Mega Backdoor Roth IRA Withdrawal Pro-Rata?

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bouncyboglehead
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Mega Backdoor Roth IRA Withdrawal Pro-Rata?

Post by bouncyboglehead » Thu Jul 19, 2018 8:53 am

I stumbled on the IRS page discussing after-tax withdrawals into a Roth account here:
https://www.irs.gov/retirement-plans/ro ... ment-plans

I was surprised by this:
Can I roll over just the after-tax amounts in my retirement plan to a Roth IRA and leave the remainder in the plan?
No, you can’t take a distribution of only the after-tax amounts and leave the rest in the plan. Any partial distribution from the plan must include some of the pretax amounts.

I was quite surprised by this because none of the literature I've read in this forum or by members of this forum mention this. Here's one by whitecoatinvestor:
https://www.whitecoatinvestor.com/the-m ... -roth-ira/

He doesn't mention the pro-rata rule. In fact, someone mentions in a comment that their CPA brought it up with them, and whitecoatinvestor says that he only needs to worry about it if the 401(k) plan only allows in-service withdrawals pro-rata. This s quite different since this is an IRS rule.

Here's another by finance buff:
https://thefinancebuff.com/rollover-aft ... -roth.html

There's not much discussion of a pro-rata conversion there either. In fact, Harry, in a comment, says that the pro-rata rule doesn't really even apply. This seems to contradict what the IRS says in my link above.

I guess the question is if "pre-tax" in this case means earnings on the after-tax amount, or if "pre-tax" means my normal 401(k) dollars. If it's the former, I'm golden. If it's the latter, that's a big surprise.

I'm confused. I've been doing this strategy for my wife's account for a few years now. It seems like the IRS rules say that I've done something wrong. If I have done something wrong, it's unclear how I would even fix it or what I should do.

lowlight21
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Re: Mega Backdoor Roth IRA Withdrawal Pro-Rata?

Post by lowlight21 » Thu Jul 19, 2018 9:24 am

This isn't a pro rata rule. It simply means that you must take cost basis plus gains when you do a rollover from after-tax 401k contributions to a Roth IRA, and you will pay marginal income tax rate on the gains.

magicrat
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Re: Mega Backdoor Roth IRA Withdrawal Pro-Rata?

Post by magicrat » Thu Jul 19, 2018 9:27 am

I agree that the IRS stuff is confusing. I routinely roll out my after tax 401k account. It always come out with the after-tax contributions and associated pre-tax gains. I don't worry about anything else.

magicrat
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Re: Mega Backdoor Roth IRA Withdrawal Pro-Rata?

Post by magicrat » Thu Jul 19, 2018 9:28 am

lowlight21 wrote:
Thu Jul 19, 2018 9:24 am
This isn't a pro rata rule. It simply means that you must take cost basis plus gains when you do a rollover from after-tax 401k contributions to a Roth IRA, and you will pay marginal income tax rate on the gains.
If your 401k plan allows rollover contributions, you may be able to roll out the after-tax account into an IRA, then roll the pre-tax amount back into your 401k and the after-tax amount into your Roth IRA. This is what I do.

lowlight21
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Re: Mega Backdoor Roth IRA Withdrawal Pro-Rata?

Post by lowlight21 » Thu Jul 19, 2018 9:32 am

magicrat wrote:
Thu Jul 19, 2018 9:28 am
If your 401k plan allows rollover contributions, you may be able to roll out the after-tax account into an IRA, then roll the pre-tax amount back into your 401k and the after-tax amount into your Roth IRA. This is what I do.
Yep, agreed. The point is that when you initiate a rollover from after-tax, the IRS says that you must take the cost basis plus earnings. You are welcome to roll the cost basis to a Roth IRA and the earnings to a Trad IRA if your 401k plan can support producing two checks. I do two after-tax rollovers per year and just pay tax on the gains to keep things simpler. And the IRS has flagged me a couple times for doing rollovers from IRAs to 401k plans because their systems don't always play nice with this.

If I can get on my soapbox for a moment, I'm annoyed because my 401k plan does not allow investment choices by contribution source, so I can only make a single investment choice for all contributions. If I could choose investments by source, I would put all after-tax contributions into money market to constrain any growth.

nolesrule
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Re: Mega Backdoor Roth IRA Withdrawal Pro-Rata?

