Extra $32,500 in Roth IRA - too good to be true?

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Bfwolf
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Post by Bfwolf »

I believe that is possible as described in Strategy #3 in the Fairmark article (see link higher up in thread). However, I don't think you can merely have them sent to the 2 different accounts, but rather have to have them cut the check to you, which will include a 20% withholding of any money you've earned on the after-tax contributions. Then you've got to put the pre-tax money in a tIRA and a day later put the rest of the money (making up for the withholding) in a Roth. And then at tax time you'll get the withheld $s back. Frankly, it's sounds like a pain in the butt so unless the earnings on your after-tax contributions are substantial, it's probably not worth the effort.
quadz42
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Post by quadz42 »

I have been reading this thread with great interest and am in the process of checking with my plan administrator to see if this is possible for me.

One risk that comes to mind is trapped cash. For example, maxing out one's contributions at $49,000, and rolling over $32.5K to a Roth IRA, could consume someone's entire expected savings. The cash would then be "trapped" in the Roth IRA account, and could not be withdrawn without some steep penalties (i.e marginal tax rate on earnings, 10% early withdrawal fee).

While there are some exceptions to the early withdrawal fee, paying taxes on earnings at the marginal rate would probably be worse than long-term capital gains taxes in the short-term (e.g. withdrawing money within a few years).

Therefore, if one is saving for a down payment on a home, this strategy might not be completely optimal, especially in areas where housing is very expensive (e.g. California). You would also be precluded from using the funds for a small business venture, or buying a car, to give a few other examples.

One solution is to contribute less than $32.5K in after-tax contributions to a 401(k), but the risk here is that the IRS would close the loophole in the near future.

Any thoughts?
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neurosphere
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Post by neurosphere »

quadz42 wrote:One risk that comes to mind is trapped cash. For example, maxing out one's contributions at $49,000, and rolling over $32.5K to a Roth IRA, could consume someone's entire expected savings. The cash would then be "trapped" in the Roth IRA account, and could not be withdrawn without some steep penalties (i.e marginal tax rate on earnings, 10% early withdrawal fee).

Any thoughts?
Yes, I have thoughts. :D

First off, this 'trapped cash' problem applies to just about all tax-advantaged retirement programs. Thus, you always have to take into account your short-term needs for cash due to other spending or investment opportunities.

One thing to keep in mind is that you can always get to your previously contributed ROTH IRA contributions (but not earnings) without penalty.

For example, I have been maxing out my Roth IRA since the beginning. Which means I have about $30,000 in Roth money I can withdraw at any time. Now suppose for 2011 I place an additional $20,000 in a Roth through this back door method. Then in 2012, something comes up and oops! boy could I really use that cash! I can then withdraw $20,000 in previous Roth contributions and have my cash back, and the net effect is that I'm back where I started. Of course, you are not exactly in the same place, since the new money in the Roth is subject to restrictions the previous money was not, but you get the idea.

Of course, this back-up plan only works if you have previous roth contributions made 'traditionally'. :lol:

Now, I haven't completely thought through the details of this, but I'm sure someone will let us know if this strategy has a hitch I haven't thought of.

NS
Chuck
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Post by Chuck »

In general, you should be able to remove, without penalty, what you have contributed to a Roth IRA. Withdrawing earnings is done with a tax and penalty.
ausmatt
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Post by ausmatt »

Chuck wrote:In general, you should be able to remove, without penalty, what you have contributed to a Roth IRA. Withdrawing earnings is done with a tax and penalty.
I think this represents the key benefit here (other than the obvious ability to fund a retirement vehicle past the previously perceived limits).

A quick clarifying question to which I believe the answer is yes --

- There is no income limit (AGI) for this type of in-service 401k after-tax dollars to Roth IRA (backdoor) conversion, correct? I.e. the $179k AGI limit would not apply.

(The previous income limit for tIRA to rIRA has been removed to my knowledge and I would think that applies here as well).
marco100
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Post by marco100 »

quarterstock wrote:Gvernon, Your plan sounds fine. I'm pleased that this strategy is a revelation to you, since I was the one who brought it up in the previous thread. It was a eureka moment for me too when I pieced it together on my own and subsequently "re-discovered" it at the Fairmark forums after extensive googling.

For what it's worth, after all that googling, the two individuals whose opinion I respect the most on the issue are Alan S at the fairmark forums and a fellow named LH2004 on the fatwallet personal finance forums. I'd encourage you to read everything you can from those two individual's on this subject; they really seem to know their stuff.

The strategy isn't too good to be true. It's just extremely limited in it's applicability. Few people have the means, desire, and plan administrator rules to take advantage of this technique. You should count yourself fortunate.

As another data point, I spoke with my 401k administrator's rollover department (Fidelity) last week. Just like last year, I clearly explained that I was requesting an in-service distribution of my after-tax contributions and their associated earnings with the intent to roll them directly over to my Roth IRA at a third-party custodian. The Fidelity rep understood the request perfectly and didn't bat an eye. The day after the transaction took place, I confirmed that my 401k account no longer contained after-tax funds.

