Mega backdoor logistics

[Krnten]

I just learned about these, AND learned that my husband's 401k plan has both the option of making the extra contributions AND in-service conversions.  I'm so excited! 

Anyways, a logistics question: how often do you mega backdoorers do the conversion?  We're in the highest tax bracket now so I'd like to minimize the taxes on the conversion, but am wondering how much of a pain it is to execute the conversion.  My initial thought was just to do it every six months or so.

Maybe the amount of hassle is just really plan-dependent...

[seattlecyclone]

It really is plan-dependent. With my plan, it's just a few clicks online to do the conversion, so I do it shortly after each paycheck. With my wife's plan, you have to call a person and fill out forms, so we do that less often than we probably should.

[shuffler]

I use the highest contribution-rate my plan allows (and live off savings), maxing out relatively quickly, and then do the conversion only once per year.  (Yes, my company continues to match for the remaining months of the year, I'm not missing out on anything.)

For me it's a only a 5-10 minute phone call.  So doing it more often wouldn't be a problem if I were motivated, which I'm not.

[ZiziPB]

I think there is a recent IRS ruling that effectively makes these conversions tax free, so the timing and frequency are not that important any more because there are no adverse tax consequences.  Under my plan, I have a 2 year "seasoning" requirement so I have to wait for 2 years from the time the funds are contributed before I can do an in-service rollover or conversion.  That automatically implied some tax consequences.  But based on the IRS ruling, you can rollover the amount originally contributed after tax to Roth and any earnings on that amount to a traditional IRA, so that is what I did earlier this year.  I think some people refer to it as a split rollover.  In any event, I did my first split rollover earlier this year and the process was pretty easy.  Our 401k admin is Fidelity and I have accounts at Fidelity so they basically did an internal transfer among the accounts.  No form to sign, I did it entirely over the phone and then just got a confirm in the mail.  I am planning to do these once a year from now on.

[Krnten]

Oh interesting, ZiziPB.  Do you have a cite for that?  I hadn't heard that the post tax earnings can be converted to Roth without paying taxes on the gains.  I assumed it worked like a regular backdoor Roth, or other types of conversions.  I will research further.

[seattlecyclone]

Oh interesting, ZiziPB.  Do you have a cite for that?  I hadn't heard that the post tax earnings can be converted to Roth without paying taxes on the gains.  I assumed it worked like a regular backdoor Roth, or other types of conversions.  I will research further.

You can't convert to Roth without paying taxes on the gains. IRS Notice 2014-54 clarifies that you can roll the gains to a traditional IRA and the principal to a Roth IRA with no tax due immediately. Before this ruling, many people assumed that if you did such a split rollover you would have to prorate the basis between the two accounts and thus would not be able to do a tax-free rollover.

I haven't personally done this type of split rollover. I convert from after-tax to Roth frequently enough that the gains are relatively minimal and not worth trying to split it up, especially when you consider that pre-tax amounts in a traditional IRA can make the "regular" backdoor Roth more of a pain.

[spud1987]

I can do in-plan withdrawals, but the problem is that my plan (administered by Vanguard) won't let me transfer the money directly to my Vanguard Roth IRA. I either have to get a check or transfer to a bank account. I have about 14k to move out of my 401k and now is a good time to do it since I wouldn't have to worry about paying tax on any investment gains (no investment gains in 2015, sigh).

I'll probably just keep my money in the 401k until I either (1) move to a new job or (2) find out that the mega Roth strategy might be repealed by Congress (a repeal is in the President's budget this year but nothing is likely to happen until we see comprehensive tax reform, likely in 2017).

[ZiziPB]

Oh interesting, ZiziPB.  Do you have a cite for that?  I hadn't heard that the post tax earnings can be converted to Roth without paying taxes on the gains.  I assumed it worked like a regular backdoor Roth, or other types of conversions.  I will research further.

You can't convert to Roth without paying taxes on the gains. IRS Notice 2014-54 clarifies that you can roll the gains to a traditional IRA and the principal to a Roth IRA with no tax due immediately. Before this ruling, many people assumed that if you did such a split rollover you would have to prorate the basis between the two accounts and thus would not be able to do a tax-free rollover.

This is what I meant.  When I said "tax -free" I meant that no immediate tax would be due.  The gain can be rolled over to a traditional IRA with no tax due the year of the rollover.  The amount will be eventually taxable just like any other funds in a tIRA.

I am in a high tax bracket currently so the last thing I want is to incur additional tax liability in connection with the mega backdoor Roth.  Stashing the gain in the tIRA will allow me to take advantage of lower tax bracket in retirement.

[brooklynguy]

I can do in-plan withdrawals, but the problem is that my plan (administered by Vanguard) won't let me transfer the money directly to my Vanguard Roth IRA. I either have to get a check or transfer to a bank account.

Why is this a problem?  I have to receive my in-service withdrawals in the form of checks too, which I have made out to Vanguard.  Or are you saying that your plan won't issue a check made payable to Vanguard instead of to you (which seems unlikely)?  Even in that case, I don't think it's a problem, because my understanding is that distributions from a 401k plan made payable to you but deposited by you into your IRA or Roth IRA within 60 days of the distribution are treated no differently than a direct rollover from the 401k to the IRA/Roth IRA (but one of our other resident tax gurus should correct me if I'm wrong about that, because I've never had reason to research that point since it's never been an issue for me).

[Cathy]

...distributions from a 401k plan made payable to you but deposited by you into your IRA or Roth IRA within 60 days of the distribution are treated no differently than a direct rollover from the 401k to the IRA/Roth IRA (but one of our other resident tax gurus should correct me if I'm wrong about that, because I've never had reason to research that point since it's never been an issue for me).

The Tax Court had actually adopted an even more generous rule than this. According to the Court, the money rolled over doesn't even need to be the same money that came out of the retirement plan; it only needs to be the same amount of money. See Bohner v. Commissioner, 143 TC No 11 (2014), footnote 2, citing Zaklama v. Commissioner, TC Memo 2012-346.