IRA v rollover 401k and valuing the backdoor roth

[randomdoc123]

I believe the answer is it depends. I am not sure if the answer is mathematical or an emotional one.

I am switching jobs and I have my old 401k and a cash balance plan pension that I need to pull out. My understanding is that if I dump the two aggregate accounts into a IRA it would be a Traditional IRA since both of these have pre-tax contributions. If this happens I will be subject to the pro-rata rule for backdoor Roths which because of my tax bracket seem unappealing.

If I move the funds into my new employer's 401k which they will accept then I will have limited choices in investments and I have to pay the 401k admin fees of 0.4% every year on the whole amount. Looking on the internet this seems to be a reasonable amount for a 401k. Luckily the 401k has index funds and I will likely put it in a Vanguard large cap with ER of .04%. I also read there is better asset protection w 401k.

I saw a post that said that if the total amount is low that it is better to put it into the 401k. I'm not sure at what point does it make more sense to leave things in an IRA. For discussion sake, if the aggregate amount is 600k, then the admin fee works out to $2400/yr which is a lot more than an IRA. After 10 years this would add up to at least 24k since I'll be contributing and getting a full match as well.

My wife and I both do backdoor Roths so total we put in around 11k-12k. How valuable is this moving forward?

I'm leaning towards dumping everything into the new 401k and offering to help find a solution to lower costs on the 401k plan.

Any thoughts?

[jfoxcpacfp]

The answer is more, imo, tactical rather than mathematical or emotional. Here are a few considerations that may help you decide :

• By rolling over to an IRA, you will pay pro-rata taxes on backdoor Roth conversions. As I’ve repeated many times here, you are simply pre-paying taxes that you will eventually pay on your IRA/401k. I am not convinced that is such a bad decision. See The Pro-Rata Rule for Backdoor Roth IRAs.


• The fees in your work 401k, otoh, are reasonable. I tend not to agree with the many on this forum who condemn account fees as I have yet to see any comparative calculations on 10- and 20-year total returns for accounts with such fees and without. If they do make that much difference and cost you hundreds of thousands of dollars over your lives, or even 10s of thousands, why do we not find studies proving this? Why do accounts, at least in my experience, tend to have similar long-term results. I believe it is because other factors are what matter and these fees (especially such low fees) become irrelevant. Reason tells me it is not a straight-line comparison.


• You will have more flexibility by rolling out to an IRA now. For example, you can contribute to your n.d. IRA for a year or two and wait until, say, 2020 to convert it all. BY then, your situation may have changed (i.e. IC income to allow you to set up a solo-401k) or you can go ahead and move to your work 401k at that point. You will not be able to do the opposite should you move it all to the 401k now.

Not a solution, but hope that helps.

[dentite21]

Hey random doc, my wife and I just went through a similar scenario so here is my advice. I am not sure what type of doctor you are but I always try to think of investing strategy in terms of my occupation - I'm a general dentist. When doing a bigger case, I work up the case in reverse order - "All 8 anterior crowns will look like this with great lip support, functional occlusion, and a shade that was matched with photos taken." Then I can start working.

My wife and I are savers. We invest a lot of our money and we are young. The Roth IRA (IRA Basics) is therefore very appealing to us once retirement hits since we know we will have a large balance of 401Ks and our already large taxable account. From here, we knew we had to convert our Traditional IRA or roll over to a 401K to avoid the Pro-Rata Rule for the backdoor Roth IRA. To avoid tax burden (if the value of your traditional IRA is high), I'd recommend a reverse rollover to your 401K. And again, this assumes that you want to continue using a backdoor Roth IRA. Yes, a 401K can have expensive fees and bad options but it is still a tax advantage account that sometimes has matches and even profit sharing.

I'd recommend thinking this through in reverse order. What makes the most sense for you when retirement hits.

(One word of warning - if you pull out the money from your old 401K then place into a traditional IRA then do a direct transfer to your new 401K be aware this can take anywhere from 15 business days to 45 business days. Doing this last minute would not be a good idea due to the Pro Rata Rule. I'd see if you could do a direct transfer between 401Ks and avoid placing the money in the traditional IRA if you still want the Backdoor Roth approach).

[randomdoc123]

Thank you for the responses. I found an article that discusses a little the "value" of the backdoor Roth by physician on fire here...

https://www.physicianonfire.com/value-of-backdoor-roth/

Assuming that I'm investing in the exact same fund in a 401k v an IRA but with the 401k, I'm getting charged .4% I think this article I found sort of compares the costs of fees...

https://www.nerdwallet.com/blog/investing/millennial-retirement-fees-one-percent-half-million-savings-impact/

Another link discussing the effects of fees. In their example they are looking a smaller number and as that number grows, I think the impact should be higher but could be wrong...

https://www.fool.com/retirement/401k/2015/04/06/average-401k-fees.aspx

@dentite; we sound similar although I am only young at heart. My wife and I save in my opinion a lot. Maxing out 401ks plus employer match and profit share, Backdoor Roths and additional into taxable accounts. Its hard to predict the future but I have a general idea of where we want to be at retirement in terms of my number. I need to model out how much would be in my different buckets as I am going to try to do roth laddering presuming it is still allowed in 20yrs but who knows.