I do look forward to hearing back from ThePrune on the issue since he's contacted the IRS directly for a verdict. But given the number of "name-brand" institutions that process these requests routinely, I have a hard time seeing how it runs afoul of any IRS regs. I'm certainly willing to make these "grey-zone transactions" even with the perceived risks. The upside is just too great. And I genuinely believe that the strategy is perfectly acceptable in the eyes of the IRS.

Just because a 401(k) distribution is of after-tax dollars, does not mean it is a "qualified" distribution. It may be legally permissible, i.e., allowing such distros may not be a violation of the 401(k) plan, but that doesn't mean it won't result in unforseen consequences, such as penalties for early withdrawal or excess contribution to Roth in a single calender year.

You have to make a distinction between what the 401(k) plan administrator is legally permitted to do; and whether or not, if that is done, it may or may not result in tax consequences to the plan member.

I'm not sure what the basis is, for anyone believing that a distribution from a 401(k) is a qualified distribution simply because it is of after-tax dollars.

I also would really really caution anyone on making important financial decisions based on anonymous advice on the internet, no matter how knowledgeable the posters you are relying seem to be.

You have to be very very careful about "confirmation bias" here--you WANT to believe this is permissible and will not result in unforseen consequences, so the inclination is to disregard possible problems--such as the fact that evidently no one has an IRS letter ruling on this; and also, the whole notion that it results in circumventing what would otherwise be the annual Roth contribution limits, yet the IRS would nevertheless provide the taxpayer with a favorable interpretation when faced with a possible ambiguity.

This is definitely not the place for "do it yourself." Anyone contemplating doing this, unless we've heard otherwise, in writing, from the IRS, should consult with a qualified tax accountant, and get a written opinion that this is OK to do. At the least, a written good faith opinion from a CPA will help you in the event of an audit.

I think I finally found the IRS publication which covers this:


http://www.irs.gov/pub/irs-drop/n-08-30.pdf
Bfwolf
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Post by Bfwolf »

I would never discourage anybody else from consulting a tax accountant or attorney, but I won't be doing so. I'm going to confirm with my plan administrator that it's doable from their end, and then I'm going to do it. I go in eyes wide open that it's a gray area, and there's always the possibility of an adverse ruling from the IRS. I'm not going to pay an expert to tell me the same.
Redbelly
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Post by Redbelly »

bdpb wrote: I'd like to hear exactly how you completed this transaction. I'm in an
identical situation and Fidelity is telling me that the after-tax contributions
can go directly to a Roth and that the earnings can go directly to an IRA with
no taxes due. I'm still not sure that this is possible based on previous
discussions but two Fidelity reps have already said the same thing.
Same here - Fido assured me it was doable. Alan S. at Fairmark says it is still a grey area and don't blink until / unless IRS clarifies. Worst case for me is to recharacterize Roth back to a TIRA and file 8606 to reflect the after tax portion.
quarterstock
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Post by quarterstock »

bdpb wrote:I'd like to hear exactly how you completed this transaction. I'm in an identical situation and Fidelity is telling me that the after-tax contributions can go directly to a Roth and that the earnings can go directly to an IRA with no taxes due. I'm still not sure that this is possible based on previous discussions but two Fidelity reps have already said the same thing.
The method that those two Fidelity reps recommended makes sense, but I prefer to just roll the whole amount into a Roth IRA and pay income tax on the associated earnings. I purposely avoid funds in my traditional IRA since I don't want to trigger any pro rata rules when I perform an unrelated Roth conversion. Additionally, I never let my after-tax contributions sit in the account for more than 6 months or so, so the tax on any earnings is negligible.

Fidelity has done this twice for me without issue. Perhaps you should inform the representative that you will be rolling over directly into a Roth IRA. This will preclude the need for them to withhold income tax from the distribution.
quadz42
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Post by quadz42 »

Bfwolf wrote:I would never discourage anybody else from consulting a tax accountant or attorney, but I won't be doing so. I'm going to confirm with my plan administrator that it's doable from their end, and then I'm going to do it. I go in eyes wide open that it's a gray area, and there's always the possibility of an adverse ruling from the IRS. I'm not going to pay an expert to tell me the same.
How much would it cost to pay a CPA to give a written opinion? If you could walk the CPA through the entire transaction, maybe you don't need an expensive one.
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Cloud
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Post by Cloud »

quadz42 wrote:
Bfwolf wrote:I would never discourage anybody else from consulting a tax accountant or attorney, but I won't be doing so. I'm going to confirm with my plan administrator that it's doable from their end, and then I'm going to do it. I go in eyes wide open that it's a gray area, and there's always the possibility of an adverse ruling from the IRS. I'm not going to pay an expert to tell me the same.
How much would it cost to pay a CPA to give a written opinion? If you could walk the CPA through the entire transaction, maybe you don't need an expensive one.
And how much is that CPA opinion worth? IMO it's not worth the paper it's written on. They could still be wrong. But Mr. Tax man my CPA said it's OK. Good luck with that.

