Mega Backdoor Roth - Roth 401K First?

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Topic Author
TallHaul
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Mega Backdoor Roth - Roth 401K First?

Post by TallHaul »

Hello all,

My plan allows the mega backdoor Roth. I have a separate Roth IRA that has been funded for over 5 years. Today, I have after-tax contributions converting immediately/automatically to a Roth 401K. I have the ability to roll those funds from the Roth 401K to the Roth IRA.

I am having trouble with the pros/cons of going after-tax to Roth 401K to Roth IRA versus after-tax to Roth IRA.

The goal is to have access to the contribution/principal without penalty, but take advantage of the growth if not spent.

The complication is the 5-year rule on contributions versus conversions versus rollovers.

Does going through the Roth 401K provide an advantage to the traditional path of after-tax straight to Roth IRA?

Thanks!
MrJedi
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Re: Mega Backdoor Roth - Roth 401K First?

Post by MrJedi »

The automatic rollovers to Roth 401k are a big convenience factor IMO. This helps minimize any earnings before the contribution becomes Roth. I have not heard of a plan that allows for automatic rollovers to Roth IRA (can't say 100% nonexistent, but it would be quite rare if it does exist)
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TallHaul
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Re: Mega Backdoor Roth - Roth 401K First?

Post by TallHaul »

MrJedi wrote: Wed Jul 21, 2021 7:13 pm The automatic rollovers to Roth 401k are a big convenience factor IMO. This helps minimize any earnings before the contribution becomes Roth. I have not heard of a plan that allows for automatic rollovers to Roth IRA (can't say 100% nonexistent, but it would be quite rare if it does exist)
The rollover to Roth IRA is manual.

I guess my Q is do I lose or gain anything going to Roth 401K before Roth IRA or is it moot?
bradpevans
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Re: Mega Backdoor Roth - Roth 401K First?

Post by bradpevans »

While decidedly NOT very Boglehead-ish, I prefer the Roth IRA to Roth 401k because I can buy essentially any security in the IRA while I’m limited to about a dozen choices on the 401k side

The “auto transfer” keeps the securities as purchased, so that’s just a designation and record keeping
However, they can subsequently be sold and used to purchase most any securities
pasadena
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Re: Mega Backdoor Roth - Roth 401K First?

Post by pasadena »

I'm not sure I understand the "after-tax to Roth IRA part" of your question. Can you detail both manipulations?
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Duckie
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Re: Mega Backdoor Roth - Roth 401K First?

Post by Duckie »

TallHaul wrote: Wed Jul 21, 2021 5:57 pm Does going through the Roth 401K provide an advantage to the traditional path of after-tax straight to Roth IRA?
No. If you want the after-tax 401k assets to quickly end up in the Roth IRA why bother detouring through the Roth 401k? Why not just go directly from after-tax 401k to Roth IRA? Does your plan have limits on the frequency of rollovers to a Roth IRA? Some plans only allow rollovers a few times a year.
TallHaul wrote: Wed Jul 21, 2021 7:15 pm I guess my Q is do I lose or gain anything going to Roth 401K before Roth IRA or is it moot?
401k plans have some ERISA protections that IRAs do not have. IRAs may have better, cheaper options than 401k plans, plus you can get the contributions out. But if you're only using the Roth 401k as a temporary stop then it's a waste of time.
latestartearner
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Re: Mega Backdoor Roth - Roth 401K First?

Post by latestartearner »

Read Mad FIentist Roth conversion ladder article.
Since any initial contribution into a Roth IRA can be withdrawn without penalty, there is a benefit to keeping your money growing tax free as much as possible inside a Roth 401k and then rolling portions of it over to a Roth IRA piece wise on an annual basis to bridge your early retirement.
Alto Astral
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Re: Mega Backdoor Roth - Roth 401K First?

