Mega Backdoor Roth Mechanics Question

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
anewboglehead
Posts: 54
Joined: Tue Mar 10, 2020 1:03 pm

Mega Backdoor Roth Mechanics Question

Post by anewboglehead »

Hi Bogleheads,

I am hoping to set up a Mega BackDoor Roth at work. Having never done one before, I wanted to double check the mechanics to hopefully make this a smooth ride. Thanks in advance for any advice, pitfalls to watch out for, etc.

Per the Wiki (https://www.bogleheads.org/wiki/Mega-backdoor_Roth), to perform the Mega Backdoor Roth Process, the 401(k) plan  must offer the following two features:

A) After-tax contributions to the 401(k), and
B) Roth conversions of after-tax contributions, either as an in-plan conversion or as an in-service distribution.


The following paragraphs are verbatim from my company "401(k) PLAN - SUMMARY PLAN DESCRIPTION"

A) "After-Tax Contributions
After-Tax Contributions will be deducted directly from your Eligible Pay on an after-tax basis and transferred to your After-Tax Contribution account. Your After-Tax Contributions in this account will be fully vested at all times. Because you have already paid taxes on these amounts, your After-Tax Contributions will not be subject to income taxes when actually distributed from the Plan. However, any earnings on your After-Tax Contributions will be subject to income taxes when your After-Tax Contributions are distributed to you. You may elect to make After-Tax Contributions to the Plan of up to 75% (in increments of one-tenth percent (0.10 percent)) of your Eligible Pay, including the ability to make a separate percentage election of up to 75% of (a) your Eligible Pay other than bonuses and commissions each pay period, and (b) your bonuses and commissions"

B1)
"In-Plan Roth Conversions
You may elect to convert your non-Roth contributions accounts to a Roth Rollover account. At the time of the conversion, the amounts converted become taxable income to you. There is no premature withdrawal penalty tax on the Roth conversion, but you will be taxed on the amounts converted as ordinary income. The funds in your Roth Rollover account will not be taxed again when later distributed to you (including earnings if the distribution is a Qualified Roth Distribution), as long as you wait until the Roth Rollover account is distributable without penalty. However, if you make a premature withdrawal, you may have to pay taxes on the investment earnings. The principal amount of a Roth conversion generally is not subject to a premature withdrawal penalty, but if you have a premature withdrawal within 5 years of the conversion, the principal and earnings withdrawn are subject to the 10% federal penalty tax (and any applicable tax penalty taxes). Please consult with your personal tax advisor to determine if this conversion is appropriate for you."

B2)
In-Service Withdrawals Prior to Age 59½
While you are an employee of *******, you may withdraw all or any portion of your Rollover and/or After-Tax Contribution account(s) at any time. However, you may not receive more than one in-service distribution during any consecutive 12-month period.

It seems I am in business! Here is the scenario:

I contribute the max to my pre-tax 401(k) = 19,500, this is deducted from my biweekly paycheck at 800 per paycheck (I do not frontload), so by the end of the year it reaches the cap and my paychecks get a bit of a bump.
Employer match = 10,500 (not sure of the actual number, but this is a nice round one).
I believe after-tax contributions can be up to 28k (due to 58k annual cap).

So I think the process works like this - I contribute post tax money (from paycheck or bonus) to a post-tax account. I convert immediately to a Roth (taxable event, no tax owed), then it's basically like a regular Roth Account.

Questions:
0) Section B1 states "At the time of the conversion, the amounts converted become taxable income to you.". However since the funds converted are post tax, I am not paying tax twice, correct?
1) Is there a way to set it up with separate pre and post tax accounts so the funds are not commingled? Seems like it should be automatic but you never know.
2) My 401(k) is held at Fidelity, does anyone know if there any cap on in-plan conversions per year? (i.e. can I contribute/convert paycheck by paycheck, or only convert X times per year)?
3) If I can contribute/convert on a per paycheck basis, is there a way to automate this (as I prefer for contributions to be converted to Roth immediately prior to investment/appreciation).
4) I also have a DCP to which I contribute the minimum to get the full match. Because this election decreases annual compensation for the 401(k) match, a true up match is added to the DCP. I believe this match does not count against the 58k cap. If it does, or if there is another scenario where "too much" is contributed (i.e. total contributions over the 58k cap), what happens?
5) It seems I have the option for both in-plan conversion and once-annual in service distribution, leaning toward the in-plan conversion if it can be set up with an automatic process. For anyone who has gone through it, what was your preference?
6) For clarification regarding withdrawals, the "5 year rule" seems to apply only if there are gains before conversion. For an in-plan conversion performed automatically, this would be trivial (few cents perhaps?). So my understanding is that the 5 year rule does not really apply to the contributions via an in-plan conversion unless there is a sizeable increase before conversion, correct? I don't plan on touching this at all until retirement, but wanted to clarify.
7) Anything else I should be thinking about?

Thanks Bogleheads!
User avatar
David Jay
Posts: 11681
Joined: Mon Mar 30, 2015 5:54 am
Location: Michigan

Re: Mega Backdoor Roth Mechanics Question

Post by David Jay »

anewboglehead wrote: Fri Aug 20, 2021 12:52 pmQuestions:
0) Section B1 states "At the time of the conversion, the amounts converted become taxable income to you.". However since the funds converted are post tax, I am not paying tax twice, correct?

Section B1 is referring to tax-deferred (i.e. "regular" 401k) in-plan conversions. You can convert tax-deferred money to Roth money but that is a taxable transaction because no taxes have ever been paid on the "regular" 401K money. This is NOT the After Tax contributions.

1) Is there a way to set it up with separate pre and post tax accounts so the funds are not commingled? Seems like it should be automatic but you never know.

Yes, Fidelity will create those accounts so no funds are comingled
I think you are confusing "After Tax" contributions (which you can roll out to a personal Roth once a year according to your SPD) with in-plan conversions.

The MBD process is simple, you make After Tax contributions into the after-tax account on a systematic basis. Once per year you can roll the money out into a personal Roth.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius
Longdog
Posts: 1606
Joined: Sun Feb 09, 2014 6:56 pm
Location: Philadelphia

Re: Mega Backdoor Roth Mechanics Question

Post by Longdog »

5) I would do the annual in-service withdrawal/rollover to a Roth IRA because you will then have a more control over which assets are held in Roth space versus pre-tax space, allowing for a more tax efficient portfolio. In other words, if you want, you can keep exclusively fixed income in your pre-tax 401k account and exclusively equities in your Roth account. I don’t think you can independently choose different investments in a Roth 401k sub-account from the pre-tax 401k account.
Steve
Topic Author
anewboglehead
Posts: 54
Joined: Tue Mar 10, 2020 1:03 pm

Re: Mega Backdoor Roth Mechanics Question

Post by anewboglehead »

David Jay wrote: Fri Aug 20, 2021 1:49 pm
anewboglehead wrote: Fri Aug 20, 2021 12:52 pmQuestions:
0) Section B1 states "At the time of the conversion, the amounts converted become taxable income to you.". However since the funds converted are post tax, I am not paying tax twice, correct?

Section B1 is referring to tax-deferred (i.e. "regular" 401k) in-plan conversions. You can convert tax-deferred money to Roth money but that is a taxable transaction because no taxes have ever been paid on the "regular" 401K money. This is NOT the After Tax contributions.

1) Is there a way to set it up with separate pre and post tax accounts so the funds are not commingled? Seems like it should be automatic but you never know.

Yes, Fidelity will create those accounts so no funds are comingled
I think you are confusing "After Tax" contributions (which you can roll out to a personal Roth once a year according to your SPD) with in-plan conversions.

The MBD process is simple, you make After Tax contributions into the after-tax account on a systematic basis. Once per year you can roll the money out into a personal Roth.
Thanks, David Jay. I think you are right, I am confused about the accounts/terminology. In the wiki, it seemed like the rollover is one option ("Roth IRA conversion"), and an (automatic) recurring conversion is another (Roth 401(k)).

In my mind, an analogy (in backdoor roth world) would be to an automatic recurring contribution to an IRA, then immediately converting to a Roth each time.

Perhaps the After-tax contribution cannot be converted to a Roth 401(k)? Is this where I am going wrong?

If I slowly accumulate in the After-tax account, my choices seem to only leave it in cash until I roll it over annually, or invest and deal with gains/losses each year before rolling it over, is the understanding correct?