Post by nolesrule » Thu Jul 19, 2018 9:33 am

There is a difference between in-service withdrawals which have specific withdrawal ordering rules (i.e. you can withdraw after-tax contributions + earnings first) and post-separation distributions/rollovers in which the distribution must be prorata.

SRenaeP
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Re: Mega Backdoor Roth IRA Withdrawal Pro-Rata?

Post by SRenaeP » Thu Jul 19, 2018 9:35 am

lowlight21 wrote:
Thu Jul 19, 2018 9:24 am
This isn't a pro rata rule. It simply means that you must take cost basis plus gains when you do a rollover from after-tax 401k contributions to a Roth IRA, and you will pay marginal income tax rate on the gains.
*You will pay marginal income tax on the gains if you can't/don't opt to have them rolled into a traditional IRA.

retiredjg
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Re: Mega Backdoor Roth IRA Withdrawal Pro-Rata?

Post by retiredjg » Thu Jul 19, 2018 9:52 am

Many people have stumbled on that rule and it apparently does not mean what it sounds like it means if the plan is using "separate accounts" for the different types of money in there.

What is important for the mega back door....If you roll out money from your after-tax account, the appropriate amount of earnings MUST go with it. If you want, the earnings can go to tIRA while the after-tax money goes to Roth IRA. Or send it all to Roth IRA and pay tax on the earnings.

Spirit Rider
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Re: Mega Backdoor Roth IRA Withdrawal Pro-Rata?

Post by Spirit Rider » Thu Jul 19, 2018 10:20 am

Many people get tripped up by this page on the IRS website if not Notice 2014-54 itself. The wording is so bad, if I was prone to conspiracy theories, I would think the IRS was intentionally trying to obfuscate.
bouncyboglehead wrote:
Thu Jul 19, 2018 8:53 am
I stumbled on the IRS page discussing after-tax withdrawals into a Roth account here:
https://www.irs.gov/retirement-plans/ro ... ment-plans

I was surprised by this:
Can I roll over just the after-tax amounts in my retirement plan to a Roth IRA and leave the remainder in the plan?
No, you can’t take a distribution of only the after-tax amounts and leave the rest in the plan. Any partial distribution from the plan must include some of the pretax amounts.
It is unfortunate that the IRS used such misleading wording here. While technically you are rolling over amounts from the plan, that is not the whole story.

The relevant wording is in the very next sentence from that link that you didn't include:
Notice 2014-54 doesn’t change the requirement that each plan distribution must include a proportional share of the pretax and after-tax amounts in the account.

To clarify even more this sentence should really say; "Notice 2014-54 doesn’t change the requirement that each plan distribution from the after-tax sub account must include a proportional share of the pretax and after-tax amounts in that account."

Technically pro-rata only applies to partial withdrawals/rollovers of the the separately accounted for after-tax contributions and associated earnings. A full withdrawal from the after-tax sub account simply represents all after-tax contributions and associated pre-tax earnings.

The key point from all of this is that distributions from after-tax accounts can be made in total isolation from from you other pre-tax and designated Roth sub accounts.

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Earl Lemongrab
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Re: Mega Backdoor Roth IRA Withdrawal Pro-Rata?

Post by Earl Lemongrab » Thu Jul 19, 2018 12:44 pm

nolesrule wrote:
Thu Jul 19, 2018 9:33 am
There is a difference between in-service withdrawals which have specific withdrawal ordering rules (i.e. you can withdraw after-tax contributions + earnings first) and post-separation distributions/rollovers in which the distribution must be prorata.
I don't believe that's correct either. When a plan uses separate accounting, you can still roll from sub-accounts without pro-rating with other sub-accounts. At least that's what I think I remember Alan S. saying.
This week's fortune cookie: "Your financial life will be secure and beneficial." So I got that going for me, which is nice.

Spirit Rider
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Re: Mega Backdoor Roth IRA Withdrawal Pro-Rata?