I'm going ahead with this eyes wide open. Not my fault no one can interrupt the IRS code. If I'm wrong then I'll deal with it later. Looks perfectly legal to me.
bdpb
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Post by bdpb »

Redbelly wrote:
bdpb wrote: I'd like to hear exactly how you completed this transaction. I'm in an
identical situation and Fidelity is telling me that the after-tax contributions
can go directly to a Roth and that the earnings can go directly to an IRA with
no taxes due. I'm still not sure that this is possible based on previous
discussions but two Fidelity reps have already said the same thing.
Same here - Fido assured me it was doable. Alan S. at Fairmark says it is still a grey area and don't blink until / unless IRS clarifies. Worst case for me is to recharacterize Roth back to a TIRA and file 8606 to reflect the after tax portion.
The Roth part is not what I'm concerned with. It appears that the after-tax
to Roth is acceptable. What I question is whether the earnings can go
to an IRA without tax due or whether they would need to go the Roth with
taxes due.
bdpb
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Post by bdpb »

quarterstock wrote:
bdpb wrote:I'd like to hear exactly how you completed this transaction. I'm in an identical situation and Fidelity is telling me that the after-tax contributions can go directly to a Roth and that the earnings can go directly to an IRA with no taxes due. I'm still not sure that this is possible based on previous discussions but two Fidelity reps have already said the same thing.
The method that those two Fidelity reps recommended makes sense, but I prefer to just roll the whole amount into a Roth IRA and pay income tax on the associated earnings. I purposely avoid funds in my traditional IRA since I don't want to trigger any pro rata rules when I perform an unrelated Roth conversion. Additionally, I never let my after-tax contributions sit in the account for more than 6 months or so, so the tax on any earnings is negligible.

Fidelity has done this twice for me without issue. Perhaps you should inform the representative that you will be rolling over directly into a Roth IRA. This will preclude the need for them to withhold income tax from the distribution.
I'm on the edge for phaseout of different credits and don't really want
any of the distribution to be taxable. That would be optimal for me.

Fidelity offered both options (i.e., Roth and IRA, Roth only). In both
cases, they would send me a check that was payable to
my Roth/IRA FBO bdpb and that no withholding is necessary unless I
wanted it.
jeh676
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Post by jeh676 »

Cloud wrote:You're not missing anything. That's exactly what I proposed in the other thread. Just remember you can't have any other IRA's or conversions will be taxed by the percentage of pretax money in all IRAs, the pro-rata rule.
Jumping in here. If I do have money in a tIRA(previous employer), but my 401(k) accepts rollovers, could I just roll the tIRA into the 401(k), and then have an empty tIRA and avoid problems with the prorata rule?
cliffedelgado
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Post by cliffedelgado »

jeh676 wrote: Jumping in here. If I do have money in a tIRA(previous employer), but my 401(k) accepts rollovers, could I just roll the tIRA into the 401(k), and then have an empty tIRA and avoid problems with the prorata rule?
Yes, that's what others have suggested as well. see http://thefinancebuff.com/the-backdoor- ... ow-to.html

However, for these in-service withdrawals/conversions, the pro-rata rule should not apply. At least that's what I believe most of us believe is the case.
jeh676
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Post by jeh676 »

cliffedelgado wrote:
jeh676 wrote: Jumping in here. If I do have money in a tIRA(previous employer), but my 401(k) accepts rollovers, could I just roll the tIRA into the 401(k), and then have an empty tIRA and avoid problems with the prorata rule?
Yes, that's what others have suggested as well. see http://thefinancebuff.com/the-backdoor- ... ow-to.html

However, for these in-service withdrawals/conversions, the pro-rata rule should not apply. At least that's what I believe most of us believe is the case.
Thank you.
Leaving the tIRA money where it is would be preferred. While my 401(k) is pretty good in the grand scheme of things, moving that much of my portfolio back into the 401(k) would mean I'd have to invest in some funds that are not as desirable as the ones I'm currently in for their asset class.

So essentially, I think this would allow me the tax advantaged space to help fund college for the kiddos without using 529s.
dan23
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Post by dan23 »

I've been reading up on this on Fairmark and have some questions. I apologize if my terminology is incorrect.
My employer has 3 types of accounts:
1) roth 401k
2) 401k
3) post 86 savings plan (this is after tax)
My employer:
1) only allows <59.5 in service non hardship withdrawals from the post 86 savings plan, not from the regular 401k. They have an option for a rollover from the savings plan to an external Roth IRA.
2) allows me to withdraw only taxable money from the savings plan if I wish to. If I understand correctly, contributions are post tax and gains are taxable
My questions:
1) If I understand a Fairmark thread correctly (thread 2,49300 - I cannot post the link since I am a new member), if I rollover to an external Roth IRA, my normal 401k money is not taken into account for taxes, only my post 86 savings plan money. I will not have to pay taxes on prorated amount including the regular 401k since I cannot withdraw from the regular 401k. Is this correct?
2) Edited - My employer allows me to specifically withdraw the taxable amount. Does it make sense to first rollover the taxable amount to a TIRA and then rollover the remainder to a Roth IRA? Will I owe 0 taxes and/or penalties if I take this route?
quadz42
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Post by quadz42 »

Check out IRS Publication 575 (I can't link to it). For details, see the section "Rollovers to Roth IRAs" on page 29. This seems to support the strategy in this thread.

