Question about after-tax 401k contributions

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Topic Author
lifebeckonss
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Joined: Thu Feb 16, 2012 3:53 pm

Question about after-tax 401k contributions

Post by lifebeckonss »

Hi all,

It seems my 401k plan allows in-service withdrawals of after-tax contributions. I will get confirmation this week. For the last 2 days I have been reading a number of threads on this forum about this topic, and here's my overall understanding of the process:

1. Max pre-tax 401k employee contribution for 2012 = $17K (Max employer match in my case = $5K)
2. Max amount that can be contributed in 2012 (pre-tax + match + after-tax) = $50K
3. Therefore max after-tax contribution for me = $28K (50K - 17K - 5K) (My plan limits after-tax contributions to 60% of gross)
4. Let's say I contribute $10K after-tax in 2012 and let's say it grows to $11K.
5. I make an in-service withdrawal of $11K (contribution + earnings) and roll it over to a Roth IRA.
6. I will have to pay ordinary income taxes on $1K (earnings) and all of my $11K will move to my Roth IRA and grow tax-free.
7. I will still be able to add $5K to the Roth IRA for 2012 (using the non-deductible tIRA --> Roth IRA backdoor method).
8. So in 2012, I moved $16K to my Roth IRA ($11K from 401K and $5K from non-deductible tIRA)
9. In case of an emergency, I can withdraw $15K out of this $16K anytime I want. This is not subject to any taxes or penalties. Nor is it subjected to any 1-year or 5-year rules.

Ques 1: Is my understanding above correct?

Ques 2: For people who make after-tax contributions to their 401k: Does your plan allow you to direct after-tax contribution to a separate bucket? I ask because I would want to minimize earnings and fluctuations. Is it possible to set it up in a way that pre-tax contribution goes to my stock and bond funds as per my AA, and after-tax contribution goes to a money-market fund in my 401k?

Ques 3: People who do in-service rollover to a Roth IRA: Do you do it once a year or multiple times? Are there advantages of doing it one way or the other?

Ques 4: From filing taxes perspective, does all of this come under Form 8606? (Of course I am assuming that the 401K custodian will provide me with a 1099 that will show the earnings component of the rollover on which I owe ordinary income taxes)

Best Regards.
jag27
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Re: Question about after-tax 401k contributions

Post by jag27 »

Hi lifebeckonss

1) Yes. From all of my reading of the various threads on this subject, your understanding of in-service distribution of after-tax 401k dollars to a Roth IRA is correct.

2) My plan doesn't allow me to specify where to contribute after-tax 401k dollars, but I max out my traditional/Roth 401k contributions (17k limit) first. Then all I have left to contribute is after-tax 401k dollars which I can then put into a money market fund to prevent large amounts of earnings before in-service distributions. This would not be a good idea if your employer match requires a contribution to each paycheck to match.

3) Plans have different limits. My plan basically allows unlimited in-service distributions so I tend to roll-over every paycheck or two to prevent having to pay taxes on earnings of those after-tax 401k dollars. Your plan may only allow 1 or 2 in-service distributions per years so you'll want to check on this.

4) I don't remember because my taxable (earnings) amounts have been basically non-existent.
xerty24
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Re: Question about after-tax 401k contributions

Post by xerty24 »

lifebeckonss wrote:9. In case of an emergency, I can withdraw $15K out of this $16K anytime I want. This is not subject to any taxes or penalties. Nor is it subjected to any 1-year or 5-year rules.
Right, and the last $1k of converted earnings would be subject to a 10% penalty if you didn't meet either the 5 year rule or any of the qualified withdrawal exceptions.
Ques 2: For people who make after-tax contributions to their 401k: Does your plan allow you to direct after-tax contribution to a separate bucket? I ask because I would want to minimize earnings and fluctuations. Is it possible to set it up in a way that pre-tax contribution goes to my stock and bond funds as per my AA, and after-tax contribution goes to a money-market fund in my 401k?
I could contribute separately, but not allocate investments separately. I think this mostly depends on how your 401k provider has their system setup. We couldn't allocate Roth vs pretax 401k money differently either.
Ques 3: People who do in-service rollover to a Roth IRA: Do you do it once a year or multiple times? Are there advantages of doing it one way or the other?
Do it once - advantages : fewer fees and paperwork, disadvantage - maybe a little more earnings get taxed. Since after-tax contributions don't have to come out of your paycheck, it may be possible to contribute the whole thing all at once (out of savings for example) and then just get everything completed in one go.
Ques 4: From filing taxes perspective, does all of this come under Form 8606? (Of course I am assuming that the 401K custodian will provide me with a 1099 that will show the earnings component of the rollover on which I owe ordinary income taxes)
Yes, Part III of 8606 typically covers this, although I think they will not give you a 1099 for the earnings but just a reporting of the conversion amount, and you supply the basis yourself. If you read the 2010 instructions, they describe how to report both the converted amount from your qualified plan to your Roth IRA, and the basis in that conversion (the difference of which is taxable income, essentially the earnings prior to conversion). However, they changed around 8606 Part III fairly extensively for 2011 and I can't find a place or reference in the instructions for where they want you to report 401k->Roth conversions. Maybe I'm just overlooking it?
No excuses, no regrets.
cliffedelgado
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Re: Question about after-tax 401k contributions

Post by cliffedelgado »

For 2010, I got a 1099-R and the info went into Form 8606 part 3.