@jfoxcpafp; I agree and understand you have to pay taxes either now or later. I think the advice of putting money in an IRA does offer more flexibility is really good point. In the short and intermediate term my wife is considering quitting her job and we might be able to lower our tax bracket with that and me cutting back to start conversions earlier albeit at higher tax rates than I was hoping for when fully retired.

Gotta think about it more but at least for my situation, I don't think the backdoor Roth is worth enough to rollover everything into the 401k plan. My wife can still do it. This has been helpful as I've completely changed my mind.

[Peds]

randomdoc123 wrote:

My wife and I both do backdoor Roths so total we put in around 11k-12k. How valuable is this moving forward?

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incredibly.

 

do you have to move the 401/CBP? can you not leave it?

if you have to move it, can you generate any 1099 income and open a solo 401k.....

[jacoavlu]

^^^ same thought.

[wxl31]

1. Sell an item on eBay for $1 (skip if you already have 1099 income from moonlighting) profit.

2. Open self-employed 401k at Fidelity.

3. Roll over 401k and CBP to Fidelity self-employed 401k (I am sure they take 401k rollovers but have no experience with CBP so do your own due diligence).

 

This allows for 1. continued yearly backdoor Roth and 2. may afford superior asset protection (depends on what state you are in).

 

The only hassle I have encountered is 1. opening the account and 2. if your SE-401k balance exceeds $250k, will have to file a form 5500 yearly with the IRS.

[jfoxcpacfp]

wxl31 wrote:

1. Sell an item on eBay for $1 (skip if you already have 1099 income from moonlighting) profit.

2. Open self-employed 401k at Fidelity.

3. Roll over 401k and CBP to Fidelity self-employed 401k (I am sure they take 401k rollovers but have no experience with CBP so do your own due diligence).

 

This allows for 1. continued yearly backdoor Roth and 2. may afford superior asset protection (depends on what state you are in).

 

The only hassle I have encountered is 1. opening the account and 2. if your SE-401k balance exceeds $250k, will have to file a form 5500 yearly with the IRS.

Click to expand...

To any readers who may be considering this move - I strongly discourage doing so. imo, @wxl31 used a sham transaction to rollover his/her retirement accounts. This account will now be open to scrutiny and adverse ruling (disallowed transaction) by the IRS - forever. The chances are low, admittedly, but if you wouldn’t create a sham schedule C simply to open a solo-k, then you should not do this.

Should @wxl31 be audited and found “lacking”, the rollover will be treated as a fully taxable distribution, subject to appropriate penalties and tax at his/her top marginal tax bracket at the time of the r/o. The SOL will never run out. The IRS will then have @wxl31 in its crosshairs for some time to come. And for what gain? The accounts could have been left at the prior employer, transferred to new employer, or rolled over to IRA and pro-rate taxes (not such a big deal) paid.

This problem is uncorrectible, even should s/he roll to an employer plan in the future. The funds have been tainted.

I truly hope this is a fictional example or that @wxl31 actually has a better basis for setting up a solo-k.

[wxl31]

I fail to see anything illegal in my example. I opened a profitable business. I applied for a TIN through the IRS website. I opened a self-employed 401k using the TIN. I contributed to the self-employed 401k, to an amount specified by the IRS rules. I utilized the ability to roll over a pre-tax account into the self-employed 401k. I filed a schedule C reporting my business profits. All of it seems above board.

Could you explain precisely why the IRS would be consider my example a sham transaction (or "lacking")?

Is it because of the dollar amount? If I had an eBay business that netted me $1,000 profit on my schedule C instead of $1, would that be OK? $10,000 maybe? Or is it a ratio of how much I want to roll over vs. how much profit the business has made?

Is it because it's a different business than medicine? If I moonlighted in an urgent care clinic for 4 hours, had a net schedule C profit of $1, opened a self-employed 401k, then proceeded to rollover $1m dollars from my other 401ks into the account, would that be considered a sham transaction?

Is it temporal proximity? If I opened a tiny self-employed 401k today, then waited 3 years to roll over $1m dollars from my other 401ks, would that be ok ? 5 years? 10 years?

Is it intent? I agree that on the surface, it appears too good to be true, a "loophole" perhaps. But so does the backdoor Roth IRA, mega-backdoor Roth IRA, using donor advised funds/bundling charitable giving, tax gain harvesting in zero capital gains tax brackets, all of which are widely viewed as smart tax planning techniques, not illegal loopholes.

