After tax 401(k) to Roth IRA law?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.

After tax 401(k) to Roth IRA law?

Postby investor1 » Wed Jan 02, 2013 9:03 pm

Can anyone please link me to the law which defines the rules for converting after tax 401(k) contributions to a Roth IRA (or even a Roth 401(k)) while still participating in plan contributions?

My SPD leads me to believe there is a penalty for doing so, but then again it hasn't been updated since 2008. I would like to know the details and when they came into effect, but am having trouble locating it.
investor1
 
Posts: 382
Joined: 15 Mar 2012

Re: After tax 401(k) to Roth IRA law?

Postby FinancialDave » Wed Jan 02, 2013 9:30 pm

I could be wrong (and often am) but I don't think there is any one IRS law that is going to cover this. I believe to some degree it might depend on the rules of the employer's plan and how they handle after tax money.

But the other question I have is say you had $100,000 of after tax money in your 401k (IRA side of 401k) -- it would seem odd that the IRS would just let you roll that into a Roth account.

Or are you asking about rolling the 401k Roth to a Roth account --- I have done that exercise.

fd
I love simulated data. It turns the impossible into the possible! Remember - Past performance is great for buying a dishwasher, but not so great for picking stocks or actively managed mutual funds!
FinancialDave
 
Posts: 884
Joined: 26 May 2011

Re: After tax 401(k) to Roth IRA law?

Postby Alan S. » Wed Jan 02, 2013 9:48 pm

No reason for there to be a penalty of the usual type, ie an early withdrawal penalty. These funds are being distributed but then are being rolled over to another account within the plan or in the case of an IRA, into a Roth IRA by conversion. There is no early withdrawal penalty for any of this activity.

Further, with respect to after tax funds, there would not be a penalty for another reason. The early withdrawal penalty only applies to the taxable portion of a distribution and after tax contributions are not taxable even if withdrawn from the plan.

If you are able to roll after tax employer plan money into a Roth IRA, there is no tax. Even though the Roth IRA has a 5 year holding period for conversions, a conversion funded by after tax money effectively has no holding period because the early withdrawal penalty from the Roth IRA only applies to the taxable portion of a conversion.

Sec 72 is the tax code section that governs how much of a given distribution is taxable, and also contains the penalty exceptions in Sec 72q and 72t.
Alan S.
 
Posts: 3102
Joined: 16 May 2011
Location: Prescott, AZ

Re: After tax 401(k) to Roth IRA law?

Postby investor1 » Wed Jan 02, 2013 9:56 pm

I'm asking about after tax contributions. I typically utilize all of the allowed 402(g)(1) space using the tradditional 401(k). If I have extra money, I would like to utilize the 415(c)(1)(A) space using after tax contributions which would be rolled over into a Roth IRA or Roth 401(k).

I know others on here do that, and I would like to read the law that enables it. I have a feeling I am going to need to contact my plan provider to get documentation/confirmation that I can do this penalty free.
Last edited by investor1 on Wed Jan 02, 2013 10:41 pm, edited 1 time in total.
investor1
 
Posts: 382
Joined: 15 Mar 2012

Re: After tax 401(k) to Roth IRA law?

Postby investor1 » Wed Jan 02, 2013 10:18 pm

Alan S. wrote:Sec 72 is the tax code section that governs how much of a given distribution is taxable, and also contains the penalty exceptions in Sec 72q and 72t.


Thanks, I will take a look.
investor1
 
Posts: 382
Joined: 15 Mar 2012

Re: After tax 401(k) to Roth IRA law?

Postby FinancialDave » Wed Jan 02, 2013 10:35 pm

Alan,

Are you saying that some plans could allow an investor to convert $100,000 of after-tax money from the IRA side of the 401k directly into a Roth IRA all in one year with no penalties?
I love simulated data. It turns the impossible into the possible! Remember - Past performance is great for buying a dishwasher, but not so great for picking stocks or actively managed mutual funds!
FinancialDave
 
Posts: 884
Joined: 26 May 2011

Re: After tax 401(k) to Roth IRA law?

Postby FinancialDave » Thu Jan 03, 2013 10:46 am

investor1 wrote:
Alan S. wrote:Sec 72 is the tax code section that governs how much of a given distribution is taxable, and also contains the penalty exceptions in Sec 72q and 72t.


Thanks, I will take a look.


Investor1,
After you take a look at the regs (which of course even the IRS has trouble interpreting sometimes), I suggest you ponder the following, which is only my humble opinion. At the end I will also offer why I think putting after-tax money into a tax-deferred account can be a poor strategy in most cases.

Consider a somewhat parallel transaction that has been discussed here at length -- that of the backdoor Roth conversion, where you put after-tax money into an IRA and then immediately convert it to a Roth. This ploy really only works, without generating tax, if you have no other IRA accounts, otherwise you are taxed on the prorated amount of IRA money that you had.

What I will throw out is that a 401k should work very much the same way (only my opinion) -- you could not convert your after tax 401k money without generating tax on a prorated basis on the tax deferred side of the account.

