Confused About 401(k) Rollover as HCE with Backdoor Roth

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scimitar
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Confused About 401(k) Rollover as HCE with Backdoor Roth

Post by scimitar » Thu Oct 19, 2017 8:39 pm

I recently left a job and would like to roll my 401(k) over from a high-fee provider to Vanguard. However, I am confused about some of the tax implications of doing so because (1) I may be classified as a "highly compensated employee" during 2017; and (2) I recently used the backdoor method to roll over $5,500 from a Traditional IRA to a Roth.

For tax year 2017, I contributed the $18,000 max to my 401(k). I recently left a small company that may not be able to continue as a going concern and would like to move the 401(k) from the company's provider to Vanguard. In May, I contributed the $5,500 max to a Traditional IRA and then converted it within a couple of weeks to a Roth to take advantage of the backdoor method. I had about $2 worth of interest income in the TIRA when I converted.

Couple of questions for folks more knowledgeable than me:

(1) I am classified as a "highly compensated employee" under the 401(k) rules. Is there anything preventing me from rolling the 401(k) over in tax year 2017? Do I have to wait and see if the 401(k) passes the discrimination test (presumably in 2018) before I can roll it over?

(2) What happens if my former employer's plan fails the discrimination test? I'm assuming I will have to pay the tax owed on the excess contribution, but how does this work if I can in fact move the 401(k) to Vanguard?

(3) Can I roll over the 401(k) to a traditional IRA in 2017 after having already fully funded my TIRA to do the Backdoor Roth? Are there any tax implications that I need to be aware of?

Thanks in advance for anyone who can help clarify things!

Spirit Rider
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Re: Confused About 401(k) Rollover as HCE with Backdoor Roth

Post by Spirit Rider » Thu Oct 19, 2017 11:40 pm

scimitar wrote:
Thu Oct 19, 2017 8:39 pm
Couple of questions for folks more knowledgeable than me:
(1) I am classified as a "highly compensated employee" under the 401(k) rules. Is there anything preventing me from rolling the 401(k) over in tax year 2017? Do I have to wait and see if the 401(k) passes the discrimination test (presumably in 2018) before I can roll it over?
No there is nothing that prevents you from rolling it over. Not that that is a good idea if an ADP testing failure is likely.
(2) What happens if my former employer's plan fails the discrimination test? I'm assuming I will have to pay the tax owed on the excess contribution, but how does this work if I can in fact move the 401(k) to Vanguard?
You will get a notice that you had an excess deferral and the amount you will have to return to your previous employer. You will have to contact Vanguard and ask for a return of that excess deferral and its earnings. That amount is retroactively not eligible for rollover, so it now an excess IRA contribution.
(3) Can I roll over the 401(k) to a traditional IRA in 2017 after having already fully funded my TIRA to do the Backdoor Roth? Are there any tax implications that I need to be aware of?
In order for a 2017 Backdoor Roth conversion to be efficient, there needs to be little to no pre-tax (traditional, SEP, SIMPLE IRA) IRA balances on 12/31/2017. So you will most definitely do not want to rollover this 401k until 1/1/2018. Even then it will prevent a 2018 Backdoor Roth.

Your best bet is to wait until at least after 3/15/2018 when excess deferrals are supposed to be returned. Then you would be much better off rolling it over to another 401k.

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Earl Lemongrab
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Re: Confused About 401(k) Rollover as HCE with Backdoor Roth

Post by Earl Lemongrab » Fri Oct 20, 2017 12:39 pm

You'd probably be better off leaving it in the 401(k), especially if the plan will be improving. Will you have a new job with a 401(k) or similar?
This week's fortune cookie: "Your financial life will be secure and beneficial." So I got that going for me, which is nice.

ERISA Stone
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Re: Confused About 401(k) Rollover as HCE with Backdoor Roth

Post by ERISA Stone » Fri Oct 20, 2017 7:42 pm

You said:
I may be classified as a "highly compensated employee" during 2017
and
I am classified as a "highly compensated employee" under the 401(k) rules.
Is your HCE status up for debate? You should already know because it's based on 2016 compensation, assuming you don't/didn't own at least 5% of the company.

scimitar
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Re: Confused About 401(k) Rollover as HCE with Backdoor Roth

Post by scimitar » Fri Oct 20, 2017 10:12 pm

Thank you all for the responses so far!
Earl Lemongrab wrote:
Fri Oct 20, 2017 12:39 pm
You'd probably be better off leaving it in the 401(k), especially if the plan will be improving. Will you have a new job with a 401(k) or similar?
Yes, the new employer offers a 401(k) plan, although the options aren't great. My main concern is what happens to my assets if my former employer becomes insolvent. My understanding is that management cannot access 401(k) funds once they are deferred, correct? Would a bankruptcy subject the funds in the 401(k) to any kind of hold that would prevent me from doing a rollover?
ERISA Stone wrote:
Fri Oct 20, 2017 7:42 pm
Is your HCE status up for debate? You should already know because it's based on 2016 compensation, assuming you don't/didn't own at least 5% of the company.
I joined the company in the fall of 2016 and would not be a HCE based on what I earned with them last year. But I was also not eligible to contribute to the 401(k) plan until January 2017 (not sure if that is relevant to the IRS inquiry). Based on the income I earned this year prior to leaving the company, I would be over the HCE threshold in dollar terms if I had stayed with them into 2018.