(edited for clarity)
Last edited by anewboglehead on Fri Aug 20, 2021 7:50 pm, edited 2 times in total.
Topic Author
anewboglehead
Posts: 54
Joined: Tue Mar 10, 2020 1:03 pm

Re: Mega Backdoor Roth Mechanics Question

Post by anewboglehead »

Longdog wrote: Fri Aug 20, 2021 5:14 pm 5) I would do the annual in-service withdrawal/rollover to a Roth IRA because you will then have a more control over which assets are held in Roth space versus pre-tax space, allowing for a more tax efficient portfolio. In other words, if you want, you can keep exclusively fixed income in your pre-tax 401k account and exclusively equities in your Roth account. I don’t think you can independently choose different investments in a Roth 401k sub-account from the pre-tax 401k account.
Interesting point. I had assumed if they were separate accounts, that they would be managed separately. I'll check into this, thanks!
bradpevans
Posts: 747
Joined: Sun Apr 08, 2018 1:09 pm

Re: Mega Backdoor Roth Mechanics Question

Post by bradpevans »

anewboglehead wrote: Fri Aug 20, 2021 7:41 pm
Longdog wrote: Fri Aug 20, 2021 5:14 pm 5) I would do the annual in-service withdrawal/rollover to a Roth IRA because you will then have a more control over which assets are held in Roth space versus pre-tax space, allowing for a more tax efficient portfolio. In other words, if you want, you can keep exclusively fixed income in your pre-tax 401k account and exclusively equities in your Roth account. I don’t think you can independently choose different investments in a Roth 401k sub-account from the pre-tax 401k account.
Interesting point. I had assumed if they were separate accounts, that they would be managed separately. I'll check into this, thanks!
In mine [megacorp / fidelity) they allow you to “roll immediately” thus avoiding any growth with tax implications
But I roll mine to Roth IRA, then I can sell and buy whatever I want (not limited to 401k funds)
retiredjg
Posts: 45464
Joined: Thu Jan 10, 2008 12:56 pm

Re: Mega Backdoor Roth Mechanics Question

Post by retiredjg »

anewboglehead wrote: Fri Aug 20, 2021 12:52 pm 0) Section B1 states "At the time of the conversion, the amounts converted become taxable income to you.". However since the funds converted are post tax, I am not paying tax twice, correct?
Correct. But if any earnings occur before the conversion, that is taxable.
1) Is there a way to set it up with separate pre and post tax accounts so the funds are not commingled? Seems like it should be automatic but you never know.
Not inside your 401k.
2) My 401(k) is held at Fidelity, does anyone know if there any cap on in-plan conversions per year? (i.e. can I contribute/convert paycheck by paycheck, or only convert X times per year)?
This is up to your plan.
3) If I can contribute/convert on a per paycheck basis, is there a way to automate this (as I prefer for contributions to be converted to Roth immediately prior to investment/appreciation).
Up to your plan.
4) I also have a DCP to which I contribute the minimum to get the full match. Because this election decreases annual compensation for the 401(k) match, a true up match is added to the DCP. I believe this match does not count against the 58k cap. If it does, or if there is another scenario where "too much" is contributed (i.e. total contributions over the 58k cap), what happens?
If it does not go into the 401k, it is not counted.

Your 5 year rule question is too complex to answer as there are many variables. But if you are doing the in-plan Roth rollover, you don't need to worry about it.
User avatar
anon_investor
Posts: 8412
Joined: Mon Jun 03, 2019 1:43 pm

Re: Mega Backdoor Roth Mechanics Question

Post by anon_investor »

bradpevans wrote: Fri Aug 20, 2021 7:51 pm
anewboglehead wrote: Fri Aug 20, 2021 7:41 pm
Longdog wrote: Fri Aug 20, 2021 5:14 pm 5) I would do the annual in-service withdrawal/rollover to a Roth IRA because you will then have a more control over which assets are held in Roth space versus pre-tax space, allowing for a more tax efficient portfolio. In other words, if you want, you can keep exclusively fixed income in your pre-tax 401k account and exclusively equities in your Roth account. I don’t think you can independently choose different investments in a Roth 401k sub-account from the pre-tax 401k account.
Interesting point. I had assumed if they were separate accounts, that they would be managed separately. I'll check into this, thanks!
In mine [megacorp / fidelity) they allow you to “roll immediately” thus avoiding any growth with tax implications
But I roll mine to Roth IRA, then I can sell and buy whatever I want (not limited to 401k funds)
Is your 401k plan that bad? I just do the in-plan conversion for my mega backdoor, the funds are excellent.
diy60
Posts: 611
Joined: Wed Sep 07, 2016 6:54 pm

Re: Mega Backdoor Roth Mechanics Question

Post by diy60 »

anon_investor wrote: Fri Aug 20, 2021 8:08 pmIs your 401k plan that bad? I just do the in-plan conversion for my mega backdoor, the funds are excellent.
There could be other good reasons to transfer out Roth 401K funds. e.g. The selection of funds in my MegaCorp 401K are excellent. However, the funds I choose are pro-rated across all of the sub-accounts within my 401K plan. So if I have an asset allocation of say 50/50, then that's what I have across all of the accounts, including the Roth 401K account. I'm guessing a lot of 401K plans are like that. Hence, whenever I did the IRR I would also follow that up with a direct rollover to my Roth IRA where I could redeploy as 100% equities and adjust the pre-tax 401K accordingly.
User avatar
anon_investor
Posts: 8412
Joined: Mon Jun 03, 2019 1:43 pm

Re: Mega Backdoor Roth Mechanics Question

Post by anon_investor »

diy60 wrote: Fri Aug 20, 2021 10:22 pm
anon_investor wrote: Fri Aug 20, 2021 8:08 pmIs your 401k plan that bad? I just do the in-plan conversion for my mega backdoor, the funds are excellent.
There could be other good reasons to transfer out Roth 401K funds. e.g. The selection of funds in my MegaCorp 401K are excellent. However, the funds I choose are pro-rated across all of the sub-accounts within my 401K plan. So if I have an asset allocation of say 50/50, then that's what I have across all of the accounts, including the Roth 401K account. I'm guessing a lot of 401K plans are like that. Hence, whenever I did the IRR I would also follow that up with a direct rollover to my Roth IRA where I could redeploy as 100% equities and adjust the pre-tax 401K accordingly.
Okay, that makes sense. I am still 100% equities outside of my emergency fund.
invest4
Posts: 555
Joined: Wed Apr 24, 2019 2:19 am

Re: Mega Backdoor Roth Mechanics Question

Post by invest4 »

You have already received some good input.

However, I strongly encourage you to call your plan provider to ensure everything is aligned and minimize the potential for unexpected surprises...there really is no substitute. There may also be small nuances which may not matter in most cases or can be solved if there is a mistake, but you want to be aware of or avoid.

* I once accidentally invested my after-tax contribution in my plan brokerage account before I made the conversion. I was eventually able to undo this, but it took quite some time (months) and was a bit painful as I discovered the employees at the plan provider struggled to figure out how to do so.

* You may need to be clear that you want 100% of after tax only in the conversion (I must fill out a form and I write it in there) to avoid an accidental conversion of other monies.

* You may also discover you actually know a bit more about conversions than those who are supporting you. My own experience was the typical support person was not familiar with this process and any questions required an escalation to someone who handled more complex topics.

Of course, I acknowledge your experience may be better or worse depending on the knowledge of your plan provider or if it is an automated process vs a manual one.

