Mega Backdoor Roth

[jhb42]

I have recently learned that I can put post-tax money into my 401k each year (up to $53,000 per year, including pre-tax contribution and corporate match) and am pursuing a Mega Backdoor Roth.  However, the details are confusing me.  I might be able to get help from Fidelity, but would like to make sure that I understand the process myself and thought I would start here....

I have an existing SEP and traditional IRA.  I will roll them into my 401k next week.  I have no other pre-tax accounts.  My understanding is that this step simply needs to occur by Dec 31 of this year.

I have adjusted my withholdings and will max the post-tax portion of my 401k by the end of May (around $26,000).  This is the point at which I get confused... Can I move just the post-tax portion of my 401k into a traditional IRA and then convert to a Roth?  Can I convert the post-tax money directly to a Roth?  Can I do this every year?

My CPA tells me that I am unable to move just the post-tax portion of the 401k and that I'll generate pro rata taxes on my pre-tax 401k.  Do I have to temporarily convert my whole 401k to a traditional IRA?  I know that there is a way to do this, but I'm unclear, as is my CPA.  I think he's ready to punch me.

Help.

 

 

 

[jfoxcpacfp]

There is no reason to roll your SEP and TIRA into your 401k. This is not a backdoor Roth conversion; Mega "backdoor" Roth is a misnomer.

If your plan allows in-plan rollovers (not withdrawals), you can split off your NRAT (Non-Roth After Tax) contributions + earnings (you will pay tax on the earnings) annually without affecting your pre-tax 401k balance. No pro-rata rules apply.

Discrimination testing may apply, but I'm not going into that here.

[jhb42]

Won't that generate pro rata taxes every year on my tIRA?

[jfoxcpacfp]

jhb42 wrote:

Won’t that generate pro rata taxes every year on my tIRA?

Click to expand...

What do you mean, on your TIRA?

[DMFA]

The plan has to allow for in-service withdrawals. You just move the post-tax portion to Roth IRA without tax or penalty.

If you move the post-tax earnings, then you have to pay taxes on those.

If the plan requires withdrawals to be complete (not partial), then you'd have to move pretax conversions to a traditional IRA. There's no pro rata involved with that because it's not a traditional IRA to Roth IRA conversion.

[jhb42]

Thank you.  This is the source of my confusion.  Just to verify....

I was under the impression that there is a way to move just the post-tax portion of my 401k to a Roth EACH YEAR, without triggering pro rata taxes on the pre-tax portion.  My CPA tells me that even with an annual in-service withdrawal of the post-tax portion to a Roth, that I will trigger pro rata taxes on the pre-tax portion of my 401k.

It seems that I can convert the post-tax portion of the 401k to a Roth and convert the pre-tax portion of the 401k to a traditional IRA at that time when I leave my job or retire, but can I make the conversion of the post-tax portion annually instead of waiting until retirement/leaving my job?

Thank you again!

 

[jfoxcpacfp]

jhb42 wrote:

Thank you.  This is the source of my confusion.  Just to verify….

I was under the impression that there is a way to move just the post-tax portion of my 401k to a Roth EACH YEAR, without triggering pro rata taxes on the pre-tax portion.  My CPA tells me that even with an annual in-service withdrawal of the post-tax portion to a Roth, that I will trigger pro rata taxes on the pre-tax portion of my 401k.

It seems that I can convert the post-tax portion of the 401k to a Roth and convert the pre-tax portion of the 401k to a traditional IRA at that time when I leave my job or retire, but can I make the conversion of the post-tax portion annually instead of waiting until retirement/leaving my job?

Click to expand...

My first response was not clear as I referred to in-plan rollovers but you are actually converting within the plan. If you roll outside the plan, you must roll out 100%. If your plan allows in-plan rollovers, you can choose to roll over only the after tax contributions (and associated earnings) to a Roth without triggering the pro-rata rules. I will correct my original response to clarify.