My third and final point is that you should never try to engage in what might be considered a "tax avoidance" strategy that you don't thoroughly understand to be totally legal --- my feeling is you are not going to get to that point from anyone here, nor from reading the actual tax code.


Given my thoughts above, my best idea would be to take the next best path to what you were trying to do. If allowed, take your after tax money out of your account, with an in service withdrawal and put it in a normal taxable account where you would get the advantage of long term capital gains. To tax event will occur in this case.

The above hints at the reason I think putting after tax money into a tax deferred account is a poor strategy - in most cases. In the first case you have already paid taxes on the money so your analysis comes down to the question "is it better to put my after tax money in a tax deferred account or a taxable account." The answer to that question, if you use any kind of halfway tax efficient investments (like an index fund,) boils down to "do I think my long term capital gains rate will be less than my normal ordinary income tax rate when I need the money." In most cases I think the long term gains win out from the taxable account, so why not just put it there in the first place and save a lot of headaches.

fd
I love simulated data. It turns the impossible into the possible! Remember - Past performance is great for buying a dishwasher, but not so great for picking stocks or actively managed mutual funds!
FinancialDave
 
Posts: 884
Joined: 26 May 2011

Re: After tax 401(k) to Roth IRA law?

Postby retiredjg » Thu Jan 03, 2013 11:03 am

investor1, I think this may be part of what you are looking for.

http://www.law.cornell.edu/uscode/text/26/415

This is Section 415 (c)(1)(A):

    (c) Limitation for defined contribution plans
    (1) In general
    Contributions and other additions with respect to a participant exceed the limitation of this subsection if, when expressed as an annual addition (within the meaning of paragraph (2)) to the participant’s account, such annual addition is greater than the lesser of—
    (A) $40,000, or
    (B) 100 percent of the participant’s compensation.
    (2) Annual addition
    For purposes of paragraph (1), the term “annual addition” means the sum of any year of—
    (A) employer contributions,
    (B) the employee contributions, and
    (C) forfeitures.

Your after-tax contributions, oddly enough, are officially known as "employee contributions". So this is the place in the law that allows you to make them. I don't know where it says you can convert them (your real question), but maybe just knowing the real name of the animal will help you figure that out.

Please note that the limit was $40k at the time this was published. As I'm sure you know, the limit is now $50k (or maybe more if it went up this week).
retiredjg
 
Posts: 16291
Joined: 10 Jan 2008

Re: After tax 401(k) to Roth IRA law?

Postby FinancialDave » Thu Jan 03, 2013 11:08 am

And if you should decide to not venture into the unknown (as I don't know anyone who has tried this) -- here is an excellent article on tax-efficiency:

http://www.bogleheads.org/wiki/Principl ... _Placement

fd
I love simulated data. It turns the impossible into the possible! Remember - Past performance is great for buying a dishwasher, but not so great for picking stocks or actively managed mutual funds!
FinancialDave
 
Posts: 884
Joined: 26 May 2011

Re: After tax 401(k) to Roth IRA law?

Postby retiredjg » Thu Jan 03, 2013 11:14 am

FinancialDave wrote:What I will throw out is that a 401k should work very much the same way (only my opinion) -- you could not convert your after tax 401k money without generating tax on a prorated basis on the tax deferred side of the account.

This is logical, but incorrect.

The law actually allows you to do exactly what investor1 wants to do, which is take an in-service distribution of his after tax money (along with its earnings) and move it to Roth IRA. It does not pro-rate in the "elective deferrals" side of the 401k plan.

If s/he does this often enough, the earnings should be minimal and trigger only small amounts of tax. If s/he waits till the end of career to do this, you are right - the earnings could be large and taxed at ordinary income rates and using taxable would have been better.
retiredjg
 
Posts: 16291
Joined: 10 Jan 2008

Re: After tax 401(k) to Roth IRA law?

Postby retiredjg » Thu Jan 03, 2013 11:24 am

FinancialDave wrote:And if you should decide to not venture into the unknown (as I don't know anyone who has tried this)....

There are a number of posters who do this on a regular basis and have for at least a few years. It is a subject that is easy to overlook so it is not particularly odd that you have missed these discussions.

If you want to really fry your brain, read this article on the subject by Kaye Thomas at Fairmark. :wink: It's a bit challenging, but covers the subject well.

Notice, the point of this article is how to convert only your basis, not the earnings too. A lot of trouble - I'd rather just convert the whole thing and be done with it. But several people here do isolate the basis and convert only that part.

http://fairmark.com/rothira/09030801-401k-basis.htm

Enjoy!
retiredjg
 
Posts: 16291
Joined: 10 Jan 2008

Re: After tax 401(k) to Roth IRA law?

Postby Default User BR » Thu Jan 03, 2013 4:03 pm

FinancialDave wrote:After you take a look at the regs (which of course even the IRS has trouble interpreting sometimes), I suggest you ponder the following, which is only my humble opinion. At the end I will also offer why I think putting after-tax money into a tax-deferred account can be a poor strategy in most cases.