Best wishes.
bradpevans
Posts: 747
Joined: Sun Apr 08, 2018 1:09 pm

Re: Mega Backdoor Roth Mechanics Question

Post by bradpevans »

anon_investor wrote: Fri Aug 20, 2021 8:08 pm
bradpevans wrote: Fri Aug 20, 2021 7:51 pm
anewboglehead wrote: Fri Aug 20, 2021 7:41 pm
Longdog wrote: Fri Aug 20, 2021 5:14 pm 5) I would do the annual in-service withdrawal/rollover to a Roth IRA because you will then have a more control over which assets are held in Roth space versus pre-tax space, allowing for a more tax efficient portfolio. In other words, if you want, you can keep exclusively fixed income in your pre-tax 401k account and exclusively equities in your Roth account. I don’t think you can independently choose different investments in a Roth 401k sub-account from the pre-tax 401k account.
Interesting point. I had assumed if they were separate accounts, that they would be managed separately. I'll check into this, thanks!
In mine [megacorp / fidelity) they allow you to “roll immediately” thus avoiding any growth with tax implications
But I roll mine to Roth IRA, then I can sell and buy whatever I want (not limited to 401k funds)
Is your 401k plan that bad? I just do the in-plan conversion for my mega backdoor, the funds are excellent.
My plan is pretty good - but was referring to the “same holdings in Roth as in tax deferred”
The IRA options is a way around that
User avatar
anon_investor
Posts: 8412
Joined: Mon Jun 03, 2019 1:43 pm

Re: Mega Backdoor Roth Mechanics Question

Post by anon_investor »

bradpevans wrote: Sat Aug 21, 2021 3:46 pm
anon_investor wrote: Fri Aug 20, 2021 8:08 pm
bradpevans wrote: Fri Aug 20, 2021 7:51 pm
anewboglehead wrote: Fri Aug 20, 2021 7:41 pm
Longdog wrote: Fri Aug 20, 2021 5:14 pm 5) I would do the annual in-service withdrawal/rollover to a Roth IRA because you will then have a more control over which assets are held in Roth space versus pre-tax space, allowing for a more tax efficient portfolio. In other words, if you want, you can keep exclusively fixed income in your pre-tax 401k account and exclusively equities in your Roth account. I don’t think you can independently choose different investments in a Roth 401k sub-account from the pre-tax 401k account.
Interesting point. I had assumed if they were separate accounts, that they would be managed separately. I'll check into this, thanks!
In mine [megacorp / fidelity) they allow you to “roll immediately” thus avoiding any growth with tax implications
But I roll mine to Roth IRA, then I can sell and buy whatever I want (not limited to 401k funds)
Is your 401k plan that bad? I just do the in-plan conversion for my mega backdoor, the funds are excellent.
My plan is pretty good - but was referring to the “same holdings in Roth as in tax deferred”
The IRA options is a way around that
I understand that, not an issue for me now since I am 100% equities. My plan has the same issue for AA. In the future I can rollover my existing Roth converted after-tax funds to my IRA and start doing what you currently do, though that is more work than converting after-tax funds to Roth in-plan every pay day (all online and takes a minute).
Topic Author
anewboglehead
Posts: 54
Joined: Tue Mar 10, 2020 1:03 pm

Re: Mega Backdoor Roth Mechanics Question

Post by anewboglehead »

retiredjg wrote: Fri Aug 20, 2021 8:03 pm
anewboglehead wrote: Fri Aug 20, 2021 12:52 pm 0) Section B1 states "At the time of the conversion, the amounts converted become taxable income to you.". However since the funds converted are post tax, I am not paying tax twice, correct?
Correct. But if any earnings occur before the conversion, that is taxable.
1) Is there a way to set it up with separate pre and post tax accounts so the funds are not commingled? Seems like it should be automatic but you never know.
Not inside your 401k.
2) My 401(k) is held at Fidelity, does anyone know if there any cap on in-plan conversions per year? (i.e. can I contribute/convert paycheck by paycheck, or only convert X times per year)?
This is up to your plan.
3) If I can contribute/convert on a per paycheck basis, is there a way to automate this (as I prefer for contributions to be converted to Roth immediately prior to investment/appreciation).
Up to your plan.
4) I also have a DCP to which I contribute the minimum to get the full match. Because this election decreases annual compensation for the 401(k) match, a true up match is added to the DCP. I believe this match does not count against the 58k cap. If it does, or if there is another scenario where "too much" is contributed (i.e. total contributions over the 58k cap), what happens?
If it does not go into the 401k, it is not counted.

Your 5 year rule question is too complex to answer as there are many variables. But if you are doing the in-plan Roth rollover, you don't need to worry about it.
Thanks for your input, retiredjg. You were a big help in setting up my backdoor roth as well, I really appreciate it!
Topic Author
anewboglehead
Posts: 54
Joined: Tue Mar 10, 2020 1:03 pm

Re: Mega Backdoor Roth Mechanics Question

Post by anewboglehead »

invest4 wrote: Sat Aug 21, 2021 11:50 am You have already received some good input.

However, I strongly encourage you to call your plan provider to ensure everything is aligned and minimize the potential for unexpected surprises...there really is no substitute. There may also be small nuances which may not matter in most cases or can be solved if there is a mistake, but you want to be aware of or avoid.

* I once accidentally invested my after-tax contribution in my plan brokerage account before I made the conversion. I was eventually able to undo this, but it took quite some time (months) and was a bit painful as I discovered the employees at the plan provider struggled to figure out how to do so.

* You may need to be clear that you want 100% of after tax only in the conversion (I must fill out a form and I write it in there) to avoid an accidental conversion of other monies.

* You may also discover you actually know a bit more about conversions than those who are supporting you. My own experience was the typical support person was not familiar with this process and any questions required an escalation to someone who handled more complex topics.

Of course, I acknowledge your experience may be better or worse depending on the knowledge of your plan provider or if it is an automated process vs a manual one.

Best wishes.
Great advice. My goal with this post was to familiarize myself with the ins-and-outs and options available to me before contacting megacorp HR/fidelity to set it up. I agree that I will probably be better prepared than the person helping me - a great point as this was also the case when I had to do a few rollovers to set up my backdoor roth.

I really appreciate all of your pointers, as well as input from BradPevans, diy60, and anon_investor. Gives me a bit more to look into and think about when setting this up, especially the fixed AA across sub accounts (I am not 100% equities :D ).

I think I am now leaning toward an in service distribution to rollover into a Roth IRA on an annual basis. I think I have two options here:
1) deduct a portion from each paycheck, putting it into an after tax account (which can be invested). Once a year, take the in service distribution and rollover to Roth IRA, paying taxes on possible gains.
2) deduct entire annual contribution from annual bonus, immediately take in service distribution and rollover to Roth IRA. No gains, so no additional taxes.

One issue I'm still trying to wrap my head around is how close I can reasonably get to the 58k mark, and what happens if I go over.

For example, what if I contribute 28k to after tax now (and immediately take in service distribution, and rollover to Roth IRA). By the end of the year, I also will have contributed 19.5k to my pre-tax. What if the employer match comes out to more than 10.5k? It seems they cannot claw back the money that was rolled over, so would some of the match be forfeited or would some of the pretax amount not be added and then be taxed and distributed to me as regular pay?

I've tried pre-calculating the employer match but there are too many variables to get an accurate number, and the variables don't become known until fairly late in the year.
SnowBog
Posts: 1839
Joined: Fri Dec 21, 2018 11:21 pm

Re: Mega Backdoor Roth Mechanics Question

Post by SnowBog »

invest4 wrote: Sat Aug 21, 2021 11:50 am You have already received some good input.

However, I strongly encourage you to call your plan provider to ensure everything is aligned and minimize the potential for unexpected surprises...there really is no substitute. There may also be small nuances which may not matter in most cases or can be solved if there is a mistake, but you want to be aware of or avoid.
+1 on this... From what I've seen there can be - and often is - massive difference between plans. And this has nothing to do with the administrator - for example 3 plans all with Fidelity might have 3 different set of rules.

Does your account on Fidelity give you a link to NetBenefits? If so, make sure to check out that side of Fidelity (I think most of the 401k stuff is managed by the NetBenefits side). You might even find a dedicated phone number to call specific to your plan (I know there is one specific to my company), so that you can talk to someone familiar with your plan.

Regarding a few of your more recent questions/thoughts:
anewboglehead wrote: Sat Aug 21, 2021 11:10 pm I think I am now leaning toward an in service distribution to rollover into a Roth IRA on an annual basis. I think I have two options here:
1) deduct a portion from each paycheck, putting it into an after tax account (which can be invested). Once a year, take the in service distribution and rollover to Roth IRA, paying taxes on possible gains.
2) deduct entire annual contribution from annual bonus, immediately take in service distribution and rollover to Roth IRA. No gains, so no additional taxes.
First thing I'd recommend is checking if your plan has an "automatic in-plan conversion" - and if so the frequency. If it does, the next question is does that limit your ability to do a roll-over to a Roth IRA. Assuming it doesn't, that might be your best option as it a) automatically converts from after-tax to Roth - ideally "immediately" - so you minimize taxes b) still lets you extract the now Roth funds and put them elsewhere if you want the extra control/segmentation.

If you don't have an "automated" option - validate it can be done manually - and if so any limits (I think you mentioned only 1 "rollover" per 12 months. If doing the "in-plan" conversion doesn't create conflicts - that's likely your best option - at least initially... It can usually be done very quickly - with little/no overhead. And then you can decide if/when to do the "rollover" to Roth IRA.

But if it creates conflicts - you may be forced to get creative...

But as each plan varies - you'll need to get into the specifics of your plan...

But some other "food for thought" - before my plan did automatic "daily" in-plan conversions - I used to direct "after-tax" to a short-term bond fund. My thinking is this was a fairly "safe" way of holding the money, not having meaningful gains - and thus keeping taxes low.