Rollovers to Roth IRAs.

"You can roll over distributions directly from a qualified retirement plan (other than a designated Roth account) to a Roth IRA. You must include in your gross income distributions from a qualified retirement plan (other than a designated Roth account) that you would have had to include in income if you had not rolled them over into a Roth IRA. However, special rules apply for any amounts rolled over in 2010. See Special rules for
2010 rollovers to Roth IRAs later. You do not include in gross income any part of a distribution from a qualified retirement plan that is a return of contributions to the plan that were taxable to you when paid. In addition, the 10% tax on early distributions does not apply.

Any amount rolled over into a Roth IRA is subject to the same rules for converting a traditional IRA into a Roth IRA. For more information, see Converting From Any Traditional IRA Into a Roth IRA in chapter 1 of Publication 590."
xerty24
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Post by xerty24 »

I wanted to comment on the concern mentioned of getting too much money "trapped" in retirement accounts. There is basically no downside here - in the same way that Roth IRAs can serve as emergency funds (since you can take your principle contributions back out at any time, without any penalty except inability to recontribute), you can withdraw your Roth conversion portion from the after-tax rollover from the 401k. While this is a non-qualified withdrawal, but it's got a basis equal to your after-tax contribution amount. You can read the rules and the quote below, but the short version is that you can take out your principle tax free just like for Roth IRA contributions, but if you want to start taking out the earnings on that principle (which per the ordering rules happen after you take out all the principle), then you face the normal 10% penalty and income tax.

I would encourage anyone with long term taxable savings to strongly consider converting as much of that as they can per this approach.
IRS Publication 575 wrote:"You can roll over distributions directly from a qualified retirement plan (other than a designated Roth account) to a Roth IRA. You must include in your gross income distributions from a qualified retirement plan (other than a designated Roth account) that you would have had to include in income if you had not rolled them over into a Roth IRA...
You do not include in gross income any part of a distribution from a qualified retirement plan that is a return of contributions to the plan that were taxable to you when paid. In addition, the 10% tax on early distributions does not apply.
UncleNemo
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Location: MN

Post by UncleNemo »

If I understand this thread correctly, a direct rollover of ROTH 401k monies to a ROTH IRA should be a completely tax-free event (earnings and contributions), if the plan allows these in-service withdrawals. Am I correct? The motivation behind the question is a desire for more control over investment choices and lower fund fees.
xerty24
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Post by xerty24 »

UncleNemo wrote:If I understand this thread correctly, a direct rollover of ROTH 401k monies to a ROTH IRA should be a completely tax-free event (earnings and contributions), if the plan allows these in-service withdrawals. Am I correct? The motivation behind the question is a desire for more control over investment choices and lower fund fees.
You can't typically rollover a Roth 401k to a Roth IRA until you reach retirement age. This thread is discussing non-deductible 401k contributions (which are different from Roth), and converting those to a Roth IRA.
quarterstock
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Post by quarterstock »

xerty24 wrote:I wanted to comment on the concern mentioned of getting too much money "trapped" in retirement accounts. There is basically no downside here - in the same way that Roth IRAs can serve as emergency funds (since you can take your principle contributions back out at any time, without any penalty except inability to recontribute), you can withdraw your Roth conversion portion from the after-tax rollover from the 401k. While this is a non-qualified withdrawal, but it's got a basis equal to your after-tax contribution amount. You can read the rules and the quote below, but the short version is that you can take out your principle tax free just like for Roth IRA contributions, but if you want to start taking out the earnings on that principle (which per the ordering rules happen after you take out all the principle), then you face the normal 10% penalty and income tax.

I would encourage anyone with long term taxable savings to strongly consider converting as much of that as they can per this approach.
I feel that to be a bit misleading. There's two issues to deal with when making pre-59.5 withdrawals from a Roth IRA: paying income tax and paying penalties.

Income Tax: When making a pre-59.5 withdrawal from a Roth IRA, contributions come out first, then conversions, then earnings. By definition, you've already paid income tax on the contributions and conversion dollars, but the earnings have yet to be taxed. You would have to remove an amount in excess of all of your contributions and conversions in order to trigger an income taxable event. I don't think anyone would advocate for this strategy.
Penalties on Contributions: There is never a penalty or a seasoning period test to remove plain Roth IRA contributions. These dollars can serve as "emergency fund" dry powder from Day 1.
Penalties on Conversions: Each set of dollars that enters a Roth IRA via a conversion is subject to its own seasoning rule, or a 5-year conversion holding period. Otherwise, a withdrawal of these funds is subject to a penalty.
Penalties on Earnings: Earnings will accumulate on contributions and conversions. Regardless of their source, withdrawing these dollars will trigger a penalty if you're not 59.5.