Post by Spirit Rider » Thu Jul 19, 2018 6:45 pm

Earl Lemongrab wrote:
Thu Jul 19, 2018 12:44 pm
nolesrule wrote:
Thu Jul 19, 2018 9:33 am
There is a difference between in-service withdrawals which have specific withdrawal ordering rules (i.e. you can withdraw after-tax contributions + earnings first) and post-separation distributions/rollovers in which the distribution must be prorata.
I don't believe that's correct either. When a plan uses separate accounting, you can still roll from sub-accounts without pro-rating with other sub-accounts. At least that's what I think I remember Alan S. saying.
You are correct when it comes to IRS taxation rules and regulations.

norules: may be referring to employer plan rules having nothing to do with IRS rules and regulations on taxation. Some employer plans require partial distributions to come from some or all sub accounts proportionally. This is most often seen whereby you can not choose whether to take distributions discretely from pre-tax or designated Roh accounts, but must take distributions proportionally.

diy60
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Re: Mega Backdoor Roth IRA Withdrawal Pro-Rata?

Post by diy60 » Thu Jul 19, 2018 7:08 pm

Earl Lemongrab wrote:
Thu Jul 19, 2018 12:44 pm
nolesrule wrote:
Thu Jul 19, 2018 9:33 am
There is a difference between in-service withdrawals which have specific withdrawal ordering rules (i.e. you can withdraw after-tax contributions + earnings first) and post-separation distributions/rollovers in which the distribution must be prorata.
I don't believe that's correct either. When a plan uses separate accounting, you can still roll from sub-accounts without pro-rating with other sub-accounts. At least that's what I think I remember Alan S. saying.
Probably depends on your specific employer plan. I retired from a MegaCorp. While in service we could do a rollover from either of these three accounts 1) pretax, 2)Roth, or 3) after tax (with associated gains). However, upon separation, the after tax sub account was combined with the pretax much like a Traditional IRA that has basis. So post separation it was either a distribution from the pretax (with pro-rata after tax basis) or from the Roth account.

nolesrule
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Re: Mega Backdoor Roth IRA Withdrawal Pro-Rata?

Post by nolesrule » Fri Jul 20, 2018 11:45 am

diy60 wrote:
Thu Jul 19, 2018 7:08 pm
Earl Lemongrab wrote:
Thu Jul 19, 2018 12:44 pm
nolesrule wrote:
Thu Jul 19, 2018 9:33 am
There is a difference between in-service withdrawals which have specific withdrawal ordering rules (i.e. you can withdraw after-tax contributions + earnings first) and post-separation distributions/rollovers in which the distribution must be prorata.
I don't believe that's correct either. When a plan uses separate accounting, you can still roll from sub-accounts without pro-rating with other sub-accounts. At least that's what I think I remember Alan S. saying.
Probably depends on your specific employer plan. I retired from a MegaCorp. While in service we could do a rollover from either of these three accounts 1) pretax, 2)Roth, or 3) after tax (with associated gains). However, upon separation, the after tax sub account was combined with the pretax much like a Traditional IRA that has basis. So post separation it was either a distribution from the pretax (with pro-rata after tax basis) or from the Roth account.
That may be where I got my assumptions from as the Plan Summary for Mrs. nolesrule's MegaCorp combined pre-tax and after-tax for post-separation withdrawals. The docs have different withdrawal instructions for in-service withdrawals, in-service hardship withdrawals (these allowed for more than just after-tax and vested company match) and post-separation withdrawals (which combined a pro-rata pre-tax and non-Roth after-tax).

diy60
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Re: Mega Backdoor Roth IRA Withdrawal Pro-Rata?

Post by diy60 » Fri Jul 20, 2018 12:47 pm

nolesrule wrote:
Fri Jul 20, 2018 11:45 am
That may be where I got my assumptions from as the Plan Summary for Mrs. nolesrule's MegaCorp combined pre-tax and after-tax for post-separation withdrawals. The docs have different withdrawal instructions for in-service withdrawals, in-service hardship withdrawals (these allowed for more than just after-tax and vested company match) and post-separation withdrawals (which combined a pro-rata pre-tax and non-Roth after-tax).
You should pat yourself on the back for reading the Plan Summary. The vast majority of people I talk to have no clue regarding the details of their employer's 401K plan. My MegaCorp had another interesting twist, it had a 2 year "seasoning" period for each after tax contribution, meaning it could not be withdrawn until the contribution was at least in the after tax sub-account for 2 years. This was an important discovery for me as I desired to keep my 401K funds in the MegaCorp 401K plan after retirement due to extreme low ER index fund offerings, but I didn't want the after tax to get thrown in as basis in the pretax account after post separation. Fortunately I was able to get around this by performing a IRR (in plan roth rollover), which was not subject to our plan's seasoning rule. I know this is deep in weeds but it drives home the point to understand the finer details of your 401K plans.