Post by Alto Astral »

TallHaul wrote: Wed Jul 21, 2021 7:15 pm
MrJedi wrote: Wed Jul 21, 2021 7:13 pm The automatic rollovers to Roth 401k are a big convenience factor IMO. This helps minimize any earnings before the contribution becomes Roth. I have not heard of a plan that allows for automatic rollovers to Roth IRA (can't say 100% nonexistent, but it would be quite rare if it does exist)
The rollover to Roth IRA is manual.

I guess my Q is do I lose or gain anything going to Roth 401K before Roth IRA or is it moot?
Roth 401K is better in 2 ways:
  1. automatic conversions - calling your plan provider every paycheck is going to be a pain and you may forget/be sick and then need deal w/ taxable earnings
  2. Better expense ratios since this is your company's fund. Vanguard's ER will be 0.04% for total stock fund in your Roth IRA and your plan's index fund could well be half that.
I have a mega backdoor too option too. I do my regular backdoor to Roth IRA but my mega backdoor to Roth 401k.
MrJedi
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Re: Mega Backdoor Roth - Roth 401K First?

Post by MrJedi »

My 401k funds are better than what I can get in an IRA. SP500 fund for 0.003%, international index fund for 0.035%, etc. That's a reason to keep in my 401k rather than IRA as well. The biggest thing for me is the automatic rollovers/conversion though...anything that simplifies and automates my investments and still follows my desired asset allocation is a big win.
TrogdorsPeasant
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Re: Mega Backdoor Roth - Roth 401K First?

Post by TrogdorsPeasant »

The reason I call every two weeks and move the after tax contribution directly out to a Roth IRA is to have complete independent control of my Roth investments. At least with my plan, if you auto convert after tax in the 401k, the “contributions” are just tracked as Roth, but follow the same allocation as the rest of your investment distribution. Thus you end up with some Roth sourced dollars in bonds if you’re running 80/20, or whatever your chosen overall 401k allocation is.

If you want to be more aggressive with Roth versus tax advantaged, it’s impossible to separate them.
SnowBog
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Re: Mega Backdoor Roth - Roth 401K First?

Post by SnowBog »

Alto Astral wrote: Wed Jul 21, 2021 9:45 pm
TallHaul wrote: Wed Jul 21, 2021 7:15 pm
MrJedi wrote: Wed Jul 21, 2021 7:13 pm The automatic rollovers to Roth 401k are a big convenience factor IMO. This helps minimize any earnings before the contribution becomes Roth. I have not heard of a plan that allows for automatic rollovers to Roth IRA (can't say 100% nonexistent, but it would be quite rare if it does exist)
The rollover to Roth IRA is manual.

I guess my Q is do I lose or gain anything going to Roth 401K before Roth IRA or is it moot?
Roth 401K is better in 2 ways:
  1. automatic conversions - calling your plan provider every paycheck is going to be a pain and you may forget/be sick and then need deal w/ taxable earnings
  2. Better expense ratios since this is your company's fund. Vanguard's ER will be 0.04% for total stock fund in your Roth IRA and your plan's index fund could well be half that.
I have a mega backdoor too option too. I do my regular backdoor to Roth IRA but my mega backdoor to Roth 401k.
I'd add a 3rd benefit, generally 401k's have better protections from creditors/law suits (with variations by state).
TallHaul wrote: Wed Jul 21, 2021 7:15 pm I guess my Q is do I lose or gain anything going to Roth 401K before Roth IRA or is it moot?
The main thing to check is if it impacts your ability to rollover from the 401k to an IRA. Due to plan differences, I've heard this might be allowed, might be blocked, or might only be allowed after you are no longer with the company.

But if your plan let's the automated "in-plan" conversion, and still let's you manually rollover the amount to a Roth IRA - then I don't think you lose anything! (And if you have automatic conversions, that helps minimize taxes - so lots to gain.)

Above is what I do - automatically convert - then occasional (manual) rollover to Roth IRA. The main reason I do both is I have more control in my Roth IRA. More specifically, my 401k plan only supports a single BrokerageLink account that mixes pre-tax and Roth - so if I buy $100 of a bond fund - it's a pro-rated amount of the pre-tax and Roth. By doing the rollover to my Roth, I can invest it 100% stocks while my 401k (with now only pre-tax) holds most of my bonds. If it wasn't for this, I'd leave the funds in my 401k...
SnowBog
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Re: Mega Backdoor Roth - Roth 401K First?