Thisfairmark article does a good job of putting it succinctly. (And it's blessed by Alan S, for what it's worth)
xerty24
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Post by xerty24 »

quarterstock wrote:Penalties on Conversions: Each set of dollars that enters a Roth IRA via a conversion is subject to its own seasoning rule, or a 5-year conversion holding period. Otherwise, a withdrawal of these funds is subject to a penalty.
But the penalty is 10% of the taxable amount of the conversion, so if you didn't pay taxes on the conversion (such as when you immediately convert a non-deductible 401k contribution), you still won't pay a penalty even if you take it out before 5 years in a non-qualified withdrawal. I leave you to work it out on 8606, but here's what they say in Pub 590 on the topic of penalties for early distributions (emphasis mine):
Pub 590, pg 65 wrote:You generally must pay the 10% additional tax on any amount attributable to the part of the amount converted or rolled over (the conversion or rollover contribution) that you had to include in income
My interpretation is even blessed by your friend Alan S, if you read the comments on the Fairmark link you gave, not just the header table.
Re: Roth IRA Rules - Table Approach
Posted by: Alan S. (IP Logged)
Date: October 14, 2010 04:40PM

Good point. If you distribute some of a fully non taxable distribution prior to the 5 year holding period, there is NO penalty since the early withdrawal penalty only applies to amounts that were taxable.
cliffedelgado
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Post by cliffedelgado »

Great point xerty24. The table in the link provided by quarterstock seems to put it fairly well.

Watch out for the penalty for the taxable conversion part if under 59.5 and 5 year conversion holding.

Code: Select all

from http://fairmark.com/forum/read.php?2,54159

UNDER AGE 59.5 
FIVE YEAR CONVERSION HOLDING PERIOD NOT MET 

Contributions: Tax-No Penalty-No 
Conversions: Tax-No Penalty-Yes (Taxable Portion)    
Conversions: Tax-No Penalty-No (Nontaxable Portion) 
Earnings: Tax-Yes Penalty-Yes 
This part should be minimal though.

Here is another link that may be helpful in figuring penalties.
http://www.fool.com/money/allaboutiras/ ... iras07.htm
quadz42
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Post by quadz42 »

I just spoke with Vanguard (my 401(k) plan administrator), and they confirmed that I would be able to withdraw the full amount of after-tax contributions, and roll them into a Roth IRA (existing account at Vanguard). They also confirmed that I would be able to roll the earnings on the after-tax contributions into a Rollover IRA (existing account at Vanguard).

The only thing that isn't completely clear to me is if I would need to roll my Rollover IRA into my 401(k) first, to avoid any potential issues, but my understanding is that this wouldn't be necessary.

Of course, any potential actions would not occur until the end of 2011 or early 2012, but I just significantly increased my 401(k) contributions...
Bfwolf
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Post by Bfwolf »

Sounds like you are looking to do something similar to strategy #2, which may not have the tax consequences you want.

http://fairmark.com/rothira/09030801-401k-basis.htm
cliffedelgado
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Post by cliffedelgado »

Bfwolf wrote:Sounds like you are looking to do something similar to strategy #2, which may not have the tax consequences you want.

http://fairmark.com/rothira/09030801-401k-basis.htm
I'm of the opinion that what quadz42 wants to do is ok and will not have any adverse tax consequences.

I thought this scenario is what you (Bfwolf) asked Alan S over at fairmark (option 2 http://fairmark.com/forum/read.php?2,56002).

Maybe I'm missing something?
Bfwolf
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Post by Bfwolf »

What I'm doing is Strategy #1, which is only OK because I'm doing an in-service withdrawal where only after-tax contributions and their earnings can be withdrawn.

If you want to move the earnings into a trad IRA, then Strategy #3 is reco'd.

Strategy #2 is not reco'd.
cliffedelgado
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Post by cliffedelgado »

Strategy 2 and 3 both try to get the earnings into a Trad/Rollover IRA and the after-tax contributions into a Roth IRA. The difference seems to be in the exact steps to accomplish this.

So are you saying that quadz42 steps sound like strategy 2 ? If so, that's where we differed. I was referring to in general, this could be done. Didn't see how quadz42's steps were strategy 2.

But do watch out when doing this. That's partially why I went with strategy 1 and paid the taxes.
Bfwolf
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Post by Bfwolf »

You're right, Cliff, it's not exactly clear what his strategy was. I should have more accurately cautioned him to follow Strategy 3 precisely if he wanted to get the earnings into a tIRA and the contributions into a Roth rather than just put it all in a Roth and pay taxes on the tIRA. I am with you: keep it simple, put it all in a Roth, and pay the small tax bill.
quadz42
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Post by quadz42 »

If there are issues with rolling the earnings into a tIRA, then I agree that keeping it simple and paying taxes on the earnings would be the best route. To minimize taxes, perhaps it would be better to use the after-contributions for the fixed-income allocation of the portfolio, or to simply just park the funds in a money market fund.
quarterstock
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Post by quarterstock »

I'd like to add two more data points to the discussion. The first is text I'm quoting directly from my Fidelity-sponsored 401k literature. The second is the key numbers from an in-service withdrawal that I performed in January of 2010.

