401k - after tax contributions in plan Roth conversions - Mega backdoor

[achvfi]

For few years I have been maxing out all my retirement accounts including spousal IRA (DW currently not working), Roth IRA, 401k, HSA up to the limits. After reaching the limits I started funneling any extra funds to brokerage account to build up flexibility.

I am close to reaching initial target of about 100K in investments in brokerage accounts and now looking to further increase Roth contributions using 401k after tax contribution to frequent in plan Roth conversion.

One thing I am wary off is I might hit Highly compensated employee designation or limits.

Does anyone have experience with 401k after tax investments in-plan Roth conversions? Are there any pitfalls I need to watch out for?

[afuera]

I've been doing a Mega Backdoor Roth in my 401K for the last 3 years so I have some insights.
First, you need to see if your 401K plan offers in-service withdrawals/conversions.  This means that they allow you to convert the after-tax contributions that you make into either a separate bucket inside your 401K (Roth in Plan Conversion) or allow you to send the after-tax contributions to an Roth IRA.  My plan allows for both so I just convert the after-tax contributions to Roth they day they hit my 401K and all the money stays inside my 401K in separate buckets.
One pitfall to look out for is if there are any frequency restrictions on withdrawals or conversions.  You want to do the conversion as soon as the after-tax contributions hit your 401K so that you minimize any growth and taxes you have to pay on that growth.  My plan has no frequency restrictions so I do a conversion every paycheck.
As far as the Highly Compensate Employee (HCE) restriction, this just means the company will limit the % you can contribute to a 401K in order to avoid messy tax laws where they could end up paying fines if they don't handle it right.  I am an HCE so my company limits me to only be able to contribute 40% on my income to a 401K.  This allows me to contribute 16% as Pre-Tax in order to take full advantage of the 19.5K tax deductible limit and then I contribute 24% as after-tax which I convert to Roth as my Mega Backdoor Roth.  So far, due to the 40% HCE limit, I haven't hit the overall 401K limit (58K for 2021) which includes Pre-Tax, Roth, After-Tax and Employer contributions but every year I get a little closer!
Let me know if you have any other questions and good luck.  Mega Backdoor Roth is an amazing strategy to maximize the amount of tax free money available to you once you start drawdown so that you are able to optimize tax brackets once you quit working.

[Arbitrage]

I have the in-plan conversion option, but opted for the IRA method instead.  I did consider in-plan for a bit when an initial conversation with a rep indicated erroneously that I could bypass my plan's conversion frequency limit using that method, but since that was bad info, I just opted for IRA for greater investing freedom.

Didn't really answer your question, I know; just wondering what is leading you to select in-plan.

[achvfi]

Thank you @afuera and @Arbitrage for responses.

Didn't really answer your question, I know; just wondering what is leading you to select in-plan.

I think Rolling over to Roth IRA is definitely better for flexibility and investment options.
My preference for in-plan conversion was just simplicity of the process, at least mentally. Which for me is key, because more complex the process I will just bog down in overthinking and never do it. Once I get some experience I will revisit this.

My plan allows for both so I just convert the after-tax contributions to Roth they day they hit my 401K and all the money stays inside my 401K in separate buckets.
One pitfall to look out for is if there are any frequency restrictions on withdrawals or conversions.  You want to do the conversion as soon as the after-tax contributions hit your 401K so that you minimize any growth and taxes you have to pay on that growth.  My plan has no frequency restrictions so I do a conversion every paycheck.
As far as the Highly Compensate Employee (HCE) restriction, this just means the company will limit the % you can contribute to a 401K in order to avoid messy tax laws where they could end up paying fines if they don't handle it right.  I am an HCE so my company limits me to only be able to contribute 40% on my income to a 401K.  This allows me to contribute 16% as Pre-Tax in order to take full advantage of the 19.5K tax deductible limit and then I contribute 24% as after-tax which I convert to Roth as my Mega Backdoor Roth.  So far, due to the 40% HCE limit, I haven't hit the overall 401K limit (58K for 2021) which includes Pre-Tax, Roth, After-Tax and Employer contributions but every year I get a little closer!
Let me know if you have any other questions and good luck.  Mega Backdoor Roth is an amazing strategy to maximize the amount of tax free money available to you once you start drawdown so that you are able to optimize tax brackets once you quit working.