I just did my taxes for 2011 and the 1099-R info did NOT go anywhere on 8606. Similar as xerty24 mentioned, I also did not see any place in the 2011 8606 to hold this information.
Topic Author
lifebeckonss
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Re: Question about after-tax 401k contributions

Post by lifebeckonss »

Thank you so much jag27, xerty24 and cliffe. Your responses are very helpful. I will try to get these clarifications from my plan admin.
jag27 wrote:2) My plan doesn't allow me to specify where to contribute after-tax 401k dollars, but I max out my traditional/Roth 401k contributions (17k limit) first. Then all I have left to contribute is after-tax 401k dollars which I can then put into a money market fund to prevent large amounts of earnings before in-service distributions. This would not be a good idea if your employer match requires a contribution to each paycheck to match.
I like your method. I will check with the plan admin if the employer match requires a contribution to each paycheck. If not then I will use this method.
xerty24 wrote:Since after-tax contributions don't have to come out of your paycheck, it may be possible to contribute the whole thing all at once (out of savings for example) and then just get everything completed in one go.
I did not know this was possible xerty24. I will check with my plan admin on this as well. I just assumed that all contributions (pre-tax or after-tax) must come via paycheck deductions. If your method works then it I like this even more.
cliffedelgado wrote:I just did my taxes for 2011 and the 1099-R info did NOT go anywhere on 8606. Similar as xerty24 mentioned, I also did not see any place in the 2011 8606 to hold this information.
Thanks cliffe. Does that mean there is no place (or need) to report a 401k --> roth conversion while filing taxes?
Default User BR
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Re: Question about after-tax 401k contributions

Post by Default User BR »

lifebeckonss wrote:4. Let's say I contribute $10K after-tax in 2012 and let's say it grows to $11K.
5. I make an in-service withdrawal of $11K (contribution + earnings) and roll it over to a Roth IRA.
6. I will have to pay ordinary income taxes on $1K (earnings) and all of my $11K will move to my Roth IRA and grow tax-free.
Another possibility is to roll the earnings back into the qualified plan if they allow incoming rollovers from IRAs. To do that, roll it into a traditional IRA, convert the basis amount, then roll the remainder back to the plan. It's more steps, but I've done it and it isn't that big of a deal. Some advocate ways to split the original rollover into a Roth and a TIRA, but you want to do back-door so that doesn't help you.


Brian
FB01
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Re: Question about after-tax 401k contributions

Post by FB01 »

Lifebeckonss,

If I contribute 2K to my After Tax 401k, I need to convert those to Roth IRA immed so there is not gains or loss immed. Am I right..will this work...
Thanks, | FB
Topic Author
lifebeckonss
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Re: Question about after-tax 401k contributions

Post by lifebeckonss »

Default User BR wrote:Another possibility is to roll the earnings back into the qualified plan if they allow incoming rollovers from IRAs.
Thanks Brian. I am trying to understand your method. Are you saying this?

1. Let's say I contribute $10K after-tax in 2012 and let's say it grows to $11K.
2. I make an in-service withdrawal of $11K (contribution + earnings) and roll it over to a tIRA.
3. I then rollover $1K from this tIRA back to my 401k and $10K to a Roth IRA.
4. I will still be able to add $5K to the Roth IRA for 2012 (using the non-deductible tIRA --> Roth IRA backdoor method).
5. So in 2012, I moved $15K to my Roth IRA ($10K from 401K and $5K from non-deductible tIRA)
Last edited by lifebeckonss on Mon Mar 12, 2012 1:11 am, edited 1 time in total.
Topic Author
lifebeckonss
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Re: Question about after-tax 401k contributions

Post by lifebeckonss »

FB01 wrote:Lifebeckonss,

If I contribute 2K to my After Tax 401k, I need to convert those to Roth IRA immed so there is not gains or loss immed. Am I right..will this work...
Yes FB01. As long as your plan allows in-service distribution of after-tax dollars, your plan should work. You may want to check with your 401k plan administrator.
FB01
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Re: Question about after-tax 401k contributions

Post by FB01 »

Hey Lifebeckonss,

Are you self employed? I was under the impression that any individual can open After tax 401K account. However, when I called Vanguard, they mentioned that it is not for individuel..it is for those who are self employed or have business...