401k plan literature:
In-Service Withdrawals must be made in the following order:
a) first, from your Rollover Account, if any;
b) next, from your After-Tax Elective Contribution Account, if any;
c) next, from your Employer pre-2007 Matching Contribution Account, PWA Contribution Account, your Employer Profit Sharing Contribution Account, your Prop Plan Matching Contributions Account,
and your Prior Plan Profit Sharing Account, amounts allocated to such Accounts that have been held for at least twenty-four months but not in excess of your vested interest; and
d) finally, if you have contributed to or had Pre-Tax Elective Deferral
Note that Fidelity's rules here are at odds with Kaye Thomas' article where he asserts that any in-service withdrawal will be treated on a pro-rata basis as coming from pre-tax and post-tax contributions. (parts B and D of my plan literature)

The second data point is a Fidelity Statement of Details for Payment made on 01/04/2010 to myself. For personal reasons, I'll decline to post a screen-cap or pdf version of the document, but I can summarize the salient numbers:
Distribution Type: Withdrawal
Creation Date: 01/04/2010
Tax Reporting State: TX
Tax Year: 2010
Yax Form: 1099R
IRS Code: G
Gross Amount: $730.50
Total Taxable Amount: $18.86 (net earnings on my after-tax basis)
Toal Non-Taxable Amount: $711.64 (100% of my theretofore after-tax basis in my 401k)
Net Unrealized Appreciation: $0.00
Ordinary Income: $18.86
Amount Eligible for Rollover: $730.50
Amount Rolled Over $0.00
Net Amount of Check: $730.50
Deduction Amount: $0.00
Paid To: [My IRA Custodian, FBO myself]
As I've stated earlier, Fidelity tracks my pre-tax and post-tax contributions in my 401k. The day after this transaction occurred, my after-tax contributions were zeroed out and I was left with only pre-tax contributions. I conclude that either Kaye Thomas' interpretation of Strategy 1 is incorrect or Fidelity is mis-handling my account and mis-reporting it on my 1099R. I'll leave it to you to decide which is more likely.

Can you see any other way to reconcile the two?
Bfwolf
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Post by Bfwolf »

Quarterstock,

I think it's possible that Kaye misspoke when he said that his advice includes in-service withdrawals. You can tell from the examples he gives that he's really talking about withdrawals after separation of service.
quadz42
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Post by quadz42 »

Regarding the taxation of earnings on after-tax contributions, I think it is useful to plug in actual numbers to gauge the implications.

Let's make the following assumptions: (1) $32,500 would be rolled over (2) the funds would be invested in a money market fund earning 1% in the 401(k) plan for six months prior to the transaction and (3) the marginal income tax rate is 35%.

A simple calculation shows that the taxes due every year would be about $60. I would gladly pay that amount to avoid any issues, paperwork, 20% withholding, etc...
quadz42
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Post by quadz42 »

401k plan literature: wrote: In-Service Withdrawals must be made in the following order:
a) first, from your Rollover Account, if any;
b) next, from your After-Tax Elective Contribution Account, if any;
c) next, from your Employer pre-2007 Matching Contribution Account, PWA Contribution Account, your Employer Profit Sharing Contribution Account, your Prop Plan Matching Contributions Account,
and your Prior Plan Profit Sharing Account, amounts allocated to such Accounts that have been held for at least twenty-four months but not in excess of your vested interest; and
d) finally, if you have contributed to or had Pre-Tax Elective Deferral
I spoke with Vanguard regarding in-service withdrawals, and they stated that it is not possible to take an in-service withdrawal of pre-tax contributions and their earnings, if you are under the retirement age of 59.5. Therefore, any withdrawals I would take would be after-tax contributions by definition (and their associated earnings).
xerty24
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Post by xerty24 »

quadz42 wrote:
401k plan literature: wrote: In-Service Withdrawals must be made in the following order:
a) first, from your Rollover Account, if any;
b) next, from your After-Tax Elective Contribution Account, if any;
c) next, from your Employer pre-2007 Matching Contribution Account, PWA Contribution Account, your Employer Profit Sharing Contribution Account, your Prop Plan Matching Contributions Account,
and your Prior Plan Profit Sharing Account, amounts allocated to such Accounts that have been held for at least twenty-four months but not in excess of your vested interest; and
d) finally, if you have contributed to or had Pre-Tax Elective Deferral
I spoke with Vanguard regarding in-service withdrawals, and they stated that it is not possible to take an in-service withdrawal of pre-tax contributions and their earnings, if you are under the retirement age of 59.5. Therefore, any withdrawals I would take would be after-tax contributions by definition (and their associated earnings).
There are different kinds of "pretax" money you might have in your 401k and it's only the "elective deferrals" (ie those from your paycheck at that job) that cannot be taken out legally via in-service withdrawal. You could have rolled over a prior pretax 401k balance and that's eligible for withdrawal. Similarly, matching contributions are pretax and, once vested, and be withdrawn as well, plan rules permitting.
quarterstock
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Post by quarterstock »

