subject to a 10% penalty if withdrawn from the Roth IRA within five years after the rollover.

Seattlecyclone's post # 28 in this thread on the IRS ordering rules is an excellent resource for determining the answer to these types of questions.

MrMoogle

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #94 on: January 08, 2015, 02:21:10 PM »
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.

ysette9

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #95 on: January 08, 2015, 02:57:51 PM »
I just spent a day reading through all of this, the related articles, checking my eligibility for after-tax contributions and all of that and then at the end stumble upon this: “Yes, the after-tax contribution option has ramifications for the highly compensated employee rules. “

Curses!

According to the email they sent me late last year I am expected to be a "HCE" and my total contributions are limited to only $3000 over the normal federal limit. I am now just informed enough on this subject to be super bummed that it really isn't an option for me.

Such is life sometimes. Back to investing in Vanguard total market....

waltworks

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #96 on: January 08, 2015, 03:08:03 PM »
Anyone who is self-employed and running their own 401k through Vanguard tried to do this yet?

-W

MrMoogle

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #97 on: January 08, 2015, 03:13:21 PM »
I'm not self-employed so I didn't read up about it, but I did scan through this:
http://thefinancebuff.com/after-tax-contributions-in-solo-401k.html

And it talks about some of the hurdles.

27y/oTennesseeRetiree

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #98 on: January 08, 2015, 03:20:33 PM »
THANK YOU all! I have a balloon payment on a Mortgage in my Roth in 2018 and you guys have just given me the key to guarantee that I have the funds to cover it without having to borrow from a private lender at crappy terms!

stuckinmn

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Re: Did the IRS just give an extra $35k/yr of tax-free-growth saving space?
« Reply #99 on: January 08, 2015, 03:24:19 PM »
Just an update for some folks as I just did my first in-service distribution to my Roth using this strategy.

My 401k provider (Fidelity) knew exactly what I was trying to do and they are mailing me a check made out to my Vanguard roth for the after tax contributions, and a much smaller check made out to my Vanguard Rollover IRA for the investment gains since October when I first started the after-tax contributions. Once I get the checks, all I need to do is forward the checks to Vanguard with instructions on the account numbers and what funds to buy.  Both Fidelity and Vanguard folks were well versed with what I was trying to do. 

tl;dr version- it's pretty easy to do.  Not something I'm going to do every pay period, expecially since any gains are just rolled over to my regular IRA, but easy enough to do every couple of months or every quarter.