But the reality is - I was letting the "tax tail" wag the dog... If I had invested it into something like a S&P 500 fund - and that plan had gains when it was ultimately converted - that's not necessarily a "bad" thing... Sure I pay taxes - but only because I made money! I still end up with more than I started with! And assuming the conversion is periodic enough - the gains should be small... (You just don't want to let funds grow for months/years before converting - that defeats the purpose of the "Mega Backdoor Roth...)
anewboglehead wrote: Sat Aug 21, 2021 11:10 pm One issue I'm still trying to wrap my head around is how close I can reasonably get to the 58k mark, and what happens if I go over.

For example, what if I contribute 28k to after tax now (and immediately take in service distribution, and rollover to Roth IRA). By the end of the year, I also will have contributed 19.5k to my pre-tax. What if the employer match comes out to more than 10.5k? It seems they cannot claw back the money that was rolled over, so would some of the match be forfeited or would some of the pretax amount not be added and then be taxed and distributed to me as regular pay?

I've tried pre-calculating the employer match but there are too many variables to get an accurate number, and the variables don't become known until fairly late in the year.
This one I wouldn't worry about... I'd be shocked if your plan administrator doesn't take care of this... My working assumption is the limit is pre-established - meaning you can only contribute $19.5k pre-tax/Roth, and your employer can make a max contribution of $10.5k. Whatever is left is the only space available for after-tax. I don't think if you make a lower pre-tax/Roth contribution - that let's you make a higher after-tax contribution (at least it doesn't seem to in my plan).

But again, would be good to discuss/confirm with your plan administrator...

One thing you may need to watch out for is if not enough people utilize the Mega Backdoor Roth. My understanding is there are restrictions on companies - to ensure this doesn't end-up as some limited perk for executives that effectively isn't available (as judged by not being used) by other employees in the organization. This doesn't apply to me - but I've heard of people ending up having their money basically reset/refunded - because their plan failed to meet the required threshold in a given year...

Lastly, food for thought - especially if your company match does not need to be spread through out the year (they'll either match as invested, or give you some form of "gross up"). Personally, I front-load my pre-tax (and thus match). My thinking is by doing so - I'm supercharging my investments ASAP in the year - including the "free" employer match which I secure earlier in the year - should something happen to my employment. Doing so also lowers taxes initially (expect social security & medicare), meaning I can put in a higher contribution % and maintain similar "net" pay (due to lower taxes). When pre-tax is maxed, I'll switch to after-tax - usually at a lower initial contribution % (I try to maintain similar net pay - which will now have more taxes removed). But eventually, social security gets maxed out - and so I can increase after-tax contributions by that amount (and maintain net pay). This has a secondary benefit of limiting the number of "conversions" and/or "roll-over" events to a smaller time period. This has worked well for me these past few years...
invest4
Posts: 555
Joined: Wed Apr 24, 2019 2:19 am

Re: Mega Backdoor Roth Mechanics Question

Post by invest4 »

anewboglehead wrote: Sat Aug 21, 2021 11:10 pm One issue I'm still trying to wrap my head around is how close I can reasonably get to the 58k mark, and what happens if I go over.

For example, what if I contribute 28k to after tax now (and immediately take in service distribution, and rollover to Roth IRA). By the end of the year, I also will have contributed 19.5k to my pre-tax. What if the employer match comes out to more than 10.5k? It seems they cannot claw back the money that was rolled over, so would some of the match be forfeited or would some of the pretax amount not be added and then be taxed and distributed to me as regular pay?

I've tried pre-calculating the employer match but there are too many variables to get an accurate number, and the variables don't become known until fairly late in the year.
I have also been working to max out contributions during the last few years. As I understand it, any excess contributions will simply be returned to you. However, I have zero interest in finding out or dealing with any additional tax paperwork and thus try not to get too cute to ensure I don't go over. It's unclear to me how your plan works and what information is available to you to help with your planning. You may feel some uncertainty during the first year, but hopefully much smoother in subsequent ones.

In my case:

* I can only contribute a max of 15% each pay check toward after-tax. I can modify this % during the year, but it may take a pay period to see the change. I have decided I will choose a set percentage and leave it. I won't completely max for the year, but I will come pretty darn close, and that is good enough.

* I can see how all contributions are flowing from both myself and employer for each pay period, both current and past years. My employer contributions are fairly consistent from year to year and thus relatively easy to project. Of course, if I have a significant change in compensation, I will need to assess and adjust. Otherwise, I occasionally check my online statements during the year to make sure everything remains as expected.

No fuss, no muss...and that's the way I like it. :sharebeer

Note: The 1099-R may be a new experience for you when filing taxes. It is important that these monies are clearly showing as ROLLOVER on your tax return and the taxable amount (if any) is what you are expecting. Assuming you utilize tax software, it shouldn't be too much of an issue. However, as the saying goes..."trust, but verify".
Topic Author
anewboglehead
Posts: 54
Joined: Tue Mar 10, 2020 1:03 pm

Re: Mega Backdoor Roth Mechanics Question

Post by anewboglehead »

SnowBog wrote: Sat Aug 21, 2021 11:56 pm
invest4 wrote: Sat Aug 21, 2021 11:50 am You have already received some good input.

However, I strongly encourage you to call your plan provider to ensure everything is aligned and minimize the potential for unexpected surprises...there really is no substitute. There may also be small nuances which may not matter in most cases or can be solved if there is a mistake, but you want to be aware of or avoid.
+1 on this... From what I've seen there can be - and often is - massive difference between plans. And this has nothing to do with the administrator - for example 3 plans all with Fidelity might have 3 different set of rules.

Does your account on Fidelity give you a link to NetBenefits? If so, make sure to check out that side of Fidelity (I think most of the 401k stuff is managed by the NetBenefits side). You might even find a dedicated phone number to call specific to your plan (I know there is one specific to my company), so that you can talk to someone familiar with your plan.

Regarding a few of your more recent questions/thoughts:
anewboglehead wrote: Sat Aug 21, 2021 11:10 pm I think I am now leaning toward an in service distribution to rollover into a Roth IRA on an annual basis. I think I have two options here:
1) deduct a portion from each paycheck, putting it into an after tax account (which can be invested). Once a year, take the in service distribution and rollover to Roth IRA, paying taxes on possible gains.
2) deduct entire annual contribution from annual bonus, immediately take in service distribution and rollover to Roth IRA. No gains, so no additional taxes.
First thing I'd recommend is checking if your plan has an "automatic in-plan conversion" - and if so the frequency. If it does, the next question is does that limit your ability to do a roll-over to a Roth IRA. Assuming it doesn't, that might be your best option as it a) automatically converts from after-tax to Roth - ideally "immediately" - so you minimize taxes b) still lets you extract the now Roth funds and put them elsewhere if you want the extra control/segmentation.

If you don't have an "automated" option - validate it can be done manually - and if so any limits (I think you mentioned only 1 "rollover" per 12 months. If doing the "in-plan" conversion doesn't create conflicts - that's likely your best option - at least initially... It can usually be done very quickly - with little/no overhead. And then you can decide if/when to do the "rollover" to Roth IRA.

But if it creates conflicts - you may be forced to get creative...

But as each plan varies - you'll need to get into the specifics of your plan...

But some other "food for thought" - before my plan did automatic "daily" in-plan conversions - I used to direct "after-tax" to a short-term bond fund. My thinking is this was a fairly "safe" way of holding the money, not having meaningful gains - and thus keeping taxes low.

But the reality is - I was letting the "tax tail" wag the dog... If I had invested it into something like a S&P 500 fund - and that plan had gains when it was ultimately converted - that's not necessarily a "bad" thing... Sure I pay taxes - but only because I made money! I still end up with more than I started with! And assuming the conversion is periodic enough - the gains should be small... (You just don't want to let funds grow for months/years before converting - that defeats the purpose of the "Mega Backdoor Roth...)
anewboglehead wrote: Sat Aug 21, 2021 11:10 pm One issue I'm still trying to wrap my head around is how close I can reasonably get to the 58k mark, and what happens if I go over.

For example, what if I contribute 28k to after tax now (and immediately take in service distribution, and rollover to Roth IRA). By the end of the year, I also will have contributed 19.5k to my pre-tax. What if the employer match comes out to more than 10.5k? It seems they cannot claw back the money that was rolled over, so would some of the match be forfeited or would some of the pretax amount not be added and then be taxed and distributed to me as regular pay?