xerty24 wrote:But the penalty is 10% of the taxable amount of the conversion, so if you didn't pay taxes on the conversion (such as when you immediately convert a non-deductible 401k contribution), you still won't pay a penalty even if you take it out before 5 years in a non-qualified withdrawal. I leave you to work it out on 8606, but here's what they say in Pub 590 on the topic of penalties for early distributions (emphasis mine):
Pub 590, pg 65 wrote:You generally must pay the 10% additional tax on any amount attributable to the part of the amount converted or rolled over (the conversion or rollover contribution) that you had to include in income
My interpretation is even blessed by your friend Alan S, if you read the comments on the Fairmark link you gave, not just the header table.
Xerty, I wanted to follow up on your critique, because I don't quite follow your reasoning, although I concede I don't fully understand what you and Alan are describing.

If I understand you correctly, then if I were to perform an in-service distribution of $120 from a 401k and roll directly to a Roth IRA, ($100 in after-tax contributions and $20 in associated earnings) then the $100 is not subject to the 5 year holding period but the $20 in earnings is? Is that what you mean by the "taxable amount of the conversion?" Because the $100 was most certainly taxable too -- in the year it was contributed. Hence my confusion. Am I on a different wavelength here?

Similarly, If I make a $5000 non-deductible contribution to a Traditional IRA, earn $25 in interest, and then convert the entire balance of the account to the same Roth IRA, is the $5000 not subject to the 5 year period, but the $25 in interest is?
quadz42
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Post by quadz42 »

In addition to rolling over after-tax contributions from a 401(k), how about also contributing $5K to a non-deductible tIRA and converting to a Roth IRA?

Of course, this might mean rolling over a tIRA (all pre-tax contributions) to the 401(k) first.
xerty24
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Post by xerty24 »

quarterstock wrote:
Pub 590, pg 65 wrote:]You generally must pay the 10% additional tax on any amount attributable to the part of the amount converted or rolled over (the conversion or rollover contribution) that you had to include in income
If I understand you correctly, then if I were to perform an in-service distribution of $120 from a 401k and roll directly to a Roth IRA, ($100 in after-tax contributions and $20 in associated earnings) then the $100 is not subject to the 5 year holding period but the $20 in earnings is? Is that what you mean by the "taxable amount of the conversion?"
The 5 year rule says whether the penalty applies, so it would cover any withdrawal of a converted amount within that period. However, and this is the important part, the penalty is only assessed on the taxable amount of the conversion. In the case of a non-deductible contribution being converted, such as we are discussing here and in your example, only the earnings on that amount will have been taxable on conversion (due to the basis in the non-deductible contribution) and consequently only the earnings withdrawn will be subject to either tax or penalty.
Because the $100 was most certainly taxable too -- in the year it was contributed.
It was not taxable as a Roth conversion. You're confusing the wages you earn (that allow you to make an IRA contribution) and the actual contribution itself. The 5 year rule essentially adds additional penalties to the tax you paid on the Roth conversion.
Similarly, If I make a $5000 non-deductible contribution to a Traditional IRA, earn $25 in interest, and then convert the entire balance of the account to the same Roth IRA, is the $5000 not subject to the 5 year period, but the $25 in interest is?
It's subject to the 5 year rule, but taxes and penalties will only be owed on the $25 (as above). The rules for non-deductible 401k and IRAs are the same here, although the tax reporting goes in slightly different places.

quadz - making non-deductible IRA contributions and converting them is generally a good idea, especially if you're careful (as you allude) with regard to pretax tIRA amounts.
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SSSS
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Post by SSSS »

Interesting thread.

My 401k plan definitely allows in-service rollouts of after-tax contributions so I'll probably take advantage of that later in the year. I've seen several posts saying that this can legally be done with matching contributions as well (but definitely not deductible or Roth contributions) if the plan allows it, but mine doesn't seem to, as far as I can tell from the literature and web interface. Is it common or rare for plans to allow matching funds to be rolled out, and if you do it and convert to Roth, are they treated like they have a basis of 0?
Default User BR
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Post by Default User BR »

SSSS wrote:I've seen several posts saying that this can legally be done with matching contributions as well (but definitely not deductible or Roth contributions) if the plan allows it, but mine doesn't seem to, as far as I can tell from the literature and web interface. Is it common or rare for plans to allow matching funds to be rolled out, and if you do it and convert to Roth, are they treated like they have a basis of 0?
My plan allows it, but imposes a penalty of suspending matching for six months afterward. Company matching contributions are pre-tax.