Alan S.
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Re: Mega Backdoor Roth IRA Withdrawal Pro-Rata?

Post by Alan S. » Fri Jul 20, 2018 3:02 pm

Many plans cease treating the after tax sub account as a separate account post separation, although there is no IRS rules that suggests this. Plans that do this apparently feel that distributions are simpler when the entire plan balance is eligible for distribution as is the case after separation from service.

After Notice 2014-54 this does not matter as much since the entire plan can be split according to non Roth after tax amounts and pre tax amounts, such that all after tax amounts can be rolled to a Roth IRA.

However, this can be problematic for participants who only want to roll the after tax amounts to their Roth IRA and leave the pre tax amounts in the plan. In the following link, Kaye Thomas of Fairmark explains the technical background:


http://fairmark.com/retirement/roth-acc ... treatment/

Smilodon
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Re: Mega Backdoor Roth IRA Withdrawal Pro-Rata?

Post by Smilodon » Mon Jul 30, 2018 6:45 pm

Spirit Rider wrote:
Thu Jul 19, 2018 6:45 pm
Some employer plans require partial distributions to come from some or all sub accounts proportionally.
Would reverse rollovers from an IRA to a 401k potentially foil the mega backdoor Roth? For example, I have a substantial traditional IRA with zero basis. I thought it might be a good idea to reverse rollover that IRA into my 401k to avoid the pro rata requirement for normal backdoor Roth IRAs. I am yet to do a normal backdoor Roth due to my having a substantial traditional IRA and therefore would be subject to the pro rata requirement.

I annually do mega backdoor Roth IRAs since my 401k allows after-tax contributions and in-service withdrawals of the after-tax contributions and associated earnings. But they also allow in-service withdrawals of reverse rollover money which is kept track of in yet its own sub account. If I did a reverse rollover from my IRA to the 401k, would just the availability of in-service withdrawals of this money subject withdrawals from the after-tax sub account to pro rata?

This subject came up in the Mega Roth Conversion Strategies episode (segment time 01:09:00 - 01:16:00) of The Retirement and IRA Show. They indicate that it would be a problem - that is, if the 401k even just allows in-service withdrawals of money rolled in from a traditional IRA, then withdrawals from the after-tax sub account would be subject to pro rata. In other words, you cannot withdrawal just from the after-tax sub account. This would effectively disrupt the mega backdoor Roth IRA. It seemed to boil down to a choice between mega or normal backdoor Roth.

retiredjg
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Re: Mega Backdoor Roth IRA Withdrawal Pro-Rata?

Post by retiredjg » Mon Jul 30, 2018 7:07 pm

Smilodon wrote:
Mon Jul 30, 2018 6:45 pm
Would reverse rollovers from an IRA to a 401k potentially foil the mega backdoor Roth? For example, I have a substantial traditional IRA with zero basis. I thought it might be a good idea to reverse rollover that IRA into my 401k to avoid the pro rata requirement for normal backdoor Roth IRAs. I am yet to do a normal backdoor Roth due to my having a substantial traditional IRA and therefore would be subject to the pro rata requirement.

I annually do mega backdoor Roth IRAs since my 401k allows after-tax contributions and in-service withdrawals of the after-tax contributions and associated earnings. But they also allow in-service withdrawals of reverse rollover money which is kept track of in yet its own sub account. If I did a reverse rollover from my IRA to the 401k, would just the availability of in-service withdrawals of this money subject withdrawals from the after-tax sub account to pro rata?

This subject came up in the Mega Roth Conversion Strategies episode (segment time 01:09:00 - 01:16:00) of The Retirement and IRA Show. They indicate that it would be a problem - that is, if the 401k even just allows in-service withdrawals of money rolled in from a traditional IRA, then withdrawals from the after-tax sub account would be subject to pro rata. In other words, you cannot withdrawal just from the after-tax sub account. This would effectively disrupt the mega backdoor Roth IRA. It seemed to boil down to a choice between mega or normal backdoor Roth.
That is not my understanding. However, I didn't listen to the podcast.