nolesrule
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Re: Confused About 401(k) Rollover as HCE with Backdoor Roth

Post by nolesrule » Sat Oct 21, 2017 12:07 pm

The HCE status is based on what you actually earn with the company in the year they look at. It's not what your potential would have been in a given year if you had stuck out the entire year.

If you have a salary of $150k but leave after 6 months and only earned $75k in the year, you would not be considered an HCE.

ERISA Stone
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Re: Confused About 401(k) Rollover as HCE with Backdoor Roth

Post by ERISA Stone » Sun Oct 22, 2017 7:37 pm

scimitar wrote:
Fri Oct 20, 2017 10:12 pm
Thank you all for the responses so far!
Earl Lemongrab wrote:
Fri Oct 20, 2017 12:39 pm
You'd probably be better off leaving it in the 401(k), especially if the plan will be improving. Will you have a new job with a 401(k) or similar?
Yes, the new employer offers a 401(k) plan, although the options aren't great. My main concern is what happens to my assets if my former employer becomes insolvent. My understanding is that management cannot access 401(k) funds once they are deferred, correct? Would a bankruptcy subject the funds in the 401(k) to any kind of hold that would prevent me from doing a rollover?
ERISA Stone wrote:
Fri Oct 20, 2017 7:42 pm
Is your HCE status up for debate? You should already know because it's based on 2016 compensation, assuming you don't/didn't own at least 5% of the company.
I joined the company in the fall of 2016 and would not be a HCE based on what I earned with them last year. But I was also not eligible to contribute to the 401(k) plan until January 2017 (not sure if that is relevant to the IRS inquiry). Based on the income I earned this year prior to leaving the company, I would be over the HCE threshold in dollar terms if I had stayed with them into 2018.
Assuming your plan is based on calendar year, if you didn't meet the HCE compensation level in 2016 (and you are not a greater than 5% owner in 2016 or 2017), then you cannot be an HCE in 2017. If 2016 was a full plan year, there is no proration based on your date of hire. It is based on your actual total compensation for the period DOH - 12/31/2016. If you met the HCE compensation level in 2017, that means you're an HCE for 2018, not 2017. That assumes your company doesn't use the Top Paid Group election. If so, we can further the conversation for 2018.

scimitar
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Re: Confused About 401(k) Rollover as HCE with Backdoor Roth

Post by scimitar » Tue Oct 24, 2017 1:54 pm

ERISA Stone wrote:
Fri Oct 20, 2017 7:42 pm
Assuming your plan is based on calendar year, if you didn't meet the HCE compensation level in 2016 (and you are not a greater than 5% owner in 2016 or 2017), then you cannot be an HCE in 2017. If 2016 was a full plan year, there is no proration based on your date of hire. It is based on your actual total compensation for the period DOH - 12/31/2016. If you met the HCE compensation level in 2017, that means you're an HCE for 2018, not 2017. That assumes your company doesn't use the Top Paid Group election. If so, we can further the conversation for 2018.
Thank you, ERISA Stone! That is very helpful. One more thing: Is my 401(k) subject to any kind of hold in a bankruptcy proceeding? My concern is that I will not be able to roll over the funds due to the automatic stay, a court order, etc. I resigned a month ago, but the firm just laid off most of the staff and is likely insolvent - proof that my employer-selection abilities are about as good as my stock picking abilities? :shock:

beehappy
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Re: Confused About 401(k) Rollover as HCE with Backdoor Roth

Post by beehappy » Tue Oct 24, 2017 2:19 pm

scimitar wrote:
Fri Oct 20, 2017 10:12 pm
Thank you all for the responses so far!
Earl Lemongrab wrote:
Fri Oct 20, 2017 12:39 pm
You'd probably be better off leaving it in the 401(k), especially if the plan will be improving. Will you have a new job with a 401(k) or similar?
Yes, the new employer offers a 401(k) plan, although the options aren't great. My main concern is what happens to my assets if my former employer becomes insolvent. My understanding is that management cannot access 401(k) funds once they are deferred, correct? Would a bankruptcy subject the funds in the 401(k) to any kind of hold that would prevent me from doing a rollover?
ERISA Stone wrote:
Fri Oct 20, 2017 7:42 pm
Is your HCE status up for debate? You should already know because it's based on 2016 compensation, assuming you don't/didn't own at least 5% of the company.
I joined the company in the fall of 2016 and would not be a HCE based on what I earned with them last year. But I was also not eligible to contribute to the 401(k) plan until January 2017 (not sure if that is relevant to the IRS inquiry). Based on the income I earned this year prior to leaving the company, I would be over the HCE threshold in dollar terms if I had stayed with them into 2018.
If your new employer allows inbound rollovers, consider doing that in 2018. You just need one or 2 index funds, and you can keep doing Backdoor Roth more efficiently.