Is this true

FB
Thanks, | FB
Default User BR
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Re: Question about after-tax 401k contributions

Post by Default User BR »

lifebeckonss wrote:Thanks Brian. I am trying to understand your method. Are you saying this?

1. Let's say I contribute $10K after-tax in 2012 and let's say it grows to $11K.
2. I make an in-service withdrawal of $11K (contribution + earnings) and roll it over to a tIRA.
3. I then rollover $1K from this tIRA back to my 401k and $10K to a Roth IRA.
4. I will still be able to add $5K to the Roth IRA for 2012 (using the non-deductible tIRA --> Roth IRA backdoor method).
5. So in 2012, I moved $15K to my Roth IRA ($10K from 401K and $5K from non-deductible tIRA)
Correct, although step 3 is a rollover to a qualified plan and a conversion to Roth. I recommend doing the conversion first. It doesn't matter what order you do it in as far as the IRS is concerned, as long as the taxable funds are out of the IRA by 12/31 of the year of conversion. That way is slightly easier, as you convert the basis amount, which you know exactly, then roll whatever is left into the plan.

First check about the incoming rollovers. Plans can restrict those. You might want to use a separate IRA for this from the one used for back-door Roth. Some plans are picky about requiring that funds rolling in come from a "rollover IRA", even though those barely exist in the tax laws anymore and there's no legal restriction on the type of IRA used in rollovers to qualified plans. As long as the money is taxable, you can roll it into a plan. There's even an exception to the pro-rata distribution rule to handle this. See Pub 590 if you're interested in the gory details.


Brian
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lifebeckonss
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Re: Question about after-tax 401k contributions

Post by lifebeckonss »

Okay so I talked to my HR as well as called Fidelity directly and I am getting some conflicting information. Here is what I found out.

1. Accelerated pre-tax contributions can lead to losing employer match: If I max out my pre-tax contribution sooner in the year, I will lose employer match. The company matches 5% but I have to contribute at least 5% pre-tax for every paycheck in the year.

2. After-tax contributions: I can make after-tax contributions (anywhere between 1% and 60% of salary). However like pre-tax contributions, these must come via payroll deductions. I asked HR if I can write a check from my savings and they said no.

3. In-service withdrawal of after-tax contributions: This was the most important question. HR manager said that our plan does not allow that. However when I called Fidelity, the rep put me on hold, did some research and came back and told me that my plan does allow that and also there is no limit on the number of in-service withdrawals I can do in a year. I want to believe the Fidelity rep, but I am now checking back with HR.
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retiredjg
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Re: Question about after-tax 401k contributions

Post by retiredjg »

I think your understanding is correct except for this last point.
lifebeckonss wrote:9. In case of an emergency, I can withdraw $15K out of this $16K anytime I want. This is not subject to any taxes or penalties. Nor is it subjected to any 1-year or 5-year rules.
My understanding is the order money comes out of a Roth IRA looks like this:

1) Ordinary contributions come out first (if you have any from before your back door contribution days)
2) First conversion - the taxable part (that would be the $1000 earnings) and there is a 10% penalty to get this
3) First conversion - the part that was not taxable when you did the conversion - the other $10k
4) Second conversion - as above
5) Third conversion - as above
Etc.
6) Earnings which may have a penalty if you have not met the 5 year and 59.5 or other exception rules

I'm not positive I have this right, but fairly sure. See fairmark.com and or IRS publications for more information.
Default User BR
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Re: Question about after-tax 401k contributions

Post by Default User BR »

lifebeckonss wrote:1. Accelerated pre-tax contributions can lead to losing employer match: If I max out my pre-tax contribution sooner in the year, I will lose employer match. The company matches 5% but I have to contribute at least 5% pre-tax for every paycheck in the year.
Many plans have a "true-up" at the end of the year for these cases. Others match after-tax just as they would pre-tax.


Brian
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lifebeckonss
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Re: Question about after-tax 401k contributions

Post by lifebeckonss »

Thanks Brian and retiredjg.

Brian, if what retiredjg is saying is true then it makes more sense for me to move the earnings back to the 401k. That way there will no taxable portion in the Roth IRA and hence no 10% penalty.

But that comes after. I first need to sort out the different things I am being told by my HR and Fidelity. I went back to the HR lady and this time she said "Oh let me check my plan documents then. I seem to remember that in-service withdrawals of after tax dollars is not allowed.". The Fidelity rep however was very confident that my plan allows it.
cliffedelgado
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Re: Question about after-tax 401k contributions

Post by cliffedelgado »

This page lists the order of the distributions from roth IRA. http://fairmark.com/rothira/distrib.htm

Regarding "Thanks cliffe. Does that mean there is no place (or need) to report a 401k --> roth conversion while filing taxes?"

