After-Tax 401(k) & Backdoor IRA

[sphynxy9291]

Hello,

Do you know if it's possible to make a backdoor IRA contribution with funds that originated as after-tax 401(k) contributions?

My plan allows me the ability to rollover just the after-tax contributions to an IRA, which I'm assuming could then be converted to Roth, bypassing the $5,500 limit. Is this accurate? Also, how are taxes handled? I'm assuming I would have to pay tax on the earnings portion of the after-tax rollover, but I'm not sure if/how that would be reported.

Thanks in advance.

[tfb]

Just roll directly into Roth IRA. No backdoor required.

[sphynxy9291]

Even if I'm past the income limit? I can go directly from After-Tax (not Roth 401(k)) to Roth IRA?

[Default User BR]

Even if I'm past the income limit? I can go directly from After-Tax (not Roth 401(k)) to Roth IRA?

Yes, rollovers are not contributions. Note that after-tax contributions will bring a share of taxable earnings with them. If rolled directly to a Roth, you will owe taxes on that amount. If the earnings amount is significant, then one of the strategies for isolating basis might be in order.


Brian

[retiredjg]

In fact, you can roll the after-tax money (and its earnings) to Roth IRA...AND....make a $5,500 Roth IRA contribution (front door or back door) if you want.

Yes, you can go after-tax 401k (not to be confused with Roth 401k) to Roth IRA directly. In fact, if you make a stop in tIRA territory on the way, it would cause pro-rating with any other money you have in tIRA, SEP IRA or SIMPLE IRA. If you don't have anything in those types of accounts, it would not matter.

[jane1]

According to our current 401k administrator, per IRS rules, if I have pre-tax and after-tax money in the 401k and I rollover to Roth, it will be pro-rata. i.e. I can't choose to rollover just the after-tax. So I would have to pay tax on the pre-tax contributions.
Of course if you only have after-tax & Roth 401k contributions in your 401k, only your earnings would be taxable when you rollover to Roth.

[Default User BR]

According to our current 401k administrator, per IRS rules, if I have pre-tax and after-tax money in the 401k and I rollover to Roth, it will be pro-rata. i.e. I can't choose to rollover just the after-tax. So I would have to pay tax on the pre-tax contributions.
Of course if you only have after-tax & Roth 401k contributions in your 401k, only your earnings would be taxable when you rollover to Roth.

If you do not have a qualifying event, like reaching age 59-1/2, employee elective deferrals (your pre-tax contributions) cannot be distributed. This is the law. If your plan tells you something else then they are wrong. If you are of age, then that's possibly correct. If the plan accepts incoming rollovers from IRAs, then one could use a TIRA to isolate the basis.


Brian

[BrandonBogle]

I have a little bit in the After-Tax subaccount of my 401k that I can make an in-service "After Tax Withdrawal" for. I plan to move this as a Direct Rollover to my Roth IRA. I understand I will pay nominal taxes on the gains as they pass into the Roth, which is fine. However, our 401k custodian also has an entry for "Hardship Withdrawal". I do not plan to use this. They also have "Regular Withdrawal". The balance on this is the total of my After-Tax contributions as well as the Discretionary Profit Sharing we've gotten over the past couple of years. I am curious about the implications of moving this balance over.

I am 30 and am currently revamping my portfolio (http://www.bogleheads.org/forum/viewtopic.php?f=1&t=110026). I presume since the plan lets me make a "Regular Withdrawal" of the After-Tax and Discretionary Profit Sharing amounts that I would NOT be subject to the 10% penalty for early distribution? Would this DPS balance work just like the a regular After-Tax rollover in that it's pro-rata only with what the plan could let me withdraw? Basically, I would do the After-Tax first so that only the DPS is left. If I did that, I would just pay nominal taxes on the entire balance since it's funds from my employer that have never been taxed?

Would that be a prudent move to make? It's sitting tax deferred along with my other 401k assets and can be invested how I please (given to me as company ESOP contributions but I can xfer out within the 401k). Either way, I will do the After-Tax because I don't want to deal with pro-rata accounting non-sense if the company and I part ways.

[Alan S.]

That doesn't sound right. The company PS contributions should not be lumped with your employee after tax contributions unless the plan does NOT maintain a separate sub account for the after tax contributions and their earnings. If the plan does maintain the separate sub account, you should be able to do a direct rollover of ONLY that sub account balance to your Roth IRA, with only the earnings on your after tax contributions taxable as part of that rollover. I think you need to clarify this difference with the plan. The goal is to get as much of the after tax balance into your Roth IRA without dragging along too much in taxable amounts from the earnings.

Any amounts that you directly roll over to your Roth IRA will not be subject to any penalty, just ordinary income tax on the taxable portion. If the distribution form you are looking at does not include the option you want, don't take the chance of checking the wrong box. Call the plan and get your question clarified.