I've tried pre-calculating the employer match but there are too many variables to get an accurate number, and the variables don't become known until fairly late in the year.
This one I wouldn't worry about... I'd be shocked if your plan administrator doesn't take care of this... My working assumption is the limit is pre-established - meaning you can only contribute $19.5k pre-tax/Roth, and your employer can make a max contribution of $10.5k. Whatever is left is the only space available for after-tax. I don't think if you make a lower pre-tax/Roth contribution - that let's you make a higher after-tax contribution (at least it doesn't seem to in my plan).

But again, would be good to discuss/confirm with your plan administrator...

One thing you may need to watch out for is if not enough people utilize the Mega Backdoor Roth. My understanding is there are restrictions on companies - to ensure this doesn't end-up as some limited perk for executives that effectively isn't available (as judged by not being used) by other employees in the organization. This doesn't apply to me - but I've heard of people ending up having their money basically reset/refunded - because their plan failed to meet the required threshold in a given year...

Lastly, food for thought - especially if your company match does not need to be spread through out the year (they'll either match as invested, or give you some form of "gross up"). Personally, I front-load my pre-tax (and thus match). My thinking is by doing so - I'm supercharging my investments ASAP in the year - including the "free" employer match which I secure earlier in the year - should something happen to my employment. Doing so also lowers taxes initially (expect social security & medicare), meaning I can put in a higher contribution % and maintain similar "net" pay (due to lower taxes). When pre-tax is maxed, I'll switch to after-tax - usually at a lower initial contribution % (I try to maintain similar net pay - which will now have more taxes removed). But eventually, social security gets maxed out - and so I can increase after-tax contributions by that amount (and maintain net pay). This has a secondary benefit of limiting the number of "conversions" and/or "roll-over" events to a smaller time period. This has worked well for me these past few years...
Hi SnowBog,

Thanks for this detailed outline of thoughts. It is super helpful to have the verbiage and also a good mental map of the possible options and routes I can take with this depending on what my plan provides.

For the overfunding, I'm sure they would figure it out in the end, I'm just concerned about *how* it would be reconciled. They can't claw back Roth (esp if I rollover), so it would probably come from pre-tax (which would be a shame, since we are in the highest bracket and deferring taxes on this income is beneficial) or the match (can/would they match less?) I'll ask the plan provider and report back. The tricky part for me is that the match is up to X percent of eligible compensation, which is basically salary plus bonus. Bonuses and pay increases are annual near the end of the year, so it's possible the numbers change quite a bit with very little time left in the year to react / most things are already contributed.

I have been considering front loading, but seems pretty complicated to manage the cash flow and changing the contribution amounts / locations throughout the year. It also doesn't seem like it would solve the potential overfunding issue. Perhaps I am just being lazy...

In any case, you have given me plenty to think about, and I also appreciate how you laid out the verbiage. Helps a ton for a newbie like me!

Thanks, and I will report back after I call my plan provider.
Topic Author
anewboglehead
Posts: 54
Joined: Tue Mar 10, 2020 1:03 pm

Re: Mega Backdoor Roth Mechanics Question

Post by anewboglehead »

invest4 wrote: Sun Aug 22, 2021 5:54 am
anewboglehead wrote: Sat Aug 21, 2021 11:10 pm One issue I'm still trying to wrap my head around is how close I can reasonably get to the 58k mark, and what happens if I go over.

For example, what if I contribute 28k to after tax now (and immediately take in service distribution, and rollover to Roth IRA). By the end of the year, I also will have contributed 19.5k to my pre-tax. What if the employer match comes out to more than 10.5k? It seems they cannot claw back the money that was rolled over, so would some of the match be forfeited or would some of the pretax amount not be added and then be taxed and distributed to me as regular pay?

I've tried pre-calculating the employer match but there are too many variables to get an accurate number, and the variables don't become known until fairly late in the year.
I have also been working to max out contributions during the last few years. As I understand it, any excess contributions will simply be returned to you. However, I have zero interest in finding out or dealing with any additional tax paperwork and thus try not to get too cute to ensure I don't go over. It's unclear to me how your plan works and what information is available to you to help with your planning. You may feel some uncertainty during the first year, but hopefully much smoother in subsequent ones.

In my case:

* I can only contribute a max of 15% each pay check toward after-tax. I can modify this % during the year, but it may take a pay period to see the change. I have decided I will choose a set percentage and leave it. I won't completely max for the year, but I will come pretty darn close, and that is good enough.

* I can see how all contributions are flowing from both myself and employer for each pay period, both current and past years. My employer contributions are fairly consistent from year to year and thus relatively easy to project. Of course, if I have a significant change in compensation, I will need to assess and adjust. Otherwise, I occasionally check my online statements during the year to make sure everything remains as expected.

No fuss, no muss...and that's the way I like it. :sharebeer

Note: The 1099-R may be a new experience for you when filing taxes. It is important that these monies are clearly showing as ROLLOVER on your tax return and the taxable amount (if any) is what you are expecting. Assuming you utilize tax software, it shouldn't be too much of an issue. However, as the saying goes..."trust, but verify".
Amen to the zero interest in finding out what happens if the case of overcontributions and the potential tax/paperwork headache that may come with. I think I am going to likely underfund by a bit just in case. I have the fortunate problem that compensation has been increasing quickly the past few years, so projections are difficult.

Appreciate all your input on this thread, and will definitely let you know how it goes!
dboeger1
Posts: 738
Joined: Fri Jan 13, 2017 7:32 pm

Re: Mega Backdoor Roth Mechanics Question

Post by dboeger1 »

I also do automatic in-plan Roth conversions with Fidelity NetBenefits. It's a beautiful thing. I think my plan required me to call their phone number to set it up. The web site allowed me to contribute a percentage to after-tax, but there was no option there for the automatic conversions, so I called and the guy I spoke to was quite knowledgeable about it and set it up very easily. It's truly an amazing benefit. I don't mess with annual IRA distributions, but then again I'm satisfied with the fund choices in my 401k.
bradpevans
Posts: 747
Joined: Sun Apr 08, 2018 1:09 pm

Re: Mega Backdoor Roth Mechanics Question

Post by bradpevans »

anewboglehead wrote: Sat Aug 21, 2021 11:10 pm
invest4 wrote: Sat Aug 21, 2021 11:50 am You have already received some good input.

However, I strongly encourage you to call your plan provider to ensure everything is aligned and minimize the potential for unexpected surprises...there really is no substitute. There may also be small nuances which may not matter in most cases or can be solved if there is a mistake, but you want to be aware of or avoid.

* I once accidentally invested my after-tax contribution in my plan brokerage account before I made the conversion. I was eventually able to undo this, but it took quite some time (months) and was a bit painful as I discovered the employees at the plan provider struggled to figure out how to do so.

* You may need to be clear that you want 100% of after tax only in the conversion (I must fill out a form and I write it in there) to avoid an accidental conversion of other monies.

* You may also discover you actually know a bit more about conversions than those who are supporting you. My own experience was the typical support person was not familiar with this process and any questions required an escalation to someone who handled more complex topics.

Of course, I acknowledge your experience may be better or worse depending on the knowledge of your plan provider or if it is an automated process vs a manual one.

Best wishes.
Great advice. My goal with this post was to familiarize myself with the ins-and-outs and options available to me before contacting megacorp HR/fidelity to set it up. I agree that I will probably be better prepared than the person helping me - a great point as this was also the case when I had to do a few rollovers to set up my backdoor roth.

I really appreciate all of your pointers, as well as input from BradPevans, diy60, and anon_investor. Gives me a bit more to look into and think about when setting this up, especially the fixed AA across sub accounts (I am not 100% equities :D ).

I think I am now leaning toward an in service distribution to rollover into a Roth IRA on an annual basis. I think I have two options here:
1) deduct a portion from each paycheck, putting it into an after tax account (which can be invested). Once a year, take the in service distribution and rollover to Roth IRA, paying taxes on possible gains.
2) deduct entire annual contribution from annual bonus, immediately take in service distribution and rollover to Roth IRA. No gains, so no additional taxes.

One issue I'm still trying to wrap my head around is how close I can reasonably get to the 58k mark, and what happens if I go over.

For example, what if I contribute 28k to after tax now (and immediately take in service distribution, and rollover to Roth IRA). By the end of the year, I also will have contributed 19.5k to my pre-tax. What if the employer match comes out to more than 10.5k? It seems they cannot claw back the money that was rolled over, so would some of the match be forfeited or would some of the pretax amount not be added and then be taxed and distributed to me as regular pay?