The goal is to put the after-tax money into a Roth, not a tax-deferred account. After all, if you wanted tax-deferral, you could leave it in the qualified plan.

FinancialDave wrote:What I will throw out is that a 401k should work very much the same way (only my opinion) -- you could not convert your after tax 401k money without generating tax on a prorated basis on the tax deferred side of the account.

When you are still in-service with the plan sponsor and under age 59-1/2, the elective deferrals can't be distributed. So no pro-rata takes place. IRS publications affirm that after-tax contributions can be distributed in-service. If from post-1986 contributions, a share of taxable earnings will accompany the distribution.

Be wary of trying to apply the rules for one thing to another, even if the two share some characteristics. It's like someone wondering why, in American football, the punt kicking team doesn't get the ball if they pick it up before the receiving team. After all, that's what happens on kick-off returns. Well, the rules are different.


Brian
Default User BR
 
Posts: 7503
Joined: 17 Dec 2007

Re: After tax 401(k) to Roth IRA law?

Postby Default User BR » Thu Jan 03, 2013 4:04 pm

FinancialDave wrote:And if you should decide to not venture into the unknown (as I don't know anyone who has tried this)

I have done this (and will be doing so again shortly). A number of others have as well.


Brian
Default User BR
 
Posts: 7503
Joined: 17 Dec 2007

Re: After tax 401(k) to Roth IRA law?

Postby FinancialDave » Thu Jan 03, 2013 4:11 pm

retiredjg wrote:
FinancialDave wrote:What I will throw out is that a 401k should work very much the same way (only my opinion) -- you could not convert your after tax 401k money without generating tax on a prorated basis on the tax deferred side of the account.

This is logical, but incorrect.

The law actually allows you to do exactly what investor1 wants to do, which is take an in-service distribution of his after tax money (along with its earnings) and move it to Roth IRA. It does not pro-rate in the "elective deferrals" side of the 401k plan.

If s/he does this often enough, the earnings should be minimal and trigger only small amounts of tax. If s/he waits till the end of career to do this, you are right - the earnings could be large and taxed at ordinary income rates and using taxable would have been better.


In the first place not all 401k plans are treated equal, in that the employer sets a number of the withdrawal and conversion rules, so that they don't get into trouble with the IRS. The bottom line is that even if you do this as you suggest above, tax will need to be paid on your after tax earnings, at your ordinary income tax rate - which is much higher than you would have had to pay on a long term gain, had you avoided after tax money in the 401k to begin with.

Now in reading the complete article you sent in your other post, I come away with the following:

1. Some so to speak "tax practioners" who thought they knew how this worked have gotten it wrong for a number of years.

2. In some of the authors justification he uses terms very similar to mine such as "it seems reasonably clear" -- meaning he doesn't really know for sure!

3. He additionally seals my item 2 above with the following closing quote:

The current situation is not stable. The IRS has yet to offer guidance on many of these issues. More importantly, the taxwriters in Congress haven't come to grips with the situation. Developments of one kind or another are to be expected. For now, the direction of those changes is hard to predict.


I'll follow this up with my own personal caution once again -- don't do things that you don't personally understand, or are of questionable legality just to save what you might "think" are a few taxes down the road ---

:?

fd
I love simulated data. It turns the impossible into the possible! Remember - Past performance is great for buying a dishwasher, but not so great for picking stocks or actively managed mutual funds!
FinancialDave
 
Posts: 884
Joined: 26 May 2011

Re: After tax 401(k) to Roth IRA law?

Postby retiredjg » Thu Jan 03, 2013 6:51 pm

FinancialDave wrote:In the first place not all 401k plans are treated equal, in that the employer sets a number of the withdrawal and conversion rules, so that they don't get into trouble with the IRS.

It is true that plans can set up their own rules for withdrawals. One poster has reported a plan that does not allow in-service withdrawals. Everybody else who does this has reported either unlimited withdrawals or something like 3 or 4 times a year.

This is not a good procedure for the person who cannot do in-service withdrawals because it works just like a large non-deductible tIRA - it turns the tax on all the earnings into ordinary rates instead of capital gains rates. It works out well for people who do withdrawals regularly because they are withdrawing frequently enough that the earnings are very limited.


The bottom line is that even if you do this as you suggest above, tax will need to be paid on your after tax earnings, at your ordinary income tax rate - which is much higher than you would have had to pay on a long term gain, had you avoided after tax money in the 401k to begin with.

Yes, tax is paid at your ordinary rate on the earnings. But if you can get an extra $10k into Roth IRA each year and only pay tax at ordinary rates on $100 in earnings, it seems to me that you come out way ahead.


Now in reading the complete article you sent in your other post, I come away with the following:

All of that is true. But you missed the most important point. There is no question this is legal (moving after-tax money into Roth IRA or tIRA). The question is the mechanism of the transfer being used by those who wish to isolate the basis of of their after-tax money. There are several ways to do it. One or two of the methods appear to have a problem meeting the requirements of the law because of the order in which the money comes out (if I recall correctly) and the IRS has consistently failed to give guidance on whether those methods are up to snuff or not. That does not negate the fact that the process is legal, even if the procedure is determined to be flawed.