Post by SnowBog »

TrogdorsPeasant wrote: Wed Jul 21, 2021 11:00 pm ... At least with my plan...

If you want to be more aggressive with Roth versus tax advantaged, it’s impossible to separate them.
Me too... But this is very plan dependent, everyone should understand how their plan works and what it allows.
Topic Author
TallHaul
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Re: Mega Backdoor Roth - Roth 401K First?

Post by TallHaul »

SnowBog wrote: Wed Jul 21, 2021 11:26 pm But if your plan let's the automated "in-plan" conversion, and still let's you manually rollover the amount to a Roth IRA - then I don't think you lose anything! (And if you have automatic conversions, that helps minimize taxes - so lots to gain.)

Above is what I do - automatically convert - then occasional (manual) rollover to Roth IRA. The main reason I do both is I have more control in my Roth IRA.
This is how I understand how my plan works and have the same benefits marked down.

Is this considered a conversation or rollover? How about going straight after-tax to Roth IRA? I am confused on this point and it's my understanding conversations have their own 5-year clock (specific to each conversion) while rollovers are subject to the standard 5-year rule.
retiredjg
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Re: Mega Backdoor Roth - Roth 401K First?

Post by retiredjg »

TallHaul wrote: Wed Jul 21, 2021 5:57 pm Hello all,

My plan allows the mega backdoor Roth. I have a separate Roth IRA that has been funded for over 5 years. Today, I have after-tax contributions converting immediately/automatically to a Roth 401K. I have the ability to roll those funds from the Roth 401K to the Roth IRA.

I am having trouble with the pros/cons of going after-tax to Roth 401K to Roth IRA versus after-tax to Roth IRA.
The advantage of the way you are doing it is that it is done automatically and it is done before any earnings occur. If you eliminate the middle step, you must do the transfer out to Roth IRA every payday and if there are earnings, you will need to keep up with how much and when they occur.

The goal is to have access to the contribution/principal without penalty, but take advantage of the growth if not spent.
What do you mean by "but take advantage of the growth if not spent".

The complication is the 5-year rule on contributions versus conversions versus rollovers.
There is no 5 year rule on direct contributions. There is a 5 year rule on conversions if any part of the conversion was taxable. There is no 5 year rule on rollovers.
Does going through the Roth 401K provide an advantage to the traditional path of after-tax straight to Roth IRA?
If you could roll directly to Roth IRA every payday before any earnings occur, there would be no advantage. The way you have it set up now. you don't have to do anything other than roll it all out of Roth 401k once a year or whenever makes sense to you.
SnowBog
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Re: Mega Backdoor Roth - Roth 401K First?

Post by SnowBog »

retiredjg wrote: Thu Jul 22, 2021 11:19 am
TallHaul wrote: Wed Jul 21, 2021 5:57 pm The complication is the 5-year rule on contributions versus conversions versus rollovers.
There is no 5 year rule on direct contributions. There is a 5 year rule on conversions if any part of the conversion was taxable. There is no 5 year rule on rollovers.
Does going through the Roth 401K provide an advantage to the traditional path of after-tax straight to Roth IRA?
If you could roll directly to Roth IRA every payday before any earnings occur, there would be no advantage. The way you have it set up now. you don't have to do anything other than roll it all out of Roth 401k once a year or whenever makes sense to you.
Personally, I don't plan on withdrawing from my Roth IRA until retirement, so I'm not worried about any 5 year limits right now. But your comment on "taxable conversions" made me question how this works...

For clarity, does it matter if OP has some taxable "gains"? Depending on the plan, even with a "daily" automatic conversion - I think it's possible you could end up with taxable gains on the converted amount (especially if their plan only does weekly, monthly, etc. conversions)?