It is confusing and I can fully understand what your CPA is going through. Michael Kitces wrote an article on it but didn't explain in-plan rollovers, which adds to the confusion. Give him this article by Harry Sit at The Finance Buff and maybe he won't punch you! Here is another for you. Hope this helps.

[jhb42]

That is awesome! Thank you! I can't wait to get this started.

[litovskyassetmanagement]

jhb42 wrote:

I have recently learned that I can put post-tax money into my 401k each year (up to $53,000 per year, including pre-tax contribution and corporate match) and am pursuing a Mega Backdoor Roth.  However, the details are confusing me.  I might be able to get help from Fidelity, but would like to make sure that I understand the process myself and thought I would start here….

I have an existing SEP and traditional IRA.  I will roll them into my 401k next week.  I have no other pre-tax accounts.  My understanding is that this step simply needs to occur by Dec 31 of this year.

I have adjusted my withholdings and will max the post-tax portion of my 401k by the end of May (around $26,000).  This is the point at which I get confused… Can I move just the post-tax portion of my 401k into a traditional IRA and then convert to a Roth?  Can I convert the post-tax money directly to a Roth?  Can I do this every year?

My CPA tells me that I am unable to move just the post-tax portion of the 401k and that I’ll generate pro rata taxes on my pre-tax 401k.  Do I have to temporarily convert my whole 401k to a traditional IRA?  I know that there is a way to do this, but I’m unclear, as is my CPA.  I think he’s ready to punch me.

Help.

 

 

 

Click to expand...

The biggest question is whether your 401k plan allows after-tax contributions and in-service withdrawals, and that's pretty rare for most plans.  So I doubt this will work unless you are a partner in a group practice (ideally without staff) and your TPA can adjust your plan design to allow for this.  In that case you can make in-service rollovers of after-tax assets into a Roth IRA directly.

Please note that pro-rata rules DO apply: if you have only Roth/after-tax assets in your plan, you can move after-tax assets into your Roth IRA, but if you have any tax-deferred assets, pro-rata rules apply and you can't just move after-tax assets.  That's one complication that makes this strategy less preferable to the alternatives.

A better solution to the above: do in-plan Roth conversion.  This is really MUCH better than what you are proposing, and it is easy to implement for any plan (vs. after-tax that is not possible for plans that have large non-HCE staff). All you have to do is convert your tax-deferred contribution to Roth, which can be done in parts (and make Roth salary deferrals), and you have the Mega Backdoor Roth IRA much cleaner and with less work.

[jhb42]

So... my CPA is still not sold, even after I sent him the following link that I found...

https://www.fidelity.com/insights/retirement/tax-friendly-way-to-rollover

It seems legitimate and legal to me, based on this Fidelity article.  Any other thoughts?  I might simply have to go against the advice of my CPA, although I'd rather not.

Thank you to anyone who has any insight.

[jfoxcpacfp]

jhb42 wrote:

So… my CPA is still not sold, even after I sent him the following link that I found…https://www.fidelity.com/insights/retirement/tax-friendly-way-to-rollover

It seems legitimate and legal to me, based on this Fidelity article.  Any other thoughts?  I might simply have to go against the advice of my CPA, although I’d rather not. Thank you to anyone who has any insight.

Click to expand...

I guess you're going to have to choose who you agree with. I don't know if your CPA simply won't admit he was wrong or if he truly doesn't believe all of the evidence you've given him but I don't think you're going to be able to convince him at this point.

[jhb42]

Okay.  Thank you so much again.  I just don't want trouble with the IRS, but this sure seems legal.  I guess I'll move forward without his approval.

[litovskyassetmanagement]

jhb42 wrote:

So… my CPA is still not sold, even after I sent him the following link that I found…

https://www.fidelity.com/insights/retirement/tax-friendly-way-to-rollover

It seems legitimate and legal to me, based on this Fidelity article.  Any other thoughts?  I might simply have to go against the advice of my CPA, although I’d rather not.