Again, the question is not whether it can be done. The are some questions about how it should be done. And people here have been quite careful to be sure they are doing it safely.


I'll follow this up with my own personal caution once again -- don't do things that you don't personally understand, or are of questionable legality just to save what you might "think" are a few taxes down the road ---

This is good advice. But do try to keep your mind open. You may eventually see this is not some cockamamie loophole dreamed up by people trying to avoid taxes. It is allowed by law. It is allowed by 401k (and I presume 403b) plans. People do it. But not a whole lot of people know about it and like you, most folks find it hard to believe it can be done. I was pretty shocked myself and would have sworn this thing was simply not possible. But it is. :D
retiredjg
 
Posts: 16291
Joined: 10 Jan 2008

Re: After tax 401(k) to Roth IRA law?

Postby Alan S. » Thu Jan 03, 2013 11:06 pm

investor1 wrote:I'm asking about after tax contributions. I typically utilize all of the allowed 402(g)(1) space using the tradditional 401(k). If I have extra money, I would like to utilize the 415(c)(1)(A) space using after tax contributions which would be rolled over into a Roth IRA or Roth 401(k).

I know others on here do that, and I would like to read the law that enables it. I have a feeling I am going to need to contact my plan provider to get documentation/confirmation that I can do this penalty free.


While the IRS has never issued on point guidance on isolating basis for in service distributions, the question has arisen whether the ATRA legislation facilitating in plan Roth rollovers will affect the pro rating of after tax distributions being rolled to a Roth IRA. Logic seems to indicate that it will not based on plans doing pro rating only on the funds that are eligible for distribution.

Consider an example where current employee has traditional 401k balance of 39k pre tax deferrals and matching, 1k of earnings on after tax contributions and 10k after tax contributions.
1) Employee chooses an in plan rollover to designated Roth. ATRA makes the entire balance eligible for this, so the in plan rollover would would be 80% taxable (and not eligible for recharacterization).
2) Employee chooses after tax rollover to Roth IRA of 10k and the 1k of earnings on the contributions. Plan only permits distributions outside the plan for this balance, not the other 39k. Pro rating in this case should only include the 11k, ie only 9.1% of the distribution should be taxable. Major advantage here to bypass the in plan rollover in favor of the Roth IRA rollover.

Further, if the plan gets confused, blindsides you with a 1099R making the Roth IRA rollover taxable, you can still recharacterize the rollover to a TIRA if you wish and eliminate the tax bill. You would then have to file an 8606 to report TIRA basis for future distributions or conversions.

Again, all this is an anecdotal conclusion because the IRS has left 1099R issuance to the best judgement of plan administrators. Anyone who plans to proceed with the Roth IRA rollover should attempt to verify what the 1099R will look like before acting. In summary, ATRA should NOT affect the handling of Roth rollovers of after tax contributions to employer plans that allow in service distributions of those contributions.
Hope this makes some sense..........
Alan S.
 
Posts: 3102
Joined: 16 May 2011
Location: Prescott, AZ

Re: After tax 401(k) to Roth IRA law?

Postby Tony_L » Thu Jan 03, 2013 11:34 pm

Things they are a changing!

Budget Deal Lets More Savers Convert To Roth 401(k)s January 3, 2013 • Bloomberg News

[Material in excess of copyright fair use removed by admin LadyGeek]
Tony_L
 
Posts: 77
Joined: 7 Apr 2009

Re: After tax 401(k) to Roth IRA law?

Postby FinancialDave » Fri Jan 04, 2013 1:24 pm

Tony_L wrote:Things they are a changing!



Budget Deal Lets More Savers Convert To Roth 401(k)s

January 3, 2013 • Bloomberg News


Deferring Taxes


The new conversion opportunity may help wealthy investors who want to leave their retirement accounts to heirs and younger savers, said John Olivieri, a partner in the private clients group at New York-based law firm White & Case LLP.

This is really a huge benefit to heirs,” Olivieri said. “Basically you can pay tax now for your kids.”


I'll agree with one word in the above HUGE --

This would be the loss to your heirs, if it turned out you paid 40% tax now to save 25% tax later!

:(

fd
I love simulated data. It turns the impossible into the possible! Remember - Past performance is great for buying a dishwasher, but not so great for picking stocks or actively managed mutual funds!
FinancialDave
 
Posts: 884
Joined: 26 May 2011

Re: After tax 401(k) to Roth IRA law?

Postby retiredjg » Fri Jan 04, 2013 1:42 pm

I'm thinking the same thing FinancialDave.

All the articles (not just this one) are talking like this us a huge opportunity. But as you say, it's really an opportunity to pay a higher tax rate now than you or someone else would pay later. Bad, bad idea.
retiredjg
 
Posts: 16291
Joined: 10 Jan 2008

Re: After tax 401(k) to Roth IRA law?

Postby Bobby Ingersoll » Fri Jan 04, 2013 1:55 pm

Does this make it possible to make after tax contributions to your 401k above the limit, and then convert those after tax funds into the Roth 401k?
Bobby Ingersoll
 
Posts: 58
Joined: 20 Oct 2009

Re: After tax 401(k) to Roth IRA law?