I've tried pre-calculating the employer match but there are too many variables to get an accurate number, and the variables don't become known until fairly late in the year.
In reference to the bold text above, my plan 'spills over' into a supplemental savings plan. While no expert, i think this plan is essentially deferred salary but does not enjoy the same backing and protections of work place retirement plans.

I *think* the idea is: employees that can easily save more than yearly limits can defer comp till later (presumably collecting when in lower tax brackets than the year they deferred)
markcoop
Posts: 1303
Joined: Fri Mar 02, 2007 8:36 am

Re: Mega Backdoor Roth Mechanics Question

Post by markcoop »

I am new to after-contributions this year. One point I am surprised about above is the co-mingling of funds in some plans. We use Fidelity like others here. I am pretty sure I can invest my Roth 401K separately, ie., only in stocks if I choose, and then when I retire roll over just the Roth part of my 401K to a Roth IRA. I do note that in order to be able to do that, the employer needs to keep track of sources of income. When I log onto my 401K account, that is exactly what I see. There is a view that shows the current value by the source of each type of contribution. They show before-tax, Roth, after-tax. In addition, they show other sources like employer contributions and things like using match-maximizer (an option to make sure you always get the max employer match) that I find interesting but have no idea why I really care. I would've thought every plan at least breaks it down to Roth money, tax-deferred money and after-tax money as all have separate tax treatments. I don't understand how you can know how much will be taxed at withdrawal time without knowing this information.

One other thing to mention. As this after-tax stuff is relatively new, I would double check everything. We have an option to do automatic after-tax daily conversions. I checked the box online to do that. First pay period, it did not happen. I called and was told sometimes, depending upon when I checked that box, it takes an extra pay period. Next pay period, it did not happen. I called and they did something on their end and said it was fixed. Next pay period, it did not happen for a third time. They finally got it right for the fourth pay period. The first 3 times they manually did the conversion when I called.
Mark
SnowBog
Posts: 1839
Joined: Fri Dec 21, 2018 11:21 pm

Re: Mega Backdoor Roth Mechanics Question

Post by SnowBog »

anewboglehead wrote: Tue Aug 24, 2021 12:40 am Hi SnowBog,

Thanks for this detailed outline of thoughts. It is super helpful to have the verbiage and also a good mental map of the possible options and routes I can take with this depending on what my plan provides.

For the overfunding, I'm sure they would figure it out in the end, I'm just concerned about *how* it would be reconciled. They can't claw back Roth (esp if I rollover), so it would probably come from pre-tax (which would be a shame, since we are in the highest bracket and deferring taxes on this income is beneficial) or the match (can/would they match less?) I'll ask the plan provider and report back. The tricky part for me is that the match is up to X percent of eligible compensation, which is basically salary plus bonus. Bonuses and pay increases are annual near the end of the year, so it's possible the numbers change quite a bit with very little time left in the year to react / most things are already contributed.

I have been considering front loading, but seems pretty complicated to manage the cash flow and changing the contribution amounts / locations throughout the year. It also doesn't seem like it would solve the potential overfunding issue. Perhaps I am just being lazy...

In any case, you have given me plenty to think about, and I also appreciate how you laid out the verbiage. Helps a ton for a newbie like me!

Thanks, and I will report back after I call my plan provider.
On the "overfunding" concern - again, I'd ask your plan administrator...

In my plan - at least in how I understand it - the "space available" is limited to the overall 401k limits minus the pre-tax/Roth limits ($19.5k) minus the company match on that amount. If I make $0 pre-tax contribution (and thus no match), I don't get to do "more" after-tax... So its very easy for the plan administrator to "cap" each source and ensure none are overfunded - regardless of which is funded first/second/etc.

But ultimately it comes down to how your plan works.

Regarding the "complexities" of front-loading... I will admit, I did a ton of modeling when I first set mine up - so there are complexities. And its probably a "your mileage may vary" based on your income/taxes/pay frequency (including things like bonuses), etc.

But where I landed ended up being fairly simple (again not simple to figure out, but simple to execute) for me.

Basically the first part of the year I get $X net pay, but I have a higher pre-tax allocation. (Remember, the more going to pre-tax - the less paid in taxes - so adding an extra $100 to pre-tax will see your net pay decrease by less than $100.)

Depending on any variable pay (and its timing), my target is to have maxed pre-tax around the time that my social security contributions are maxed out or 6 months - whichever comes first. Usually (due to my pay timing), its the social security limit, so when I switch from pre-tax to after-tax, the higher taxes are partially offset by not having to pay social security taxes. I also adjust my contribution % (lower) - so the combined net result is effectively a reasonably consistent $X net pay.

If/once after-tax ends up maxed - then I just have a > $X net pay. That's a problem I can "live with"...

So basically what I do is by Jan 1 - set my pre-tax to Y% and after-tax to 0%, and then once pre-tax is maxed (whenever that happens) I switch to 0% pre-tax and Z% after-tax. If/when after-tax is maxed, I set it back for the next year (for sure by 1/1) as my plan won't allow me to over contribute, so I don't need to wait until 1/1 to change it for the following year.

Now - I do add one extra "complexity" to this... As I have variable pay (bonuses/etc.) that may come in throughout the year, assuming I don't need the cash and would like to see the money invested - I will increase my contribution %'s in advance. Let's say I have a $20k bonus payment that I don't "need" in my bank account, I'll increase my contribution % in advance to put most of that $20k [in addition to my normal contribution] into my 401k. If I'm "behind" on my pre-tax plan, I'll do most/all of it there. But if I'm on-track or ahead, I might do some into both or do everything into after-tax.

Admittedly, this overhead is more than most people probably want to deal with... If I didn't have as much variable pay, I probably wouldn't be doing this. And candidly, I didn't do this until 3+ years ago when I realized a) what a Mega Backdoor Roth was b) that I had access to one for years and didn't know. So this isn't some magical thing... But by getting more money into tax-advantaged accounts sooner, in theory you should get a small bump (same idea is "lump sum" is better than "dollar cost averaging" - the sooner you can get money working for you the better).
RebeccaVA
Posts: 1
Joined: Wed Aug 25, 2021 7:42 pm

Re: Mega Backdoor Roth Mechanics Question

Post by RebeccaVA »

I am 401k plan administrator for a small company (28 participants), and can share how our plan works. We do not have an employer match, but a profit-sharing contribution; the amount is determined in late December. I would never allow an employee to contribute more than the limit ($58K in 2021), because it would cause plan compliance tests to fail and a bunch of rigmarole to correct the excess. The employee would get a distribution of deferrals to bring them back to $58K. If we had a match, it might cause partial forfeiture of their match; see https://www.irs.gov/retirement-plans/fi ... articipant

You want to avoid contributing too much to the after-tax subaccount because your plan administrator will probably cut off your match to keep you at $58K. You don't want to save too much of your paycheck, only to have the company cut back their contribution! We have a very generous company, and would bonus out the surplus in January if the profit-sharing comes in higher than expected - but you can't depend on that.

Because we are small, I offer a "concierge" service for participants who want to reach the $58K limit. I estimate the maximum profit-sharing contribution for each, and advise them how much after-tax can be safely contributed. In late December when profit-sharing is fixed, I adjust the after-tax contribution from their final paycheck, to bring them up to $58K. I then roll out / convert the after-tax subaccounts to each participant's Roth IRA.

These procedures, unfortunately, are not spelled out in the participants' SPD (Summary Plan Description), or not even fully described in the plan documents. They are part of the plan's "operation", so find a friendly HR person who can explain how your plan operates. Perhaps they can assist you with reaching or approaching the $58K limit. In the absence of assistance, I would make sure to under-contribute to the after-tax subaccount, rather than lose some of your match.
retiredjg
Posts: 45464
Joined: Thu Jan 10, 2008 12:56 pm

Re: Mega Backdoor Roth Mechanics Question

Post by retiredjg »

RebeccaVA, welcome to the forum. :happy

We don't have very many people here with your knowledge and experience. You may find yourself very busy!
Topic Author
anewboglehead
Posts: 54
Joined: Tue Mar 10, 2020 1:03 pm

Re: Mega Backdoor Roth Mechanics Question

Post by anewboglehead »

markcoop wrote: Tue Aug 24, 2021 7:24 am One point I am surprised about above is the co-mingling of funds in some plans. We use Fidelity like others here. I am pretty sure I can invest my Roth 401K separately....