My working theory was - much like regular Backdoor Roth (or direct contributions), you can always withdraw the "taxable/after-tax" contribution amount. So if I contribute $10k to Mega Backdoor Roth which lands as $11k due to gains before conversion, I can still withdraw the "original" $10k amount. But I can't touch any of the "gains" (that $1k - or any subsequent growth) without meeting the Roth rules or paying the penalty. But maybe I misunderstood...
Topic Author
TallHaul
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Re: Mega Backdoor Roth - Roth 401K First?

Post by TallHaul »

retiredjg wrote: Thu Jul 22, 2021 11:19 am What do you mean by "but take advantage of the growth if not spent".
Say I get a 25K commission check. I want the freedom to spend some/all of it without penalty (principal) but if I don't want to spend it, it will grow tax free.
Topic Author
TallHaul
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Re: Mega Backdoor Roth - Roth 401K First?

Post by TallHaul »

SnowBog wrote: Thu Jul 22, 2021 4:22 pm My working theory was - much like regular Backdoor Roth (or direct contributions), you can always withdraw the "taxable/after-tax" contribution amount. So if I contribute $10k to Mega Backdoor Roth which lands as $11k due to gains before conversion, I can still withdraw the "original" $10k amount. But I can't touch any of the "gains" (that $1k - or any subsequent growth) without meeting the Roth rules or paying the penalty. But maybe I misunderstood...
This is my understanding as well and what I'm trying to confirm.
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1789
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Re: Mega Backdoor Roth - Roth 401K First?

Post by 1789 »

The point is the following: You most likely (close to 100%) wont be able to go to Roth IRA directly from 401k regardless of which path you choose. Basically in order to minimize the hustle and number of phone calls needed to go to Roth Ira, the best thing you can do is to enroll in auto conversion to Roth 401k within the plan and then roll that contributions + earnings to Roth Ira annually. This is what i do.
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retiredjg
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Re: Mega Backdoor Roth - Roth 401K First?

Post by retiredjg »

SnowBog wrote: Thu Jul 22, 2021 4:22 pm
retiredjg wrote: Thu Jul 22, 2021 11:19 am
TallHaul wrote: Wed Jul 21, 2021 5:57 pm The complication is the 5-year rule on contributions versus conversions versus rollovers.
There is no 5 year rule on direct contributions. There is a 5 year rule on conversions if any part of the conversion was taxable. There is no 5 year rule on rollovers.
Does going through the Roth 401K provide an advantage to the traditional path of after-tax straight to Roth IRA?
If you could roll directly to Roth IRA every payday before any earnings occur, there would be no advantage. The way you have it set up now. you don't have to do anything other than roll it all out of Roth 401k once a year or whenever makes sense to you.
Personally, I don't plan on withdrawing from my Roth IRA until retirement, so I'm not worried about any 5 year limits right now. But your comment on "taxable conversions" made me question how this works...

For clarity, does it matter if OP has some taxable "gains"? Depending on the plan, even with a "daily" automatic conversion - I think it's possible you could end up with taxable gains on the converted amount (especially if their plan only does weekly, monthly, etc. conversions)?

My working theory was - much like regular Backdoor Roth (or direct contributions), you can always withdraw the "taxable/after-tax" contribution amount. So if I contribute $10k to Mega Backdoor Roth which lands as $11k due to gains before conversion, I can still withdraw the "original" $10k amount. But I can't touch any of the "gains" (that $1k - or any subsequent growth) without meeting the Roth rules or paying the penalty. But maybe I misunderstood...
You misunderstood. It does not work that way.

If you contribute $10k to an after-tax account (or make a non-deductible contribution to tIRA) and it grows to $11k before rolling out/converting to Roth IRA, the extra $1k will be taxed when you do the conversion. That $1k has a 5 tax year clock attached to it.

When withdrawing from the Roth IRA, the $1k comes out before the $10k. If the clock has not finished running, there is a 10% penalty on the $1k.

This is how it works for the ordinary backdoor process as well as the mega-backdoor (if going directly from after-tax account to Roth IRA).

