Mega Backdoor Scenario on Gains / Losses

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curi0usAndCuri0user
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Mega Backdoor Scenario on Gains / Losses

Post by curi0usAndCuri0user » Fri Jul 19, 2019 12:36 pm

Suppose I contribute $10k in 2019 to an after-tax 401(K), intending to do a mega backdoor. Normally, I'd do the rollover into the Roth IRA and pay any taxes on the gains. But what if the market dives (let's say the $10k becomes $5k)? My 401(K) provider said they won't carry forward any losses to offset future gains. In that case:

1) Does it make sense to wait on the conversion, say until 2020 (or whenever) until the combination of the original contribution + subsequent contributions have enough gains to put me back at $0 profit / loss?

2) Is there a limit on the amount of post-tax 401(K) contributions that can be rolled over in a given year? I know max 401(K) contributions (pre-tax + employer + post-tax) for 2019 are 56k, but wasn't sure if there are any stipulations around converting multiple years of post-tax 401(K) contributions at once (say $100k at once).

3) Is there any pro-rata rule to worry about while holding funds in post-tax 401(K) with this strategy and still doing the normal backdoor every year (IRA to Roth)?

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anon_investor
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Re: Mega Backdoor Scenario on Gains / Losses

Post by anon_investor » Fri Jul 19, 2019 1:03 pm

curi0usAndCuri0user wrote:
Fri Jul 19, 2019 12:36 pm
1) Does it make sense to wait on the conversion, say until 2020 (or whenever) until the combination of the original contribution + subsequent contributions have enough gains to put me back at $0 profit / loss?
In theory yes, but in practice it probably does not make a difference. Since, the amount that you lost that you are waiting to "grow" back would have the same tax treatment if it was in a Roth. You would get 0 real benefit by waiting; any the potential of it growing too quickly and above the basis amount before you could convert (e.g. a really good market day).

2) Is there a limit on the amount of post-tax 401(K) contributions that can be rolled over in a given year? I know max 401(K) contributions (pre-tax + employer + post-tax) for 2019 are 56k, but wasn't sure if there are any stipulations around converting multiple years of post-tax 401(K) contributions at once (say $100k at once).
There is no legal limit on the conversions, but your plan my have a limit, which with your plan admin.

3) Is there any pro-rata rule to worry about while holding funds in post-tax 401(K) with this strategy and still doing the normal backdoor every year (IRA to Roth)?
There should be none, provided your plan properly segregates the after-tax amount from pre-tax and roth amounts.

megabad
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Re: Mega Backdoor Scenario on Gains / Losses

Post by megabad » Fri Jul 19, 2019 2:10 pm

I would wait (though it is very difficult for anyone reasonably invested in low cost index funds to have a loss at this exact current moment in time this calendar year but it may be possible in the future). Otherwise, you have lowered the amount of tax advantaged contribution space in your Roth IRA (the money you can take out before 59.5).

edit: caveats...
Last edited by megabad on Mon Jul 22, 2019 5:16 pm, edited 1 time in total.

jacoavlu
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Re: Mega Backdoor Scenario on Gains / Losses

Post by jacoavlu » Fri Jul 19, 2019 2:34 pm

are the after tax contributions in the 401k invested differently than the funds would be within the Roth IRA? If not, I don't think waiting makes any difference. Think about it:

1. Ideal: After tax contribution $10k. Rolled over to Roth immediately, results in $10k in Roth IRA.

2. After tax contribution $10k. With losses decreased to $5k while in 401k. If rolled over, now $5k in Roth IRA. If gains 100% over next 6 months, now there's $10k in Roth IRA.

3. After tax contribution $10k. With losses decreased to $5k while in 401k. Stays within 401k. Gains 100% over next 6 months, now is $10k. Rollover to Roth results in... $10k in Roth IRA.

Now of course it depends on how the 401k segregates your various subaccounts, and whether you have the ability to direct how things are invested.

Alan S.
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Re: Mega Backdoor Scenario on Gains / Losses

Post by Alan S. » Fri Jul 19, 2019 3:00 pm

curi0usAndCuri0user wrote:
Fri Jul 19, 2019 12:36 pm
My 401(K) provider said they won't carry forward any losses to offset future gains.
Did they answer this question in a manner that clearly indicates that they understood the question? Many reps would not understand the question.

If so, would their answer be different if you left a couple bucks in the sub account to avoid a 0 balance?