If it turns out that the plan does NOT maintain the sub account and is pro rating the entire plan balance you are eligible to distribute, there is another way to isolate your basis to the Roth IRA, but it involves getting the distribution paid to you, and you must have the cash to replace the mandatory 20% withholding on the pre tax portion. You then do your own rollovers, first the pre tax amount goes to your TIRA and then the after tax amount with the cash necessary to replace any withheld amounts to your Roth IRA. This would be totally tax free, it just hits your cash flow temporarily, but you could reduce your salary withholding to recover the money without waiting an entire year when your file your 2013 return.

[BrandonBogle]

That doesn't sound right. The company PS contributions should not be lumped with your employee after tax contributions unless the plan does NOT maintain a separate sub account for the after tax contributions and their earnings. If the plan does maintain the separate sub account, you should be able to do a direct rollover of ONLY that sub account balance to your Roth IRA, with only the earnings on your after tax contributions taxable as part of that rollover. I think you need to clarify this difference with the plan. The goal is to get as much of the after tax balance into your Roth IRA without dragging along too much in taxable amounts from the earnings.

Sorry if I was not clear. My three choices for withdrawal are:
- Hardship Withdrawal
- After-Tax Withdrawal
- Regular Withdrawal

If I pick "Regular Withdrawal", it has an available balance equal to my DPS + my After-Tax contributions + After-Tax earnings. I would presume this would be pro-rata between those two.

If I pick "After-Tax Withdrawal", it has an available balance equal to my After-Tax contributions + After-Tax earnings.

I plan to do a "After-Tax Withdrawal" so I do not have to worry about any pro-rate nonsense. Once that is done though, I wonder about considering the "Regular Withdrawal". None of these funds then would be taxed already, so I'd have to pay nominal taxes on that. The question mainly is if that would be worthwhile. I already max out my 401k and Roth IRA annually, with the 401ks (old + current) being 65% of my portfolio and my Roth IRA being almost 20% of my portfolio. Based on your last sentence though, this sounds like it would NOT be a worthwhile move.

[Default User BR]

I wonder about considering the "Regular Withdrawal". None of these funds then would be taxed already, so I'd have to pay nominal taxes on that.

Without knowing your tax rate(s) it's difficult to say. Generally it's not a great idea to convert tax-deferred to Roth. If your plan isn't good, it might be worthwhile to roll out the employer contributions to a TIRA and leave them there. If at some time you needed to do backdoor Roth, that would be a problem.


Brian

[BrandonBogle]

I wonder about considering the "Regular Withdrawal". None of these funds then would be taxed already, so I'd have to pay nominal taxes on that.

Without knowing your tax rate(s) it's difficult to say. Generally it's not a great idea to convert tax-deferred to Roth. If your plan isn't good, it might be worthwhile to roll out the employer contributions to a TIRA and leave them there. If at some time you needed to do backdoor Roth, that would be a problem.


Brian

Thanks Brian. I linked to my portfolio a little further up (http://www.bogleheads.org/forum/viewtopic.php?f=1&t=110026). I'm 25%/8% marginal, 15%/7% effective. The main goal was to get rid of the tracking and any pro-rata concerns of the After-Tax down the road. Based on your and Alan's suggestions, I feel more comfortable leaving the the DPS as is in the 401k. I've got decent non-Vanguard low-cost index choices in there.

[Default User BR]

Thanks Brian. I linked to my portfolio a little further up (http://www.bogleheads.org/forum/viewtopic.php?f=1&t=110026). I'm 25%/8% marginal, 15%/7% effective. The main goal was to get rid of the tracking and any pro-rata concerns of the After-Tax down the road. Based on your and Alan's suggestions, I feel more comfortable leaving the the DPS as is in the 401k. I've got decent non-Vanguard low-cost index choices in there.

That sounds good. I would try to avoid converting much taxable at those rates, but a small amount of earnings won't make a big difference.


Brian

[Alan S.]

The real benefit of the "after tax withdrawal" option is not future simplicity, but transferring this mostly balance to a Roth IRA where earnings will eventually be tax free. If left in the 401k those earnings would eventually be taxable. In addition, being able to limit the pro rating to just your after tax sub account is an option that may disappear the instant you separate from service (depends on company plan provisions).

Beyond that, rolling funds to a Roth IRA (Converting) is subject to the same analytics as doing a TIRA to Roth IRA conversion. Most important is the cost you pay for the Roth conversion vrs what your marginal tax rate would be in retirement for pre tax distributions if you did not convert. The inflection point is when you think those two rates are about the same. In that situation, you might still do modest conversions to attain some tax diversification if you are light on the Roth end. If you are light on the pre tax end, do not convert any more. There are other minor considerations as well, such as estate planning issues, whether you are insuring LT care or not, etc. If you are a good saver, avoid health breakdowns, divorces, or costly job loss, you are more likely to accumulate enough to face higher tax rates in retirement than you think. But if you come up short on those 4 factors, you will accumulate far less and conversions are best avoided or at least limited.

If your conversion will be partly taxable and partly tax free under the pro rate rules, the above decision proportioneately changes from a no brainer if the conversion is tax free to the above considerations when the conversion becomes 100% taxable. A simplistic way of looking at this when your conversion is 50% taxable is to reduce actual marginal rate for conversion by 50%, ie a 28% marginal rate is treated as 14% for purposes of determining the cost of the conversion.