In our plan we cant do the conversion on the website. We have to fill a in-plan conversion form mail every time we want to do the conversion.
I couldn't find any limits on frequency conversion. I am thinking doing it once a month.

Years back, last time I was trying to front load 401k contributions early in the year with humongous contribution %, I got hit with HCE limit of only 17% in our company unfortunately and got refunded some money back.

I am hoping that times have changed since, employees are contributing more and also company upped the match recently.

[Tigerpine]

Check out for fees, too.  My plan doesn't have any frequency limits that I'm aware of, but they charge a $25 fee per occurance.

[achvfi]

I have the in-plan conversion option, but opted for the IRA method instead.  I did consider in-plan for a bit when an initial conversation with a rep indicated erroneously that I could bypass my plan's conversion frequency limit using that method, but since that was bad info, I just opted for IRA for greater investing freedom.

Didn't really answer your question, I know; just wondering what is leading you to select in-plan.

@Arbitrage, can you explain steps how process of after tax 401k contribution to conversion into roth IRA works. It will help me decide if its worth it.
For instance
1) You request in service withdrawal
2) You get a check in mail
3) You deposit after tax contributions to Roth IRA
4) You get some IRS form at end of year to file.

So on...

Thank you

[Arbitrage]

I have the in-plan conversion option, but opted for the IRA method instead.  I did consider in-plan for a bit when an initial conversation with a rep indicated erroneously that I could bypass my plan's conversion frequency limit using that method, but since that was bad info, I just opted for IRA for greater investing freedom.

Didn't really answer your question, I know; just wondering what is leading you to select in-plan.

@Arbitrage, can you explain steps how process of after tax 401k contribution to conversion into roth IRA works. It will help me decide if its worth it.
For instance
1) You request in service withdrawal
2) You get a check in mail
3) You deposit after tax contributions to Roth IRA
4) You get some IRS form at end of year to file.

So on...

Thank you

No need to take the rollover money in hand.  I opened a Roth IRA at the same company where the 401(k) is hosted to simplify the process, as my existing Roth IRA is elsewhere.

The process for my rollover is:

1. Call the plan administrator and inform them that I want to roll my after-tax money into my Roth IRA (on the website, they term it a "Rollover Withdrawal")
2. Select in-kind (keeping the same funds) or liquidation.  For me, only one of my investments will transfer in-kind.
3. Generally, at close of market that day, the conversion is executed. 
4. The following day, you can reinvest as desired.  In-kind transfers are never out of the market.  Liquidated funds will be out of the market for one business day.
5. They will send you a tax notice, then a tax form at the end of the year to pay the growth as regular income.

My administrator does require me to call, unfortunately, even though they specifically identify exactly how much I have available as pre-approved rollover.  Website limitation.  Since I'm only allowed four rollovers per year, it's not a big deal to have that 10 minute call four times.

If your Roth IRA is held elsewhere, you could probably just do a trustee-to-trustee transfer, again not taking the money in hand, but your money would be out of the market longer, and there would be additional steps.  Thus the new IRA for me.

[seattlecyclone]

Didn't really answer your question, I know; just wondering what is leading you to select in-plan.

I did in-plan conversions for my mega backdoor because (a) it was easier, and (b) my 401(k) has institutional-class index funds with slightly lower expense ratios than I'd get in an IRA.

[achvfi]

No need to take the rollover money in hand.  I opened a Roth IRA at the same company where the 401(k) is hosted to simplify the process, as my existing Roth IRA is elsewhere.