This is why it is very nice and convenient to have automatic Roth conversions on after-tax accounts - there should be no conversion clocks to keep up with.
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goodenyou
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Re: Mega Backdoor Roth - Roth 401K First?

Post by goodenyou »

Texas two-step here. 401k after-tax spillover can be converted to Roth 401k. Roth 401k can be rolled out to a Roth IRA at anytime (once Roth IRA is set up). All manually with annoying menus, terrible hold music and long waits on the phone. The sooner the better for converting after tax to Roth 401k so no taxes are incurred with any gains.
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SnowBog
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Re: Mega Backdoor Roth - Roth 401K First?

Post by SnowBog »

retiredjg wrote: Fri Jul 23, 2021 7:28 am
SnowBog wrote: Thu Jul 22, 2021 4:22 pm
retiredjg wrote: Thu Jul 22, 2021 11:19 am
TallHaul wrote: Wed Jul 21, 2021 5:57 pm The complication is the 5-year rule on contributions versus conversions versus rollovers.
There is no 5 year rule on direct contributions. There is a 5 year rule on conversions if any part of the conversion was taxable. There is no 5 year rule on rollovers.
Does going through the Roth 401K provide an advantage to the traditional path of after-tax straight to Roth IRA?
If you could roll directly to Roth IRA every payday before any earnings occur, there would be no advantage. The way you have it set up now. you don't have to do anything other than roll it all out of Roth 401k once a year or whenever makes sense to you.
Personally, I don't plan on withdrawing from my Roth IRA until retirement, so I'm not worried about any 5 year limits right now. But your comment on "taxable conversions" made me question how this works...

For clarity, does it matter if OP has some taxable "gains"? Depending on the plan, even with a "daily" automatic conversion - I think it's possible you could end up with taxable gains on the converted amount (especially if their plan only does weekly, monthly, etc. conversions)?

My working theory was - much like regular Backdoor Roth (or direct contributions), you can always withdraw the "taxable/after-tax" contribution amount. So if I contribute $10k to Mega Backdoor Roth which lands as $11k due to gains before conversion, I can still withdraw the "original" $10k amount. But I can't touch any of the "gains" (that $1k - or any subsequent growth) without meeting the Roth rules or paying the penalty. But maybe I misunderstood...
You misunderstood. It does not work that way.

If you contribute $10k to an after-tax account (or make a non-deductible contribution to tIRA) and it grows to $11k before rolling out/converting to Roth IRA, the extra $1k will be taxed when you do the conversion. That $1k has a 5 tax year clock attached to it.

When withdrawing from the Roth IRA, the $1k comes out before the $10k. If the clock has not finished running, there is a 10% penalty on the $1k.

This is how it works for the ordinary backdoor process as well as the mega-backdoor (if going directly from after-tax account to Roth IRA).

This is why it is very nice and convenient to have automatic Roth conversions on after-tax accounts - there should be no conversion clocks to keep up with.
Understood on the $1k (although didn't realize it comes out "first")... I figured that had a 5 year clock (and maybe early withdrawal penalties if under 59.5).

But what about the original after-tax $10k? Can that be withdrawal at any time once it's rolled to the Roth IRA?
nolesrule
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Re: Mega Backdoor Roth - Roth 401K First?

Post by nolesrule »

SnowBog wrote: Fri Jul 23, 2021 10:50 am
Understood on the $1k (although didn't realize it comes out "first")... I figured that had a 5 year clock (and maybe early withdrawal penalties if under 59.5).

But what about the original after-tax $10k? Can that be withdrawal at any time once it's rolled to the Roth IRA?
Yes, but the $1k would come out first, so if you withdraw $10k it would be the $1k subject to the penalty (if within 5 years of the conversion) and $9k of the after-tax basis.

All conversions in the same year are aggregated for withdrawal purposes with pre-tax components of conversions coming out before the after-tax components. Once 5 tax years have passed then the pre-tax component and after-tax component are treated the same (no penalty), so it no longer matters.

As such it is important that you track by year direct contribution amounts, conversion of pre-tax dollars and conversion of after-tax dollars.
tomsense76
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Re: Mega Backdoor Roth - Roth 401K First?