Postby neurosphere » Fri Jan 04, 2013 2:03 pm

retiredjg wrote:I'm thinking the same thing FinancialDave.

All the articles (not just this one) are talking like this us a huge opportunity. But as you say, it's really an opportunity to pay a higher tax rate now than you or someone else would pay later. Bad, bad idea.


It depends right? Suppose I have an estate of $10M. For the sake of simplicity, let's say the estate tax is 40% on amounts over $5M. If I die, $10M gets passed on to my heirs, but there will be taxes owed of 0.4*5M = $2M.

However, lets say I have a 401k with a balance of $3M as part of the estate. If I convert the 401k to a roth, I pays taxes at rates of 39.6% on that 3M. Those taxes lower the amount of my estate by the same amount, and thus lower the taxes my estate has to pay. Thus *I* paid the taxes now, but the eventual estate tax is lowered by about the same amount, and my heirs now inherit a Roth IRA when I die and avoid any taxes they would have paid if they were cashing out my regular 401k.

Am I missing something?

NS
I am not an actor, even though I play one on television.
User avatar
neurosphere
 
Posts: 1289
Joined: 17 Jan 2010
Location: NYC

Re: After tax 401(k) to Roth IRA law?

Postby Alan S. » Fri Jan 04, 2013 2:53 pm

Bobby Ingersoll wrote:Does this make it possible to make after tax contributions to your 401k above the limit, and then convert those after tax funds into the Roth 401k?


Probably, but see my earlier post in this thread why it would be better to convert to a Roth IRA, if the plan allows in service distributions of only the after tax sub account.
Alan S.
 
Posts: 3102
Joined: 16 May 2011
Location: Prescott, AZ

Re: After tax 401(k) to Roth IRA law?

Postby Default User BR » Fri Jan 04, 2013 3:48 pm

FinancialDave wrote:In the first place not all 401k plans are treated equal, in that the employer sets a number of the withdrawal and conversion rules, so that they don't get into trouble with the IRS.

There was a previous poll thread. Most plans reported in the poll that allow after-tax contributions als permitted in-service distribution.

http://www.bogleheads.org/forum/viewtopic.php?f=11&t=104829

FinancialDave wrote:The bottom line is that even if you do this as you suggest above, tax will need to be paid on your after tax earnings, at your ordinary income tax rate - which is much higher than you would have had to pay on a long term gain, had you avoided after tax money in the 401k to begin with.

I'm not entirely sure you understand the process.

1. Make after-tax contributions.
2. Take in-service distribution of contributions (brings a share of earnings).
3a. Put into a Roth IRA and pay taxes on only the earnings
or
3b. Use one of the methods for isolating basis so that the earnings are tax-deferred and the basis in Roth.

I personally take the distribution and place into a traditional IRA, convert the basis to Roth, and roll the earnings back into the qualified plan. I see nothing in the tax laws that would indicate that this is not legal. Do you?


Brian
Default User BR
 
Posts: 7503
Joined: 17 Dec 2007

Re: After tax 401(k) to Roth IRA law?

Postby investor1 » Fri Jan 04, 2013 4:14 pm

retiredjg wrote:I'm thinking the same thing FinancialDave.

All the articles (not just this one) are talking like this us a huge opportunity. But as you say, it's really an opportunity to pay a higher tax rate now than you or someone else would pay later. Bad, bad idea.

Just to clarify, I'm not talking about the recent bill which makes it possible to convert traditional 401(k) assets to a Roth 401(k). I am interested in making after tax contributions after I have already max'ed out traditional/roth contributions ($17.5k) and my IRA contributions. I would then want to convert those after tax contributions to a Roth IRA (or Roth 401(k)). It would be ideal for that conversion to occur before the after tax contributions have earnings.

Basically, I'm looking for a way to utilize the $17.5k-$51k space in my 401(k) in a way which provides some incentive to lock this money into a federally regulated retirement account as oppose to contributing to a brokerage account and merely paying LTCG taxes on the earnings when I withdraw which could happen whenever I want.
investor1
 
Posts: 382
Joined: 15 Mar 2012

Re: After tax 401(k) to Roth IRA law?

Postby retiredjg » Fri Jan 04, 2013 8:17 pm

Bobby Ingersoll wrote:Does this make it possible to make after tax contributions to your 401k above the limit, and then convert those after tax funds into the Roth 401k?

If by "above the limit" you mean above your $17,500 in elective deferrals, my understanding is that has been allowed by law since 2010. However, not all plans that had Roth 401k had chosen to be amended to allow it.

In the above article from Bloomberg, I think that is the 12% of plans it refers to - that 12% of 401k plans have allowed this (in plan conversion of after tax contributions to Roth 401k) since it was made legal in 2010.

Alan S, it seems your answer is somewhat different. Am I understanding this wrong?
retiredjg
 
Posts: 16291
Joined: 10 Jan 2008

Re: After tax 401(k) to Roth IRA law?