One other thing to mention. As this after-tax stuff is relatively new, I would double check everything. We have an option to do automatic after-tax daily conversions. I checked the box online to do that. First pay period, it did not happen. I called and was told sometimes, depending upon when I checked that box, it takes an extra pay period. Next pay period, it did not happen. I called and they did something on their end and said it was fixed. Next pay period, it did not happen for a third time. They finally got it right for the fourth pay period. The first 3 times they manually did the conversion when I called.
Thanks Mark, I checked with my plan (as you recommended to double check everything!) and the accounts are commingled, without the ability to segregate at all. They do track the basis and gains for appropriate tax treatment at distribution, but I am not able to direct them to separate investments - that is, any allocation chosen for pre tax contributions must be mirrored for roth contributions.
Topic Author
anewboglehead
Posts: 54
Joined: Tue Mar 10, 2020 1:03 pm

Re: Mega Backdoor Roth Mechanics Question

Post by anewboglehead »

RebeccaVA wrote: Wed Aug 25, 2021 8:15 pm I am 401k plan administrator for a small company (28 participants), and can share how our plan works. We do not have an employer match, but a profit-sharing contribution; the amount is determined in late December. I would never allow an employee to contribute more than the limit ($58K in 2021), because it would cause plan compliance tests to fail and a bunch of rigmarole to correct the excess. The employee would get a distribution of deferrals to bring them back to $58K. If we had a match, it might cause partial forfeiture of their match; see https://www.irs.gov/retirement-plans/fi ... articipant

You want to avoid contributing too much to the after-tax subaccount because your plan administrator will probably cut off your match to keep you at $58K. You don't want to save too much of your paycheck, only to have the company cut back their contribution! We have a very generous company, and would bonus out the surplus in January if the profit-sharing comes in higher than expected - but you can't depend on that.

Because we are small, I offer a "concierge" service for participants who want to reach the $58K limit. I estimate the maximum profit-sharing contribution for each, and advise them how much after-tax can be safely contributed. In late December when profit-sharing is fixed, I adjust the after-tax contribution from their final paycheck, to bring them up to $58K. I then roll out / convert the after-tax subaccounts to each participant's Roth IRA.

These procedures, unfortunately, are not spelled out in the participants' SPD (Summary Plan Description), or not even fully described in the plan documents. They are part of the plan's "operation", so find a friendly HR person who can explain how your plan operates. Perhaps they can assist you with reaching or approaching the $58K limit. In the absence of assistance, I would make sure to under-contribute to the after-tax subaccount, rather than lose some of your match.
Thanks Rebecca! You truly do offer a high level of service to the folks in your plan, they are super lucky!

I was told that the "likely, but not guaranteed" course of action was to refund aftertax contributions. This would get super hairy if there was a gain, as the gain associated would also be refunded, with tax due. Of course, this would all happen after taxes were filed, such that I would have to file an amendment. So pretty important for me not to overfund.

SnowBog wrote: Tue Aug 24, 2021 1:05 pm On the "overfunding" concern - again, I'd ask your plan administrator...

In my plan - at least in how I understand it - the "space available" is limited to the overall 401k limits minus the pre-tax/Roth limits ($19.5k) minus the company match on that amount. If I make $0 pre-tax contribution (and thus no match), I don't get to do "more" after-tax... So its very easy for the plan administrator to "cap" each source and ensure none are overfunded - regardless of which is funded first/second/etc.

But ultimately it comes down to how your plan works.

Regarding the "complexities" of front-loading... I will admit, I did a ton of modeling when I first set mine up - so there are complexities. And its probably a "your mileage may vary" based on your income/taxes/pay frequency (including things like bonuses), etc.
I'm a big fan of your modeling and finding the solution that works for you! I'm still thinking through this for next year.

So here is my plan of now, at least for this year, to get as close to max as possible:
Max Pre-tax = 19,500
Calculate match based on [salary + bonus (number revealed in Sept)] * 0.045. (4.5% match on salary and bonus)
"Max" post-tax with bonus, leaving 1k buffer.

Next year, I am considering some sort of front loading strategy. The problem is that the match of bonus * 0.045, not revealed until late in the year, and can be highly variable. SnowBog makes a great point about front loading and basically getting an extra "year" of investing, so waiting each year until bonus is put in to do the MBDR with the bonus is not ideal, but still much preferred to putting it into taxable, so the solution may be to semi-front load the early part of the year, and then figure it out with the bonus to get close, then have no contributions at the end of the year...gets complicated! :oops:

Thanks all for help, I think I am close to getting this all finalized!
SnowBog
Posts: 1839
Joined: Fri Dec 21, 2018 11:21 pm

Re: Mega Backdoor Roth Mechanics Question

Post by SnowBog »

anewboglehead wrote: Fri Aug 27, 2021 12:22 pm So here is my plan of now, at least for this year, to get as close to max as possible:
Max Pre-tax = 19,500
Calculate match based on [salary + bonus (number revealed in Sept)] * 0.045. (4.5% match on salary and bonus)
"Max" post-tax with bonus, leaving 1k buffer.

Next year, I am considering some sort of front loading strategy. The problem is that the match of bonus * 0.045, not revealed until late in the year, and can be highly variable. SnowBog makes a great point about front loading and basically getting an extra "year" of investing, so waiting each year until bonus is put in to do the MBDR with the bonus is not ideal, but still much preferred to putting it into taxable, so the solution may be to semi-front load the early part of the year, and then figure it out with the bonus to get close, then have no contributions at the end of the year...gets complicated! :oops:

Thanks all for help, I think I am close to getting this all finalized!
For clarity, do you have a "cap" on the employer match?

For my plan, employer matches x% on salary + bonus - but the max they'll ever contribute is 50% of the total contribution amount (aka $9,750 or $19,500 * 50%). And they will "true-up" any matches. So in theory (I wish) I could max out the entire $19,500 contribution in January, hit the max, and if I get a $50k bonus in December it would get 0% match (as I'd have already hit the max).

But based on your last post - maybe your plan match is more like 4.5% match on salary up to $19,500 contribution + a separate match on the bonus? And then that "extra" match obviously impacts the amount of after-tax you can contribute... If so, I see the challenge now!
Topic Author
anewboglehead
Posts: 54
Joined: Tue Mar 10, 2020 1:03 pm

Re: Mega Backdoor Roth Mechanics Question

Post by anewboglehead »

SnowBog wrote: Fri Aug 27, 2021 1:59 pm
anewboglehead wrote: Fri Aug 27, 2021 12:22 pm So here is my plan of now, at least for this year, to get as close to max as possible:
Max Pre-tax = 19,500
Calculate match based on [salary + bonus (number revealed in Sept)] * 0.045. (4.5% match on salary and bonus)
"Max" post-tax with bonus, leaving 1k buffer.

Next year, I am considering some sort of front loading strategy. The problem is that the match of bonus * 0.045, not revealed until late in the year, and can be highly variable. SnowBog makes a great point about front loading and basically getting an extra "year" of investing, so waiting each year until bonus is put in to do the MBDR with the bonus is not ideal, but still much preferred to putting it into taxable, so the solution may be to semi-front load the early part of the year, and then figure it out with the bonus to get close, then have no contributions at the end of the year...gets complicated! :oops:

Thanks all for help, I think I am close to getting this all finalized!
For clarity, do you have a "cap" on the employer match?

For my plan, employer matches x% on salary + bonus - but the max they'll ever contribute is 50% of the total contribution amount (aka $9,750 or $19,500 * 50%). And they will "true-up" any matches. So in theory (I wish) I could max out the entire $19,500 contribution in January, hit the max, and if I get a $50k bonus in December it would get 0% match (as I'd have already hit the max).

But based on your last post - maybe your plan match is more like 4.5% match on salary up to $19,500 contribution + a separate match on the bonus? And then that "extra" match obviously impacts the amount of after-tax you can contribute... If so, I see the challenge now!
Hi SnowBog,

my SPD reads:

"XXX will make Matching Contributions equal to 100% of your combined Pre-Tax and Roth Contributions for the Plan Year (excluding any Catch-Up Contributions), up to a maximum of 4.5% of your Eligible Pay for that Plan Year."

So it sounds like 4.5% of eligible comp up to 19.5k total match. I don't think I will cap it this year :twisted:

The issue is my bonus comes near end of year, and the amount is variable, though I do believe I earn a match of 4.5%. There is also likely a salary increase at time of the bonus, which may raise the match a hair.

I think I am going to under-contribute by 500-1k. I am OK with slightly undercontributing (still get a nice big chunk of Roth space I didn't have before) so as to be pretty confident I will not end up in a headache of paperwork with a refunded overcontribution.