Thank you to anyone who has any insight.

Click to expand...

The problem is that this article did NOT say the following:
1) It did not say that annual solo 401k after-tax contributions are OK to rollover, every year, into a Roth IRA.  IRS examples always talk about employer plans where one is an employee and one-time rollovers (or rather infrequent ones).  We don't know whether they would consider using annual solo 401k rollovers as OK or not at this point (and nobody wants to find out after the fact that IRS doesn't like this).

2) It did not say that you have to pay taxes on any tax-deferred assets on a pro-rata basis when you roll over the after-tax money.  You will pay pro rata taxes since you can't move just after-tax assets if you also have tax-deferred ones in the plan.  But you can after-tax to Roth and tax-deferred to Traditional. By the way, the gains from after-tax contributions are tax-deferred, who would have thought - makes no sense, but that's what IRS appears to be saying.

So if you just happen to have an employer plan with after-tax assets, your CPA should follow the IRS rules:

https://www.irs.gov/retirement-plans/rollovers-of-after-tax-contributions-in-retirement-plans

This is exactly what you can do.  You can also make after-tax contributions to a solo 401k plan.  This is not an issue at all.  It is the annual rollovers of after-tax assets (provided that you only have after-tax contributions so you don't trigger pro rata rules) that some people are concerned about.

No wonder your CPA is on the fence, I would be too since most of this stuff is rather new.  I would try to work with your CPA to understand exactly what their issue is, and what they are comfortable with.  Do the legwork, and don't rely on articles that provide only 1/2 of the whole picture.  I would advise, again, to do in-plan Roth conversion in your own solo 401k plan.  There is absolutely NO need to do after-tax, unless of course you have a small 1099 income.  And in that case I would advise to do after-tax, and wait until Roth conversions are allowed for after-tax assets inside the plan (which makes sense that this should be allowed, yet at this point we don't have any guidance).  However, in that case any gains will be tax-deferred, but hopefully those won't be that big.

 

[jhb42]

I'm so sorry, but I need to clarify what you are saying...

I think that you are pointing out that a single conversion of the 401k at the time of retirement or leaving my job to a Roth (post tax) and traditional IRA (pre-tax) is clearly allowed at the moment.  However, moving only post-tax money on an annual basis is not clearly acceptable at this time, based on the IRS's rules for which you provided a link.

So your recommendation, should I continue to fund my post-tax 401k is to wait and do a single conversion at a later date.

Also, instead of waiting, I could avoid the post-tax 401k question and open a solo 401k instead?  I'm not self-employed.  Even if I were, can only self-employed income be contributed to the solo 401k?

[litovskyassetmanagement]

jhb42 wrote:

I’m so sorry, but I need to clarify what you are saying…

I think that you are pointing out that a single conversion of the 401k at the time of retirement or leaving my job to a Roth (post tax) and traditional IRA (pre-tax) is clearly allowed at the moment.  However, moving only post-tax money on an annual basis is not clearly acceptable at this time, based on the IRS’s rules for which you provided a link.

So your recommendation, should I continue to fund my post-tax 401k is to wait and do a single conversion at a later date.

Also, instead of waiting, I could avoid the post-tax 401k question and open a solo 401k instead?  I’m not self-employed.  Even if I were, can only self-employed income be contributed to the solo 401k?

Click to expand...

If you do not have in-plan Roth conversion option, then you should do after-tax, if that's allowed by the employer, so that at a later date you can make the conversion.  Most practices do not allow after-tax as that screws up the testing and would require high employer contributions to non-HCE staff. I wonder if on demand rollovers are even allowed by your employer if you wanted to do this on an annual basis (most employers don't allow this).  If you work for a smaller practice, you might be able to change plan provisions to allow for in-plan Roth conversions, and this would take care of the whole after-tax issue. A solo 401k will only work if you have 1099 income significant enough to fund a solo 401k.