Postby retiredjg » Fri Jan 04, 2013 8:23 pm

investor1 wrote:
retiredjg wrote:I'm thinking the same thing FinancialDave.

All the articles (not just this one) are talking like this us a huge opportunity. But as you say, it's really an opportunity to pay a higher tax rate now than you or someone else would pay later. Bad, bad idea.

Just to clarify, I'm not talking about the recent bill which makes it possible to convert traditional 401(k) assets to a Roth 401(k). I am interested in making after tax contributions after I have already max'ed out traditional/roth contributions ($17.5k) and my IRA contributions. I would then want to convert those after tax contributions to a Roth IRA (or Roth 401(k)). It would be ideal for that conversion to occur before the after tax contributions have earnings.

Basically, I'm looking for a way to utilize the $17.5k-$51k space in my 401(k) in a way which provides some incentive to lock this money into a federally regulated retirement account as oppose to contributing to a brokerage account and merely paying LTCG taxes on the earnings when I withdraw which could happen whenever I want.

investor1, I'm not sure if you were speaking to me or to others in the thread. But if you were speaking to me, I do understand the difference and I do understand that is what you were talking about.

I'm not sure everybody else does though. The Bloomberg article is about something new and different although similar enough to cause confusion. Perhaps I should not have commented since that article is not directly on topic. On the other hand, some people may not realize that article has nothing to do with your original question, so it is good you pointed it out.
retiredjg
 
Posts: 16291
Joined: 10 Jan 2008

Re: After tax 401(k) to Roth IRA law?

Postby retiredjg » Fri Jan 04, 2013 8:34 pm

But...I do have to wonder, investor1, if the new law will cause your after tax money to be pro-rated with something. As mentioned above by Alan S...

While the IRS has never issued on point guidance on isolating basis for in service distributions, the question has arisen whether the ATRA legislation facilitating in plan Roth rollovers will affect the pro rating of after tax distributions being rolled to a Roth IRA. Logic seems to indicate that it will not based on plans doing pro rating only on the funds that are eligible for distribution.

"Logic seems to dictate" may not end up being correct. I think I might be concerned about going forward myself - at least until something is made clearer.

I wonder if you could roll your after tax money to tIRA (which should be allowed without pro-rating, shouldn't it?) and then convert that to Roth IRA? Of course, this would only work (if it even needs to be done) if you have no other tIRA, SIMPLE, or SEP IRAs "in the way".
retiredjg
 
Posts: 16291
Joined: 10 Jan 2008

Re: After tax 401(k) to Roth IRA law?

Postby FinancialDave » Mon Jan 07, 2013 5:21 pm

investor1 wrote:
retiredjg wrote:I'm thinking the same thing FinancialDave.

All the articles (not just this one) are talking like this us a huge opportunity. But as you say, it's really an opportunity to pay a higher tax rate now than you or someone else would pay later. Bad, bad idea.

Just to clarify, I'm not talking about the recent bill which makes it possible to convert traditional 401(k) assets to a Roth 401(k). I am interested in making after tax contributions after I have already max'ed out traditional/roth contributions ($17.5k) and my IRA contributions. I would then want to convert those after tax contributions to a Roth IRA (or Roth 401(k)). It would be ideal for that conversion to occur before the after tax contributions have earnings.

Basically, I'm looking for a way to utilize the $17.5k-$51k space in my 401(k) in a way which provides some incentive to lock this money into a federally regulated retirement account as oppose to contributing to a brokerage account and merely paying LTCG taxes on the earnings when I withdraw which could happen whenever I want.


Investor1,
I do understand what you are saying, and it would be great if we could all put $51k into a Roth every year by whatever means seems legal - which I will let others continue to bat around. Here is just my own opinion on how I treat a problem like this (defined as trying to convert all your after-tax 401k money to a Roth):

1. This does not fall under something that I would classify as KISS, nor is it something that I think anyone can say is "strictly" approved by the IRS -- meaning a ruling exists that says you can specifically do this as a way to get $51k of your 401k money into a Roth. If Congress and the IRS had meant you to do this they just would have set it up that way.

2. The second reason I don't see this as a good idea, stems from the fact that most people put too high a regard on getting all of their money into a Roth, without understanding the long term affect of doing so. In other words, it is a well know fact (by most anyway) that there is no long term economic advantage of a Roth over a non-Roth investment, provided that you assume your tax rate now is the same as the tax rate later. The fact is the scale will favor the IRA money now if your tax rate is higher now (which is where I perceive your income could very well be), but would favor the Roth now for younger investors in a lower tax bracket now. The problem is we can never know our future tax rate, so I always recommend a "risk reduction" philosophy of doing some of each -this will give you the most flexibility in retirement to minimize your lifetime tax burden.

3. Because we never know what future tax laws will bring, I see putting some money in all three places (Roth 401k, trad. 401k, taxable acct.) as a form of diversification.

4. I also don't know about your 401k, but for me the cost is not low enough and the choice of funds diverse enough for me to what to put all my investing money in there, as a 1-2% difference in total returns can make hundreds of thousands of dollars difference when compounded for 30-40 years.