Post by tomsense76 »

I've been doing the same thing you are. The benefit is the immediate conversion of the money avoids as much tax as possible. Should add I may stop rolling it over to a Roth IRA in the future. Already have a lot of contributions rolled over at this point. The protections on the 401k are really good. Plus can always roll over more money if needed
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SnowBog
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Re: Mega Backdoor Roth - Roth 401K First?

Post by SnowBog »

nolesrule wrote: Fri Jul 23, 2021 11:10 am
SnowBog wrote: Fri Jul 23, 2021 10:50 am
Understood on the $1k (although didn't realize it comes out "first")... I figured that had a 5 year clock (and maybe early withdrawal penalties if under 59.5).

But what about the original after-tax $10k? Can that be withdrawal at any time once it's rolled to the Roth IRA?
Yes, but the $1k would come out first, so if you withdraw $10k it would be the $1k subject to the penalty (if within 5 years of the conversion) and $9k of the after-tax basis.

All conversions in the same year are aggregated for withdrawal purposes with pre-tax components of conversions coming out before the after-tax components. Once 5 tax years have passed then the pre-tax component and after-tax component are treated the same (no penalty), so it no longer matters.

As such it is important that you track by year direct contribution amounts, conversion of pre-tax dollars and conversion of after-tax dollars.
Gotcha! So the "comes out first" also means "would be withdrawn from Roth IRA first". Which means the $10k can be withdrawn without tax or penalties, but only after the $1k of "gains" were withdrawn with penalties.
nolesrule
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Re: Mega Backdoor Roth - Roth 401K First?

Post by nolesrule »

Yes withdrawal order rules for Roth IRA are as follows:

1. All direct contributions to Roth
2. All conversions to Roth by year and within each year:
2a. All conversions of pre-tax dollars come out first
2b. All conversions of after-tax dollars come out last
3. Earnings in the Roth account

This ordering applies to Federal withdrawal order. State withdrawal orders may be different.
retiredjg
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Re: Mega Backdoor Roth - Roth 401K First?

Post by retiredjg »

SnowBog wrote: Fri Jul 23, 2021 10:50 am But what about the original after-tax $10k? Can that be withdrawal at any time once it's rolled to the Roth IRA?
When you take money out of Roth IRA, it comes out in a certain designated order. You don't get to pick what you take out.

The first money that comes out is considered to be direct contributions if you have any. For this example, I assume you have no direct contributions.

When all the contributions have been exhausted, the next money that comes out is your oldest conversion (by year). But the taxable part of the conversion comes out before the part of the conversion was not taxed. If the 5 tax year clock has not finished running, there will be a penalty on what was the taxable part of the conversion.
SnowBog
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Re: Mega Backdoor Roth - Roth 401K First?

Post by SnowBog »

retiredjg wrote: Fri Jul 23, 2021 4:20 pm
SnowBog wrote: Fri Jul 23, 2021 10:50 am But what about the original after-tax $10k? Can that be withdrawal at any time once it's rolled to the Roth IRA?
When you take money out of Roth IRA, it comes out in a certain designated order. You don't get to pick what you take out.

The first money that comes out is considered to be direct contributions if you have any. For this example, I assume you have no direct contributions.

When all the contributions have been exhausted, the next money that comes out is your oldest conversion (by year). But the taxable part of the conversion comes out before the part of the conversion was not taxed. If the 5 tax year clock has not finished running, there will be a penalty on what was the taxable part of the conversion.
Ok, let's tie this together then...

So if I'm following, my Backdoor Roth contribution of $6k/year (or whatever it was for past years) is usually the "first in" for me (no "direct" contributions). So if I did say 4 years of $6k = $24k I can withdraw without tax or penalty.

Let's say in the 5th year, I make another Backdoor for $6k + Mega Backdoor for our $11k example before (with $1k gains).

If I'd already withdrawn the $24k above, and wanted $6k more - does the Backdoor Roth come first? Does it matter on "timing" of when it was made vs. MBR?
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