ERISA Stone
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Re: Confused About 401(k) Rollover as HCE with Backdoor Roth

Post by ERISA Stone » Tue Oct 24, 2017 4:26 pm

scimitar wrote:
Tue Oct 24, 2017 1:54 pm
ERISA Stone wrote:
Fri Oct 20, 2017 7:42 pm
Assuming your plan is based on calendar year, if you didn't meet the HCE compensation level in 2016 (and you are not a greater than 5% owner in 2016 or 2017), then you cannot be an HCE in 2017. If 2016 was a full plan year, there is no proration based on your date of hire. It is based on your actual total compensation for the period DOH - 12/31/2016. If you met the HCE compensation level in 2017, that means you're an HCE for 2018, not 2017. That assumes your company doesn't use the Top Paid Group election. If so, we can further the conversation for 2018.
Thank you, ERISA Stone! That is very helpful. One more thing: Is my 401(k) subject to any kind of hold in a bankruptcy proceeding? My concern is that I will not be able to roll over the funds due to the automatic stay, a court order, etc. I resigned a month ago, but the firm just laid off most of the staff and is likely insolvent - proof that my employer-selection abilities are about as good as my stock picking abilities? :shock:
Qualified retirement plan assets are not assets of the corporation and should be free and clear. If you had assets in a non-qualified plan, it could be a different story. Now that you gave that nugget, I would be inclined to take a distribution ASAP. Companies aren't supposed to be able to touch the money in the plan trust, but that doesn't mean people don't do shady things.

Spirit Rider
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Re: Confused About 401(k) Rollover as HCE with Backdoor Roth

Post by Spirit Rider » Tue Oct 24, 2017 4:43 pm

ERISA Stone wrote:
Tue Oct 24, 2017 4:26 pm
scimitar wrote:
Tue Oct 24, 2017 1:54 pm
Thank you, ERISA Stone! That is very helpful. One more thing: Is my 401(k) subject to any kind of hold in a bankruptcy proceeding? My concern is that I will not be able to roll over the funds due to the automatic stay, a court order, etc. I resigned a month ago, but the firm just laid off most of the staff and is likely insolvent - proof that my employer-selection abilities are about as good as my stock picking abilities? :shock:
Qualified retirement plan assets are not assets of the corporation and should be free and clear. If you had assets in a non-qualified plan, it could be a different story. Now that you gave that nugget, I would be inclined to take a distribution ASAP. Companies aren't supposed to be able to touch the money in the plan trust, but that doesn't mean people don't do shady things.
The company can not access the funds and the trusts are exempt from creditors, but I would also rollover the assets ASAP.

There are situations where the plan can be frozen and you will be unable the access your assets for an indeterminate amount of time.

ERISA Stone
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Re: Confused About 401(k) Rollover as HCE with Backdoor Roth

Post by ERISA Stone » Tue Oct 24, 2017 5:08 pm

Spirit Rider wrote:
Tue Oct 24, 2017 4:43 pm

The company can not should not be able to access the funds and the trusts are exempt from creditors, but I would also rollover the assets ASAP.

I made a small edit here. While the company shouldn't have access to the 401k funds, some owners of failing companies have been known to perform unethical, if not illegal, activities. I agree with you - rollover ASAP and move on. No need to take on the risk.

For the OP - if you had mentioned the bankruptcy initially, HCE or not, I think the advice would've been to take the distribution and worry about any corrective action when it's time. If the company is in bad shape, they may not even be paying for year-end testing anyway.

scimitar
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Re: Confused About 401(k) Rollover as HCE with Backdoor Roth

Post by scimitar » Tue Oct 24, 2017 9:08 pm

Ok, thank you both. I will try to get the funds out of the former employer's plan as soon as possible. The easiest option seems to be to roll over to the new employer's (albeit mediocre) 401(k) plan, but I am not yet eligible to participate and as you both note, I am very worried about the temptations to which management of a failing firm might succumb while I wait.

So that leaves me with a taxable distribution or a rollover to a traditional IRA, correct? Having done a Roth conversion already, I'm assuming that a rollover to a TIRA would cause me some 2017 tax complications at this point? The TIRA currently sits at $0 post-conversion but would receive approximately $18k from my 401(k) rollover.

Spirit Rider
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Re: Confused About 401(k) Rollover as HCE with Backdoor Roth

Post by Spirit Rider » Tue Oct 24, 2017 9:19 pm

Your only good immediate option is to roll it over to your current 401k. If you roll it over to a traditional IRA by 12/31/17. It will make the majority of the Backdoor Roth taxable.

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