5. If it was me, I would probably do something like a 60/40 split in the 401k in favor of the Roth, then put about 1/2 of your after-tax allocation in the 401k, and the rest in a taxable account, and focus your efforts on your asset allocation and fund selection, rather than what most of this thread has been about, because in the end there is a chance it was not the best use of your money.

fd
I love simulated data. It turns the impossible into the possible! Remember - Past performance is great for buying a dishwasher, but not so great for picking stocks or actively managed mutual funds!
FinancialDave
 
Posts: 884
Joined: 26 May 2011

Re: After tax 401(k) to Roth IRA law?

Postby Jfet » Mon Jan 07, 2013 6:20 pm

FinancialDave wrote:
2. The second reason I don't see this as a good idea, stems from the fact that most people put too high a regard on getting all of their money into a Roth, without understanding the long term affect of doing so. In other words, it is a well know fact (by most anyway) that there is no long term economic advantage of a Roth over a non-Roth investment, provided that you assume your tax rate now is the same as the tax rate later. The fact is the scale will favor the IRA money now if your tax rate is higher now (which is where I perceive your income could very well be), but would favor the Roth now for younger investors in a lower tax bracket now. The problem is we can never know our future tax rate, so I always recommend a "risk reduction" philosophy of doing some of each -this will give you the most flexibility in retirement to minimize your lifetime tax burden.


Sorry, not buying this. If a person makes too much to contribute to directly to a Roth but can contribute to a non deductable IRA, there is a big long term advantage in getting the money into the Roth instead of the non-deductable IRA because they have paid the current tax rate on the money in either way. If the tax rate in retirement is 0%, then I will agree with you that it made no difference.
Jfet
 
Posts: 1033
Joined: 21 Dec 2010

Re: After tax 401(k) to Roth IRA law?

Postby Default User BR » Mon Jan 07, 2013 7:45 pm

FinancialDave wrote:1. This does not fall under something that I would classify as KISS, nor is it something that I think anyone can say is "strictly" approved by the IRS -- meaning a ruling exists that says you can specifically do this as a way to get $51k of your 401k money into a Roth. If Congress and the IRS had meant you to do this they just would have set it up that way.

Pshaw. The tax code if full of things like that. Including the ever-popular backdoor Roth. The Congress and the IRS wouldn't have time to illuminate every single possible scenario that the tax code presents.

FinancialDave wrote:2. The second reason I don't see this as a good idea, stems from the fact that most people put too high a regard on getting all of their money into a Roth, without understanding the long term affect of doing so. In other words, it is a well know fact (by most anyway) that there is no long term economic advantage of a Roth over a non-Roth investment, provided that you assume your tax rate now is the same as the tax rate later.

That's only if you are comparing Roth to tax-deferred. It's not an option to put this in tax-deferred. All you could do is put it in taxable and pay tax on distributions and possibly capital gains down the road.

FinancialDave wrote:3. Because we never know what future tax laws will bring, I see putting some money in all three places (Roth 401k, trad. 401k, taxable acct.) as a form of diversification.

This doesn't stop you from doing so.

FinancialDave wrote:4. I also don't know about your 401k, but for me the cost is not low enough and the choice of funds diverse enough for me to what to put all my investing money in there, as a 1-2% difference in total returns can make hundreds of thousands of dollars difference when compounded for 30-40 years.

Ok, now I'm not sure you actually understand the process. The contributions don't stay in the 401(k), unless you're doing in-plan conversion. We're discussing in-service rollovers. The money leaves the plan and goes into the Roth IRA of your choice.


Brian
Default User BR
 
Posts: 7503
Joined: 17 Dec 2007

Re: After tax 401(k) to Roth IRA law?

Postby retiredjg » Mon Jan 07, 2013 10:21 pm

FinancialDave, I'll comment as well on your item #2. This is money that is going to be taxed anyway. So your choices are to

    -put it (or some of it anyway) in a tIRA in the form of a non-deductible contribution (which you agree is not a great idea)

    -put it in a taxable account (not a bad idea at all)

    -put it in post-tax contributions to 401k which are then rolled out to Roth IRA (even better than taxable)
I think we all agree that people are blind to the advantages of deductible contributions to tIRA and naively enamored of the whole Roth IRA concept. But that is not the question here. This is a choice of taxable vs Roth. I can't imagine any argument that would make taxable preferable to Roth for long term savings.

I don't know where it is, but somewhere in the law, it is specified what can and cannot be withdrawn from 401k. In fact, that was one of the original questions in the original post although we don't have a definitive answer yet. Maybe someone will find it sometime soon and make you feel more confident that this is not just some workaround that people are taking advantage of in an ill-advised way. Do you really imagine that all these 401k plans actually state what you can take out of your 401k if it is not allowed by law?
retiredjg
 
Posts: 16291
Joined: 10 Jan 2008

Re: After tax 401(k) to Roth IRA law?

Postby Default User BR » Tue Jan 08, 2013 3:03 pm

I guess we need to break down which aspects are considered questionable.