The conversion/taxable amounts go on line 16ab but other than that, I haven't found any place for the info to go.

You should have access to the plan documents. I would hope that's required by law!
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retiredjg
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Re: Question about after-tax 401k contributions

Post by retiredjg »

lifebeckonss wrote:Brian, if what retiredjg is saying is true then it makes more sense for me to move the earnings back to the 401k. That way there will no taxable portion in the Roth IRA and hence no 10% penalty.
Moving the earnings back to the 401k is probably preferable. However, if you have several years' worth of ordinary contributions sitting in the Roth IRA, you may not dig deep enough into the Roth IRA to hit the tier than has the penalty. Or just pay the penalty if it is actually an emergency.
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lifebeckonss
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Re: Question about after-tax 401k contributions

Post by lifebeckonss »

retiredjg wrote:Moving the earnings back to the 401k is probably preferable. However, if you have several years' worth of ordinary contributions sitting in the Roth IRA, you may not dig deep enough into the Roth IRA to hit the tier than has the penalty. Or just pay the penalty if it is actually an emergency.
Thanks retiredjg. Your point is well taken.

However I do not have several years of regular contributions sitting in my Roth IRA. I just opened my Roth IRA a few weeks ago and right now it only has $10K in it ($5K for 2011 and $5K for 2012, funded using the non-deductible tIRA --> Roth IRA back door). Am I correct in assuming that there will be no penalty (or 5-year rule) if I wish to take that $10K out?

I am still trying to understand the process, and will keep educating myself. There is another thread going on by icedtea (http://www.bogleheads.org/forum/viewtop ... =1&t=90740) that I am keenly following. My situation is very similar to icedtea. I am learning so much here :)
Last edited by lifebeckonss on Tue Mar 13, 2012 12:51 pm, edited 1 time in total.
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retiredjg
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Re: Question about after-tax 401k contributions

Post by retiredjg »

lifebeckonss wrote:However I do not have several years of regular contributions sitting in my Roth IRA. I just opened my Roth IRA a few weeks ago and right now it only has $10K in it ($5K for 2011 and $5K for 2012, funded using the non-deductible tIRA --> Roth IRA back door). Am I correct in assuming that there will be no penalty (or 5-year rule) if I wish to take that $10K out?
It is my understanding that what you said is correct.
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lifebeckonss
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Re: Question about after-tax 401k contributions

Post by lifebeckonss »

cliffedelgado wrote:This page lists the order of the distributions from roth IRA. http://fairmark.com/rothira/distrib.htm
Regarding "Thanks cliffe. Does that mean there is no place (or need) to report a 401k --> roth conversion while filing taxes?"
The conversion/taxable amounts go on line 16ab but other than that, I haven't found any place for the info to go.
You should have access to the plan documents. I would hope that's required by law!
Thanks Cliffe. Yes I have access to the plan docs but it seems like the whole in-service withdrawal process is not often spelled out very clearly in the plan docs.

By the way, this is for anyone who wishes to find out if their plan allows it or not: Please don't just take your HR rep's word on it. Often times HR people will just say "No it is not allowed" because they get this question very rarely and they don't want to spend the time researching it. Saying No to this is an easy way out. Retiredjg made this point in one of his posts. Saying Yes on the other hand is a difficult thing because it must be backed by research. Please pick up the phone and call your 401K custodian directly (Fidelity in my case).
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lifebeckonss
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Re: Question about after-tax 401k contributions

Post by lifebeckonss »

Here is an update.

Initially, I talked to our HR manager and asked if "in-service withdrawals of after-tax contributions" are allowed. She immediately said "No". And I was bummed.

I then called Fidelity and the rep told me that yes they are allowed with my plan and there is no limit on the number of withdrawals per year. I told this to the HR manager who then said she will check back the plan and get back to me.

Today, I called Fidelity again and talked to another rep. He confirmed what the first rep said. I asked more questions and here is a summary of what I was told:
1. Yes, in-service withdrawals of after-tax contribution is allowed.
2. There is no limit on the number of withdrawals per year. There is no fees associated with this.
3. I can choose what percentage of my salary goes to pre-tax or after-tax, but I cannot choose to allocate investments this way. (It would have been great if I could have moved after-tax to a MMF but that is not allowed).
4. Fidelity keeps the pre-tax and after-tax dollars in separate buckets, so at any given point of time it is very easy to know how much I can withdraw using in-service withdrawal. He even said that the website will tell me my balance in each bucket.
5. For my plan, employer match is only given to pre-tax contributions.
6. He also said that I should request my HR to provide me with the SPD (Summary of Plan Description). That should have all of this outlined.

It looks like I am good to go.
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retiredjg
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Re: Question about after-tax 401k contributions

Post by retiredjg »

This is good news!
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