And why would the IRS care? I reported my eBay income, subjecting it to taxation, which is already better than what most eBay sellers are doing. The only benefit I receive, that pertains to the IRS, is the ability to do backdoor Roth IRAs, which is permitted by the current language. If the argument is that I'm circumventing pro rata taxes by doing this, then would the IRS also consider rolling over a TIRA to an employer's 401k plan illegal? Or would my sham example be legal if I didn't do any subsequent backdoor Roth IRAs?

I have a lot of respect for both you and spiritrider, have learned much from both of you here, and I look forward to your further thoughts on the issue.

PS - Full disclosure - the eBay example is fictional. However, when I opened my self-employed 401k, it was for a miniscule amount of moonlighting income in residency. The current account balance is vastly higher than the total direct contributions, largely as a result of several rollovers of 401ks from prior employers.

[DMFA]

wxl31 wrote:

However, when I opened my self-employed 401k, it was for a miniscule amount of moonlighting income in residency.

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Because you did actual work and received actual net earnings from self-employment under IRC §401(c)(1).  You also met the IRS's 9 Hobby Rules.  The IRS has definitions for what constitutes a "business or trade" in IRC §62, although they're woefully nonspecific...selling one thing once for $1 is not exactly continuity or regularity.

wxl31 wrote:

I have a lot of respect for both you and spiritrider, have learned much from both of you here, and I look forward to your further thoughts on the issue.

Click to expand...

Well, forget you, too.

[MPMD]

jfoxcpacfp wrote:

wxl31 wrote:

1. Sell an item on eBay for $1 (skip if you already have 1099 income from moonlighting) profit.

2. Open self-employed 401k at Fidelity.

3. Roll over 401k and CBP to Fidelity self-employed 401k (I am sure they take 401k rollovers but have no experience with CBP so do your own due diligence).

 

This allows for 1. continued yearly backdoor Roth and 2. may afford superior asset protection (depends on what state you are in).

 

The only hassle I have encountered is 1. opening the account and 2. if your SE-401k balance exceeds $250k, will have to file a form 5500 yearly with the IRS.

Click to expand…

To any readers who may be considering this move – I strongly discourage doing so. imo, @wxl31 used a sham transaction to rollover his/her retirement accounts. This account will now be open to scrutiny and adverse ruling (disallowed transaction) by the IRS – forever. The chances are low, admittedly, but if you wouldn’t create a sham schedule C simply to open a solo-k, then you should not do this.

Should @wxl31 be audited and found “lacking”, the rollover will be treated as a fully taxable distribution, subject to appropriate penalties and tax at his/her top marginal tax bracket at the time of the r/o. The SOL will never run out. The IRS will then have @wxl31 in its crosshairs for some time to come. And for what gain? The accounts could have been left at the prior employer, transferred to new employer, or rolled over to IRA and pro-rate taxes (not such a big deal) paid.

This problem is uncorrectible, even should s/he roll to an employer plan in the future. The funds have been tainted.

I truly hope this is a fictional example or that @wxl31 actually has a better basis for setting up a solo-k.

Click to expand...

kind of first i've heard of that.

i feel like people on here are always saying "do a few online surveys and open a solo 401k."

my understanding of the Hobby rules lead me to believe that they would not totally resolve this question either. if i do one or two moonlighting shifts never planning to do more but just wanting to create solo 401k space i don't see how that should fall afoul of the IRS. in this case why would the IRS care? it's still in a 401k you haven't avoided any taxes whatsoever.

not an issue for me as i have multiple ongoing streams of 1099 income from several clients but i would like to know more about this just for my own education.

 

EDIT: going to try to get a specific thread going on this.

[randomdoc123]

Thank you for the ideas but I worry I might mess something up with the solo 401k that I will pass for now.

[jfoxcpacfp]

MPMD wrote:

kind of first i’ve heard of that. i feel like people on here are always saying “do a few online surveys and open a solo 401k.” my understanding of the Hobby rules lead me to believe that they would not totally resolve this question either. if i do one or two moonlighting shifts never planning to do more but just wanting to create solo 401k space i don’t see how that should fall afoul of the IRS. in this case why would the IRS care? it’s still in a 401k you haven’t avoided any taxes whatsoever. not an issue for me as i have multiple ongoing streams of 1099 income from several clients but i would like to know more about this just for my own education.

Click to expand...

If you're at least working in your profession, I really don't have a problem with the solo-k. I believe @spiritrider and I differ on whether doing online surveys counts. I'm ok with it, s/he, I seem to recall, is less tolerant.

But I do draw the line at a one-time eBay transaction granting you the ability to qualify to open a solo-k.