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Duckie
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Re: Mega Backdoor Scenario on Gains / Losses

Post by Duckie » Fri Jul 19, 2019 5:30 pm

curi0usAndCuri0user wrote:Suppose I contribute $10k in 2019 to an after-tax 401(K), intending to do a mega backdoor. Normally, I'd do the rollover into the Roth IRA and pay any taxes on the gains. But what if the market dives (let's say the $10k becomes $5k)?
Why can't you use a money market or stable value fund in the 401k after-tax sub-account? There will be no losses and minimal gains.

artgerst
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Re: Mega Backdoor Scenario on Gains / Losses

Post by artgerst » Fri Jul 19, 2019 6:27 pm

Duckie wrote:
Fri Jul 19, 2019 5:30 pm
curi0usAndCuri0user wrote:Suppose I contribute $10k in 2019 to an after-tax 401(K), intending to do a mega backdoor. Normally, I'd do the rollover into the Roth IRA and pay any taxes on the gains. But what if the market dives (let's say the $10k becomes $5k)?
Why can't you use a money market or stable value fund in the 401k after-tax sub-account? There will be no losses and minimal gains.
This is what I do also. I try to minimize complexity especially since there is potential 401k compliance failures in which case some of the money may need to be returned

CppCoder
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Re: Mega Backdoor Scenario on Gains / Losses

Post by CppCoder » Fri Jul 19, 2019 8:58 pm

curi0usAndCuri0user wrote:
Fri Jul 19, 2019 12:36 pm
Suppose I contribute $10k in 2019 to an after-tax 401(K), intending to do a mega backdoor. Normally, I'd do the rollover into the Roth IRA and pay any taxes on the gains. But what if the market dives (let's say the $10k becomes $5k)? My 401(K) provider said they won't carry forward any losses to offset future gains.
I agree with Alan S., you need to make sure the rep understood the question. If worded the way you worded this question, I think our reps would give the same answer. A "loss" is not carried over. However, my plan does, however, permit a nonzero basis to exist on a zero balance. I know this for certain because I've done this, effectively "capturing a loss."

In your example, if I contributed $10k, it became $5k, and then I converted, I would be left with $0 and $5k of "basi"s (they track your taxed contributed amount. Next year, if I contributed $10k and it grew to $15k before I converted, my account would say I had $15k of basis and the conversion would be tax free.

For accounts that allow conversions every paycheck, this isn't really useful. My administrator, however, only allows one conversion annually, so it can be useful depending on the investment strategy. For me personally, I usually have small gains/losses over the half year between contribution and conversion because I invest exclusively in our bond fund in my aftertax account.

tesuzuki2002
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Re: Mega Backdoor Scenario on Gains / Losses

Post by tesuzuki2002 » Fri Jul 19, 2019 9:06 pm

Your loss in the 401k makes. I different. You are essentially trading shares for Shares at this point. The $ value is with in legal limits.

roken
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Re: Mega Backdoor Scenario on Gains / Losses

Post by roken » Fri Jul 19, 2019 9:19 pm

megabad wrote:
Fri Jul 19, 2019 2:10 pm
I would wait (though it is very difficult for anyone reasonably invested in low cost index funds to have a loss).
Feels important to call out this dangerous rationale. It is not hard to lose a lot of money in index funds, all investment is at risk despite the optics of this long bull market.

megabad
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Re: Mega Backdoor Scenario on Gains / Losses

Post by megabad » Mon Jul 22, 2019 2:12 pm

roken wrote:
Fri Jul 19, 2019 9:19 pm
megabad wrote:
Fri Jul 19, 2019 2:10 pm
I would wait (though it is very difficult for anyone reasonably invested in low cost index funds to have a loss).
Feels important to call out this dangerous rationale. It is not hard to lose a lot of money in index funds, all investment is at risk despite the optics of this long bull market.
Just wanted to clarify my statement that, in the specific case of having invested in 2019 thus far, it is very difficult to have a loss at this moment in time. Actually it is nearly impossible if you were invested in the broad us equity market. That was what I meant, should have clarified. I meant that this question and answer doesn't really apply to most bogleheads currently. But, you are correct, it certainly could in the future.

decapod10
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Re: Mega Backdoor Scenario on Gains / Losses

Post by decapod10 » Mon Jul 22, 2019 2:30 pm

megabad wrote:
Fri Jul 19, 2019 2:10 pm
I would wait (though it is very difficult for anyone reasonably invested in low cost index funds to have a loss). Otherwise, you have lowered the amount of tax advantaged space in your Roth IRA.
I don't believe this is true.

$10k goes into after-tax 401k. Market crashes, you have $5k. Convert that into your Roth IRA, you have $5k of Roth IRA money. Market recovers and now you have $10k in Roth IRA money.

Alternatively, $10k goes into after-tax 401k. Market crashes, you have $5k. You wait until the market recovers, now you have $10k after tax 401k. You covert to Roth IRA, now you have $10k in Roth IRA money.

Taxwise, the 2 scenarios are identical.

The only potential upside to waiting is that it is possible that there is a benefit if you need to withdraw money early. Since the first scenario you have only $5k contributionss, while the second you have $10k contributions, although even on this I am not 100% sure this is correct. When you convert a Roth 401k to Roth IRA on separation, the contribution amount is based on the amount you contributed to the Roth 401k, not the total conversion amount. I don't know how it applies to Mega Backdoor Roth IRA.

megabad
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Re: Mega Backdoor Scenario on Gains / Losses

Post by megabad » Mon Jul 22, 2019 5:14 pm

decapod10 wrote:
Mon Jul 22, 2019 2:30 pm
megabad wrote:
Fri Jul 19, 2019 2:10 pm
I would wait (though it is very difficult for anyone reasonably invested in low cost index funds to have a loss). Otherwise, you have lowered the amount of tax advantaged space in your Roth IRA.
I don't believe this is true.