The process for my rollover is:

1. Call the plan administrator and inform them that I want to roll my after-tax money into my Roth IRA (on the website, they term it a "Rollover Withdrawal")
2. Select in-kind (keeping the same funds) or liquidation.  For me, only one of my investments will transfer in-kind.
3. Generally, at close of market that day, the conversion is executed. 
4. The following day, you can reinvest as desired.  In-kind transfers are never out of the market.  Liquidated funds will be out of the market for one business day.
5. They will send you a tax notice, then a tax form at the end of the year to pay the growth as regular income.

My administrator does require me to call, unfortunately, even though they specifically identify exactly how much I have available as pre-approved rollover.  Website limitation.  Since I'm only allowed four rollovers per year, it's not a big deal to have that 10 minute call four times.

If your Roth IRA is held elsewhere, you could probably just do a trustee-to-trustee transfer, again not taking the money in hand, but your money would be out of the market longer, and there would be additional steps.  Thus the new IRA for me.

Interesting. Thank you for the details.

[Arbitrage]

Didn't really answer your question, I know; just wondering what is leading you to select in-plan.

I did in-plan conversions for my mega backdoor because (a) it was easier, and (b) my 401(k) has institutional-class index funds with slightly lower expense ratios than I'd get in an IRA.

I agree that there are absolutely good reasons to opt for in-plan conversions.  For instance, the plans I've heard about that allow for automatic conversions with every paycheck.  Absent the good reasons, I'd opt for the IRA method.

[afuera]

Didn't really answer your question, I know; just wondering what is leading you to select in-plan.

I did in-plan conversions for my mega backdoor because (a) it was easier, and (b) my 401(k) has institutional-class index funds with slightly lower expense ratios than I'd get in an IRA.

I agree that there are absolutely good reasons to opt for in-plan conversions.  For instance, the plans I've heard about that allow for automatic conversions with every paycheck.  Absent the good reasons, I'd opt for the IRA method.

My process for in-plan conversions used to be the same as yours for in-service withdrawals which is a 10-15 min phone call every paycheck to request they to do the conversion.  The conversion was also typically processed by end of business day.  Starting 1/1/2021 my plan finally let us set up automatic conversions so I called and set it up and now the after-tax contributions turn themselves into Roth-In-Plan Conversion contributions the second they hit my account all on their own.  1/15 was the first paycheck it processed and it was so satisfying to log in and see everything happened the way it was supposed to.  No more phone calls for me!

[afuera]

Didn't really answer your question, I know; just wondering what is leading you to select in-plan.

I did in-plan conversions for my mega backdoor because (a) it was easier, and (b) my 401(k) has institutional-class index funds with slightly lower expense ratios than I'd get in an IRA.

I had the exact same reasons for choosing in-plan conversion rather than in-service withdrawals.  I didn't want multiple Roth IRAs at different institutions to keep track of since I already had one at a different institution when I started doing the Mega Backdoor Roth.

[achvfi]

Didn't really answer your question, I know; just wondering what is leading you to select in-plan.

I did in-plan conversions for my mega backdoor because (a) it was easier, and (b) my 401(k) has institutional-class index funds with slightly lower expense ratios than I'd get in an IRA.

I agree that there are absolutely good reasons to opt for in-plan conversions.  For instance, the plans I've heard about that allow for automatic conversions with every paycheck.  Absent the good reasons, I'd opt for the IRA method.

My process for in-plan conversions used to be the same as yours for in-service withdrawals which is a 10-15 min phone call every paycheck to request they to do the conversion.  The conversion was also typically processed by end of business day.  Starting 1/1/2021 my plan finally let us set up automatic conversions so I called and set it up and now the after-tax contributions turn themselves into Roth-In-Plan Conversion contributions the second they hit my account all on their own.  1/15 was the first paycheck it processed and it was so satisfying to log in and see everything happened the way it was supposed to.  No more phone calls for me!

Sweet! Automatic conversions sound great. I hope we get those some day.