Brian
xerty24
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Post by xerty24 »

Is there any reason you can think for a plan not to offer rolling out of matching contributions? It's not as clearly a win as the after-tax side (since some people won't want to pay to convert to Roth), but it's an extra option that might be valuable to some.
living2notWork
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Re: Extra $32,500 in Roth IRA - too good to be true?

Post by living2notWork »

gvernon wrote:So after reading this thread:

http://www.bogleheads.org/forum/viewtopic.php?t=65836

And then following it up with my 401k provider via phone call, it seems as if I can use the after-tax option in my 401k plan to contribute an extra $32,500 into a Roth IRA this year (and every year).

The process goes like this:

1. Max out pre-tax (or Roth) 401k - $16,500
2. Contribute on an after-tax basis (my company plan allows up to 80% of salary to be contributed after-tax) up to the IRS combined limit of $49,000
3. Request an in-service withdrawal of after-tax funds - $32,500, rollover to a Roth IRA, and then pay taxes on any earnings as ordinary income
Bonus - Rollovers have no effect on the regular $5000 Roth IRA contribution limit, so I can do that too!

Am I missing anything? This seems too good to be true?

This method would also enable one to "convert" the money in a taxable investing account into a Roth IRA in a matter of months by contributing the max allowable to after-tax 401k while living off of the money from the taxable account (knowing that there may be some capital gains, but this seems like a small price to pay). Using the money in the taxable account as a replacement paycheck would help to max out the after-tax 401k ASAP, and therefore reduce the time the amount could grow and create earnings which would be taxed at ordinary income.

Thoughts?

I WISH I COULD... my plan only allows in-service withdraws after 59.5. Damn Fidelity!
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SSSS
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Post by SSSS »

Default User BR wrote:Company matching contributions are pre-tax
So that means if you roll those contributions to an IRA and convert it to Roth, it's treated as a cost basis of 0 and you have to pay tax on the entire amount, right?
xerty24
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Post by xerty24 »

SSSS wrote:
Default User BR wrote:Company matching contributions are pre-tax
So that means if you roll those contributions to an IRA and convert it to Roth, it's treated as a cost basis of 0 and you have to pay tax on the entire amount, right?
Well, you pay like you would for converting any other traditional IRA you have. If you have any non-zero basis from other non-deductible contributions, that would impact the taxable amount. If you have only fully deductible IRAs, the whole amount would be taxable.
WorkToLive
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Post by WorkToLive »

What is the advantage of having the invested money in your Roth IRA as opposed to your Roth 401k? If my understanding of the discussion above is correct, you are just moving money from your Roth 401k into your regular Roth. So how is that helpful?
zookeeper
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Post by zookeeper »

xerty24 wrote:
SSSS wrote:
Default User BR wrote:Company matching contributions are pre-tax
So that means if you roll those contributions to an IRA and convert it to Roth, it's treated as a cost basis of 0 and you have to pay tax on the entire amount, right?
Well, you pay like you would for converting any other traditional IRA you have. If you have any non-zero basis from other non-deductible contributions, that would impact the taxable amount. If you have only fully deductible IRAs, the whole amount would be taxable.
Actually, I believe that when converting 401k funds to a Roth IRA, you don't have to aggregate the 401k with existing tIRAs. 401k funds can now be directly converted to Roth IRAs without having to have a tIRAs as an intermediate step.
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SSSS
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Post by SSSS »

WorkToLive wrote:What is the advantage of having the invested money in your Roth IRA as opposed to your Roth 401k?
This thread isn't about rolling Roth 401k contributions to your Roth IRA (that's not possible while still employed unless you're 60+), it's about rolling non-deductible after-tax contributions to your IRA & then converting them to Roth. This is a lesser-known type of 401k contribution and in general it's inferior to deductible and Roth contributions, but it does allow you contribute above the $16,500 limit of deductible + Roth contributions, so if you can then roll it into your Roth IRA, that's a really good move.

There's a combined limit of $49,000 for all 401k contributions. You could make $8000 in deductible contributions and $8500 in Roth contributions (hitting the $16,500 limit), get matching contributions of $2500 for example, we're at $19,000 so far, leaving you able to contribute up to $30,000 of non-deductible after-tax contributions which you could then convert to Roth. You might be able to roll & convert your matching contributions as well if your plan allows it.

But in a more general sense regarding your question about Roth IRA versus Roth 401k, it's better to have money in the IRA because you can invest it in anything you want rather than your limited 401k choices. This isn't much of an issue if you have good 401k options, and the 401k could have advantages such as letting you invest in Institutional-level funds.
WorkToLive
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Post by WorkToLive »

SSSS wrote:This thread isn't about rolling Roth 401k contributions to your Roth IRA (that's not possible while still employed unless you're 60+), it's about rolling non-deductible after-tax contributions to your IRA & then converting them to Roth.
Thank you, SSSS, makes perfect sense now. I don't believe my plan allows this type of contribution, as was pointed out by a PP.
mpny
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Solo 401k

Post by mpny »

Is anyone with a Solo 401k considering this, and maxing out nondeductible personal contributions at 32.5 and taking the company contribution component to zero?
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