$10k goes into after-tax 401k. Market crashes, you have $5k. Convert that into your Roth IRA, you have $5k of Roth IRA money. Market recovers and now you have $10k in Roth IRA money.

Alternatively, $10k goes into after-tax 401k. Market crashes, you have $5k. You wait until the market recovers, now you have $10k after tax 401k. You covert to Roth IRA, now you have $10k in Roth IRA money.

Taxwise, the 2 scenarios are identical.

The only potential upside to waiting is that it is possible that there is a benefit if you need to withdraw money early. Since the first scenario you have only $5k contributionss, while the second you have $10k contributions, although even on this I am not 100% sure this is correct. When you convert a Roth 401k to Roth IRA on separation, the contribution amount is based on the amount you contributed to the Roth 401k, not the total conversion amount. I don't know how it applies to Mega Backdoor Roth IRA.
Sorry typo above. Your second point was my intent. "lowered the amount of roth tax advantaged contribution space" i guess is what is should read. Just meant it gives you more money that you can withdraw at any time (prior to 59.5). Other than that, basically my reason for waiting is why rollover more often than you have to if there is no penalty for not doing so? Obviously this should be a pretty rare occurrence anyway since there is not much point in contributing to a Roth account if gains are zero or less consistently.

lakpr
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Re: Mega Backdoor Scenario on Gains / Losses

Post by lakpr » Mon Jul 22, 2019 8:33 pm

I have actually experienced this scenario (loss in after-tax account).

Before I knew about the MBR in my plan, I set my contributions to 20% of my paycheck, and I maxed out the annual 401k contributions by around mid October. Some of that money spilled over to After-Tax account by default, and that's when I came to know that the plan has MBR feature.

I immediately started contributing the max that my plan allows (10% max per paycheck). But then I tried to convert the after-tax money to Roth 401k within the plan (no external rollover to IRAs allowed in my plan), no one seemed to know how to accomplish that. It took me really a solid 3 months before the procedure was ironed out. One representative said that if I convert money to Roth within the plan, 20% of the conversion amount will be withheld and sent to IRS to cover for taxes. That defeats the purpose of MBR, so I declined. A few days later I tried calling another representative, and this person asked me to send a form filled out requesting in-plan conversions. The first time I was sent a form for "Non-Distributable Amounts conversion", looks like the representative misunderstood me as wanting to convert my traditional 401k contribution to Roth 401k. This took another 3 weeks to resolve, since I indicated to NOT withhold any taxes as part of the conversion and the team handling the form said they must!

Finally, a knowledgeable representative sent me a form that allows conversion of "Distributable Amounts" to Roth 401k within the plan. My first conversion actually took place in January 2019.

You know what happened between October 2018 (then a record high) and late December. My contributions lost 10% of their value. I am not sure what the tax implications would be if I use up all the amount then in the plan for conversion, so I left about $100 and asked the plan administrator to convert the rest to Roth 401k. By that time, the amount of contributions were something like 3200, balance was around $2700, I asked for $2500 to be converted. Loss of $500 or so, but balance remaining was $200.
Next two paychecks I contributed another $560 each, but then asked the plan administrator to convert $1200 only (balance after fluctuations was $1280 or so).
Repeat once every two paychecks.

So far my Roth conversion amounts have still been less than the contributions even including growth between when I contributed and when I converted (due to paperwork taking inordinate amount of time, as well as my choice to do conversions only once a month).

In a sense, I was "tax loss harvesting" the loss experienced in the after-tax account towards conversion into Roth. Always leaving a few dollars in the after-tax account that even if they double, they would still not completely overcome the remaining "loss".

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curi0usAndCuri0user
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Re: Mega Backdoor Scenario on Gains / Losses

Post by curi0usAndCuri0user » Mon Aug 05, 2019 1:23 pm

I spoke with multiple representatives and used some of the language in these replies to confirm my plan provider does not carry over basis (i.e., they do not offset gains with losses). I should also mention that:

(1) There isn't an option to set a different asset allocation than my standard employee deductible 401K contributions (even though deductible and after-tax contributions are maintained separately). I set those to be 100% stock market index, thus my after-tax contributions follow

2) I am limited to at most 4 MBR conversions / year (no chance to minimize losses/gains by executing conversions immediately)

retiredjg
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Re: Mega Backdoor Scenario on Gains / Losses

Post by retiredjg » Mon Aug 05, 2019 1:39 pm

curi0usAndCuri0user wrote:
Mon Aug 05, 2019 1:23 pm
I spoke with multiple representatives and used some of the language in these replies to confirm my plan provider does not carry over basis (i.e., they do not offset gains with losses).
Don't be surprised if you find out the reality is different from what the multiple reps told you. :D

It really does not matter in the long run if you convert at a loss or not. You are converting shares, not dollars, and the shares will grow the same in the roth 401k account or in the after-tax account.

If they don't keep up with the basis, you have not lost anything. If they do keep up with the basis, you'll get a little into Roth tax free. In other words a little unexpected bonus.

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