One other twist in this, is that because the funds are commingled, I am considering moving a chunk to bonds. My current AA is 90 equities /10 bonds.
I am considering moving like 2% from equities to bonds, and then making all contributions towards equities. (This is the only way I can make new contributions in roth be 100% equities). I can rebalance to bonds either in taxable with munis, or in spouse 401(k), though the next project is to look into spouse SPD to see if we can also do a MBDR there.... I'm not sure if this (or an annual rollover) is worth the headache to be 100% in equities in Roth. Could be optimizing at the margins...

The other way to think about it is that I am getting 28k Roth space, 90% of which is 100% equities (if I leave my current contribs where they are), which is like getting 25k Roth space and a bonus of 3k roth space in bonds lol.
Topic Author
anewboglehead
Posts: 54
Joined: Tue Mar 10, 2020 1:03 pm

Re: Mega Backdoor Roth Mechanics Question

Post by anewboglehead »

Update:
It appears there is a cap for compensation considered for the match, set by the IRS in section 401(a)(17). More info here:
https://www.irs.gov/retirement-plans/40 ... nual-limit

So the maximum allowed by the IRS for 2021 is (290k * match).

So now my understanding is that I will be within the limits with contributions of:
Pre-tax: 19,500
Match: 13,050 (cannot exceed 290,000 * 0.045)
Post-tax: 25,450 (to be immediately converted via in-plan roth conversion to Roth).
Roth: 0
Total IRS limit: 58,000

So far I have not found a way to avoid commingling, except to perform an annual rollover.
SnowBog
Posts: 1839
Joined: Fri Dec 21, 2018 11:21 pm

Re: Mega Backdoor Roth Mechanics Question

Post by SnowBog »

anewboglehead wrote: Wed Sep 01, 2021 11:10 am Update:
It appears there is a cap for compensation considered for the match, set by the IRS in section 401(a)(17). More info here:
https://www.irs.gov/retirement-plans/40 ... nual-limit

So the maximum allowed by the IRS for 2021 is (290k * match).

So now my understanding is that I will be within the limits with contributions of:
Pre-tax: 19,500
Match: 13,050 (cannot exceed 290,000 * 0.045)
Post-tax: 25,450 (to be immediately converted via in-plan roth conversion to Roth).
Roth: 0
Total IRS limit: 58,000

So far I have not found a way to avoid commingling, except to perform an annual rollover.
I didn't realize there was an IRS limit on the match (beyond the overall $58k limit)...

But this was what I expected, that your after-tax would end up being capped at a pre-set max amount. Otherwise lots of people would have the problem you were concerned about...

By the way - very nice company match! When I first saw 4.5% I was thinking your plan sucks, as my match is 50%. But above made clear yours is 4.5% of gross pay where mine is only a match on the first $19500 contributed to 401k. That's awesome your employer matches based on gross pay! :beer

Bummer on the comingling... That's the primary reason I do rollovers into my Roth, so I can invest my Roth funds differently.
nolesrule
Posts: 2063
Joined: Thu Feb 26, 2015 10:59 am

Re: Mega Backdoor Roth Mechanics Question

Post by nolesrule »

SnowBog wrote: Wed Sep 01, 2021 12:24 pm I didn't realize there was an IRS limit on the match (beyond the overall $58k limit)...
The limit on income that is eligible for contributions and match calculations is generally 5x the per-employer total contribution limit. I don't know what the law says, but that's what I've observed.

I believe the compensation limit also applies to calculating percentage-based employee deferrals and contributions and not just the employer match.
Topic Author
anewboglehead
Posts: 54
Joined: Tue Mar 10, 2020 1:03 pm

Re: Mega Backdoor Roth Mechanics Question

Post by anewboglehead »

SnowBog wrote: Wed Sep 01, 2021 12:24 pm
anewboglehead wrote: Wed Sep 01, 2021 11:10 am Update:
It appears there is a cap for compensation considered for the match, set by the IRS in section 401(a)(17). More info here:
https://www.irs.gov/retirement-plans/40 ... nual-limit

So the maximum allowed by the IRS for 2021 is (290k * match).

So now my understanding is that I will be within the limits with contributions of:
Pre-tax: 19,500
Match: 13,050 (cannot exceed 290,000 * 0.045)
Post-tax: 25,450 (to be immediately converted via in-plan roth conversion to Roth).
Roth: 0
Total IRS limit: 58,000

So far I have not found a way to avoid commingling, except to perform an annual rollover.
I didn't realize there was an IRS limit on the match (beyond the overall $58k limit)...

But this was what I expected, that your after-tax would end up being capped at a pre-set max amount. Otherwise lots of people would have the problem you were concerned about...

By the way - very nice company match! When I first saw 4.5% I was thinking your plan sucks, as my match is 50%. But above made clear yours is 4.5% of gross pay where mine is only a match on the first $19500 contributed to 401k. That's awesome your employer matches based on gross pay! :beer

Bummer on the comingling... That's the primary reason I do rollovers into my Roth, so I can invest my Roth funds differently.
Update!
Automatic daily in-plan Roth conversion set up. Took a phone call, apparently my netbenefits is not set up to do this online.

Caps are confirmed at 19,500 pre-tax, 13,050 (=IRS limit of 290k x 0.045) match. 58k total. I don't believe there are any other categories unaccounted for to the 401k, since I have no direct Roth contributions. If there are any other possible categories that anyone knows about that I could be missing, please let me know!

Thus, this year I will shoot for 58,000 - 19,500 - 13,050 = 25,450 into my after-tax account to be converted to Roth.

There was an issue with commingling, I believe I have discovered a workaround, at least at Fidelity. My plan allows use of brokeragelink with no fee. In my investment choices, I can choose to direct investment elections in three buckets, 401(k), Rollovers, and Roth 401(k). They had all been set to 100% brokeragelink. I changed the Roth 401(k) to a plan-side investment. This allows me to keep all the Roth money plan side - where can be rebalanced, etc, as long as all investment choices are plan side. Same goes for brokeragelink side (which I am keeping as pre-tax). I can rebalance and keep them all pre-tax. This gives me the ability to have different asset allocations, and freedom to rebalance while keeping separation between roth (plan side) and pre-tax (brokeragelink).

One more question that came up was that in the plan side investments, under the passive tier, I have three options.
BLKRK US EQ MKT IDX (BlackRock US Equity Market Index-F, ER 0.0176, benchmark DJ US Total Stk Mkt)
BLKRK INTL EQUITY F (BlackRock International Equity Index Fund F, ER 0.0507, benchmark MSCI AC Wld ex US (G))
BLKRK US DEBT INDEX (BlackRock US Debt-F, ER 0.0224, benchmark BBg US Agg Bond)

I cannot seem to access a prospectus for these options. Also I noticed they have some interesting language. They all say "Information on this investment option was provided by your plan sponsor, plan trustee, investment manager, trustee or third party data provider. This investment is not a mutual fund." (emphasis mine).

Interestingly, it also says "The Fund is an "index fund" that seeks investment to match". It uses index fund in quotes. What does that mean?! Is it not an index fund?! :confused

So it's not a mutual fund, and not an index fund. No ticker associated. Anyone have similar experiences? (Maybe I should start a new thread for this?)

Thanks in advance!
retiredjg
Posts: 45464
Joined: Thu Jan 10, 2008 12:56 pm

Re: Mega Backdoor Roth Mechanics Question

Post by retiredjg »

Sounds like a "collective investment trust" or CIT. Perfectly fine and often lower cost.

https://www.bogleheads.org/wiki/Collect ... ent_Trusts
MrJedi
Posts: 1072
Joined: Wed May 06, 2020 11:42 am

Re: Mega Backdoor Roth Mechanics Question

Post by MrJedi »

CITs are less regulated since they are only found in qualified plans, so they are often cheaper than mutual fund equivalents. That's a good thing.
Topic Author
anewboglehead
Posts: 54
Joined: Tue Mar 10, 2020 1:03 pm

Re: Mega Backdoor Roth Mechanics Question

Post by anewboglehead »

retiredjg wrote: Tue Sep 14, 2021 6:35 pm Sounds like a "collective investment trust" or CIT. Perfectly fine and often lower cost.

https://www.bogleheads.org/wiki/Collect ... ent_Trusts

MrJedi wrote: Tue Sep 14, 2021 6:45 pm CITs are less regulated since they are only found in qualified plans, so they are often cheaper than mutual fund equivalents. That's a good thing.
Thank retiredjg and MrJedi, it is a few bp cheaper than the already very cost effective Three Fund Portfolio funds I usually use. Thanks for the reassurance it is ok.

I think everything is set to go, will see if it works on Friday!
Post Reply