1. Can you make after-tax non-Roth contributions? Certainly, many IRS pubs mention them.
2. Can you take in-service distributions of these? Again, yes.
3. Can you roll them over? From the IRS Pub 17
Rollover of nontaxable amounts. You may be able to roll over the nontaxable part of a distribution (such as your after-tax contributions) made to another qualified retirement plan that is a qualified employee plan or a 403(b) plan, or to a traditional or Roth IRA. The transfer must be made either through a direct rollover to a qualified plan or 403(b) plan that separately accounts for the taxable and nontaxable parts of the rollover or through a rollover to a traditional or Roth IRA.


I don't recall seeing an IRS pub titled, "Here's how to boost Roth with after-tax 401(k)", but so what?


Brian
Default User BR
 
Posts: 7503
Joined: 17 Dec 2007

Re: After tax 401(k) to Roth IRA law?

Postby Alan S. » Tue Jan 08, 2013 7:04 pm

Probably the central issue here relates to plan accounting. The following addresses separate accounts starting on p 10. Note that citations are footnoted on many of his conclusions, and Sec 72(d)(2) appears to be the most relevant. Most plans are probably set up this way, but not necessarily all of them.

http://www.texastaxsection.org/LinkClic ... D&tabid=80
Alan S.
 
Posts: 3102
Joined: 16 May 2011
Location: Prescott, AZ

Re: After tax 401(k) to Roth IRA law?

Postby retiredjg » Thu Jan 10, 2013 10:56 am

Alan S. posted this link in a different thread. I think it has the answers to your original questions - in the Executive Summary.

http://retirementlc.com/documents/20120 ... utions.pdf
retiredjg
 
Posts: 16291
Joined: 10 Jan 2008

Re: After tax 401(k) to Roth IRA law?

Postby tioga » Mon Jan 21, 2013 1:09 am

FinancialDave, there are two links posted by Alan S and retiredjg that shed much light on the rollover of 401(k) after-tax contributions+earnings into a Roth IRA. These links are:

http://www.texastaxsection.org/LinkClic ... D&tabid=80
http://retirementlc.com/documents/20120 ... utions.pdf

Would you like to comment on your earlier cautionary posts after reading these?
tioga
 
Posts: 16
Joined: 12 May 2011

Re: After tax 401(k) to Roth IRA law?

Postby investor1 » Mon Jan 21, 2013 3:40 am

retiredjg wrote:Alan S. posted this link in a different thread. I think it has the answers to your original questions - in the Executive Summary.

http://retirementlc.com/documents/20120 ... utions.pdf

Thanks!

...you too, Alan!
investor1
 
Posts: 382
Joined: 15 Mar 2012

Re: After tax 401(k) to Roth IRA law?

Postby tioga » Mon Jan 21, 2013 10:22 am

[quote="investor1"][quote="retiredjg"]Alan S. posted this link in a different thread. I think it has the answers to your original questions - in the Executive Summary.

http://retirementlc.com/documents/20120 ... utions.pdf[/quote]
Thanks!

...you too, Alan![/quote]

True. A great many thanks to Alan for having done much here on Bogleheads for shedding light on these options.
tioga
 
Posts: 16
Joined: 12 May 2011

Re: After tax 401(k) to Roth IRA law?

Postby Phineas J. Whoopee » Mon Jan 21, 2013 8:27 pm

Default User BR wrote:I guess we need to break down which aspects are considered questionable.

1. Can you make after-tax non-Roth contributions? Certainly, many IRS pubs mention them.
2. Can you take in-service distributions of these? Again, yes.
3. Can you roll them over? From the IRS Pub 17
Rollover of nontaxable amounts. You may be able to roll over the nontaxable part of a distribution (such as your after-tax contributions) made to another qualified retirement plan that is a qualified employee plan or a 403(b) plan, or to a traditional or Roth IRA. The transfer must be made either through a direct rollover to a qualified plan or 403(b) plan that separately accounts for the taxable and nontaxable parts of the rollover or through a rollover to a traditional or Roth IRA.


I don't recall seeing an IRS pub titled, "Here's how to boost Roth with after-tax 401(k)", but so what?


Brian

Hi Investor1, Brian,

retiredjg quoted the law as originally requested and Default User BR quoted publication 17. I mean to point you to the specific reporting instructions.

I recommend you have a look at the Rollovers section (beginning on p. 27) of IRS publication 575, Pension and Annuity Income. In particular I suggest you read the paragraphs headed Rollover of nontaxable amounts and How to report.

http://www.irs.gov/pub/irs-pdf/p575.pdf

PJW
User avatar
Phineas J. Whoopee
 
Posts: 2011
Joined: 18 Dec 2011

Re: After tax 401(k) to Roth IRA law?

Postby investor1 » Tue Jan 22, 2013 9:07 pm

Thanks PJW!
investor1
 
Posts: 382
Joined: 15 Mar 2012


Return to Investing - Theory, News & General

Who is online

Users browsing this forum: arcticpineapplecorp., Bing [Bot], cfs, columbia, oldzey, Rodc and 65 guests