There are several sub-accounts in a 401k that law and regulations allow to be rolled out to IRA and/or Roth IRA. Unless there is something in your plan that requires it, my understanding is that what happens in one sub-account is independent of what happens in the other sub-accounts.

In other words, you should be able to roll your after-tax account to Roth without affecting the other accounts inside the 401k...unless there is some specific requirement in your plan...which would really surprise me.

Spirit Rider
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Re: Mega Backdoor Roth IRA Withdrawal Pro-Rata?

Post by Spirit Rider » Mon Jul 30, 2018 7:12 pm

I have no interest in listening to a 2 1/4 hour link, because if they said that they are wrong. The only IRS pro-rata requirement on after-tax contributions is with pre-tax earnings on those contributions in the same after-tax account. No other balances in any other account matter.

An employer can have company policies that require pro-rata distributions. Like retiredjg:, I am unaware of any company that has such a policy on in-service rollovers. You can certainly verify that with your employer.

The only case where I have seen this is when you seek to have partial withdrawals after retirement. Some companies do require equal payments or RMDs to come pro-rata from all accounts.

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Earl Lemongrab
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Re: Mega Backdoor Roth IRA Withdrawal Pro-Rata?

Post by Earl Lemongrab » Mon Jul 30, 2018 11:39 pm

Smilodon wrote:
Mon Jul 30, 2018 6:45 pm
I annually do mega backdoor Roth IRAs since my 401k allows after-tax contributions and in-service withdrawals of the after-tax contributions and associated earnings. But they also allow in-service withdrawals of reverse rollover money which is kept track of in yet its own sub account. If I did a reverse rollover from my IRA to the 401k, would just the availability of in-service withdrawals of this money subject withdrawals from the after-tax sub account to pro rata?

This subject came up in the Mega Roth Conversion Strategies episode (segment time 01:09:00 - 01:16:00) of The Retirement and IRA Show. They indicate that it would be a problem - that is, if the 401k even just allows in-service withdrawals of money rolled in from a traditional IRA, then withdrawals from the after-tax sub account would be subject to pro rata. In other words, you cannot withdrawal just from the after-tax sub account. This would effectively disrupt the mega backdoor Roth IRA. It seemed to boil down to a choice between mega or normal backdoor Roth.
Megacorp allows incoming rollovers. It allows after-tax contributions. It allows in-service distributions of either. It allows rollovers from only one of them. The 1099s from after-tax rollovers list the taxable amount equivalent to the earnings.

Remember that unlike an IRA, the accounting for basis is the responsibility of the plan. If they get it wrong, there's a big problem because the accounting on the remaining portions of the sub-accounts will be wrong. It's not a matter of the IRS making you cough up some more tax. They'd have to go to the plan and make them change the basis on the sub-accounts.

Where did this radio show get its supposed information?
This week's fortune cookie: "Your financial life will be secure and beneficial." So I got that going for me, which is nice.

Smilodon
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Re: Mega Backdoor Roth IRA Withdrawal Pro-Rata?

Post by Smilodon » Tue Jul 31, 2018 5:57 pm

Thanks to retiredjg, Spirit Rider, and Earl Lemongrab for your responses.
Earl Lemongrab wrote:
Mon Jul 30, 2018 11:39 pm
Where did this radio show get its supposed information?
I am not sure. I stumbled on the podcast while browsing iTunes, and that particular episode caught my attention. But apparently the hosts were mistaken and gave out bad advice regarding this particular point. Maybe I'll send them an email and request a citation regarding the rule they said (or at least strongly implied) exists. The consensus here (bogleheads) is that the IRS does not impose a pro rata requirement in this circumstance (that being both after-tax and rollover balances exist and are available for in-service withdrawal), but it's possible (but unlikely) the plan itself could.

I reviewed my 401k plan's SPD today and confirmed both after-tax (with associated earnings) and rollover contributions are available for in-service withdrawal. It did not stipulate anything about pro rata if you happen to have balances in both. From this I gather I could just withdraw the after-tax (with associated earnings) as I've done in past years, even if I roll into the plan my existing traditional IRA balance to align for future normal backdoor Roths. This seems consistent with the collective experience you three described.

Thanks for the comments, and I will respond if I hear anything from my inquiry to The Retirement and IRA Show.

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