Mega Backdoor Roth: Conversion or Rollover?

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pancake19
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Mega Backdoor Roth: Conversion or Rollover?

Post by pancake19 » Thu Jan 11, 2018 1:45 pm

Tried searching for this but couldn't find. People frequently use the terminology of "rollover" and "conversion" interchangeably when it comes to Mega Backdoor Roth.

However, is the move from 401K after tax to rIRA a rollover or conversion?

I ask because my understanding is a conversion to rIRA requires 5 year waiting period before withdrawals of contributions are allowed without a 10% penalty -- this impacts normal backdoor roth conversions, effectively locking it for 5 years. However does the same apply to mega backdoor roth?

I read the wiki which always uses the word "rollover" and does not highlight the 5-year period as a disadvantage

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tfb
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Re: Mega Backdoor Roth: Conversion or Rollover?

Post by tfb » Thu Jan 11, 2018 2:42 pm

pancake19 wrote:
Thu Jan 11, 2018 1:45 pm
Tried searching for this but couldn't find. People frequently use the terminology of "rollover" and "conversion" interchangeably when it comes to Mega Backdoor Roth.

However, is the move from 401K after tax to rIRA a rollover or conversion?

I ask because my understanding is a conversion to rIRA requires 5 year waiting period before withdrawals of contributions are allowed without a 10% penalty -- this impacts normal backdoor roth conversions, effectively locking it for 5 years. However does the same apply to mega backdoor roth?

I read the wiki which always uses the word "rollover" and does not highlight the 5-year period as a disadvantage
It's a rollover. However, the same 5-year waiting period applies. Note the 10% penalty is only on the taxable portion of the rollover, not on the entire amount. I addressed it in

Mega Backdoor Roth and Access To Your Money Before 59-1/2
Harry Sit, taking a break from the forums.

pancake19
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Re: Mega Backdoor Roth: Conversion or Rollover?

Post by pancake19 » Fri Jan 12, 2018 10:47 am

Pretty good writeup but I have to admit I'm still a bit confused, maybe partly because it doesn't discussed backdoor roth in parallel to the mega backdoor. Is the following correct?

1. Direct contributions to rIRA (non backdoor): never any penalty
1b. Earnings on direct contributions to rIRA (non backdoor): 10% penalty if before 59 1/2 except for specified reasons

2. Rollover of after tax to rIRA (mega backdoor contributions): never any penalty --> Is this correct? It's how I read your post
2b. Pre-rollover earnings: 10% penalty if withdrawn within 5 years of rollover --> If I have rolled over more than once, can I withdraw the contributions from each rollover (FIFO) before dipping into the earnings on which I pay the penalty?
2c. Post-rollover earnings on rollover balance: same as 1b

3. Contributions from conversion of tIRA to rIRA (backdoor contributions): 10% if withdrawn within 5 years of conversion
3b. Pre-conversion earnings: same as 2b
3c. Post-conversion earnings on conversion balance: same as 1b

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tfb
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Re: Mega Backdoor Roth: Conversion or Rollover?

Post by tfb » Fri Jan 12, 2018 12:02 pm

pancake19 wrote:
Fri Jan 12, 2018 10:47 am
Pretty good writeup but I have to admit I'm still a bit confused, maybe partly because it doesn't discussed backdoor roth in parallel to the mega backdoor. Is the following correct?

1. Direct contributions to rIRA (non backdoor): never any penalty
1b. Earnings on direct contributions to rIRA (non backdoor): 10% penalty if before 59 1/2 except for specified reasons

2. Rollover of after tax to rIRA (mega backdoor contributions): never any penalty --> Is this correct? It's how I read your post That's correct, and no regular income tax either.
2b. Pre-rollover earnings: 10% penalty but no regular income tax if withdrawn within 5 years of rollover --> If I have rolled over more than once, can I withdraw the contributions from each rollover (FIFO) before dipping into the earnings on which I pay the penalty? No, each rollover is treated as a whole unit. Within each whole unit, pre-rollover earnings come out first.
2c. Post-rollover earnings on rollover balance: same as 1b

3. Contributions from conversion of tIRA to rIRA (backdoor contributions): 10% if withdrawn within 5 years of conversion This is not correct. Same as 2.
3b. Pre-conversion earnings: same as 2b
3c. Post-conversion earnings on conversion balance: same as 1b
Answered inline. When you do multiple contributions, rollovers, and contributions, you need a spreadsheet to track each event and document the taxable and non-taxable amounts of each rollover/conversion. Or you just resign to wait until 59-1/2, when everything is forgiven.
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pancake19
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Re: Mega Backdoor Roth: Conversion or Rollover?

Post by pancake19 » Fri Jan 12, 2018 2:46 pm

Thanks for the replies tfb, appreciate the help

However I'm confused by your response to #3 because that was the one I was most certain about. Everything I have read has stated that the principal of a tIRA to rIRA conversion (i.e. backdoor roth conversion) is subject to a 10% withdraw penalty with done within 5 years.

https://www.kitces.com/blog/understandi ... nversions/

Your response stated that the there is never any penalty, just like the principal of after-tax 401k rollovers (i.e. mega backdoor roth)?

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Re: Mega Backdoor Roth: Conversion or Rollover?

Post by ENT Doc » Fri Jan 12, 2018 3:00 pm

Different question, but are earnings on the after-tax contributions taxed as ordinary income? If so, what is the ideal strategy for maximizing the MBDR if the employer only allows one rollover a year?

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Re: Mega Backdoor Roth: Conversion or Rollover?

Post by Spirit Rider » Fri Jan 12, 2018 3:11 pm

Yes, employee after-tax contribution earnings are subject to ordinary income tax.

The best option to avoid this is a split rollover. After-tax contributions -> Roth IRA, earnings -> traditional IRA.

Of course this doesn't work if you are also doing a backdoor Roth. If this is true you have two possible options:
  1. Roll the traditional IRA back in to the plan if they allow it. Believe it or not, many do.
  2. Generate some self-employment income, adopt a one-participant 401k that accepts rollovers (not Vanguard) and roll any taxable IRA assets into the one-participant 401k.
If neither of these are a viable option, you are left with paying the taxes.

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Re: Mega Backdoor Roth: Conversion or Rollover?

Post by ENT Doc » Fri Jan 12, 2018 3:34 pm

Could you just do a max % paycheck contribution to your after-tax bucket and then just roll that over immediately? Otherwise, while you're waiting to fill up the after tax space to the maximum, the earnings all are trapped in a pre-tax account of some sort rather than in a Roth. Is it better to wait and maximize the after-tax space to enable a larger Roth rollover and forgo the (assumed) earnings that have accumulated?

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Re: Mega Backdoor Roth: Conversion or Rollover?

Post by tfb » Fri Jan 12, 2018 3:40 pm

pancake19 wrote:
Fri Jan 12, 2018 2:46 pm
Thanks for the replies tfb, appreciate the help

However I'm confused by your response to #3 because that was the one I was most certain about. Everything I have read has stated that the principal of a tIRA to rIRA conversion (i.e. backdoor roth conversion) is subject to a 10% withdraw penalty with done within 5 years.

https://www.kitces.com/blog/understandi ... nversions/

Your response stated that the there is never any penalty, just like the principal of after-tax 401k rollovers (i.e. mega backdoor roth)?
Whether the "principal" is pre-tax or after-tax makes a difference. If it's pre-tax it's subject to the 10% penalty. If it's after-tax then only the pre-conversion earnings are subject to the 10% penalty. The Kitces blog post talks about a regular Roth conversion of pre-tax money.
Kitces wrote:As the name implies, the second 5-year rule applies not to (new) Roth contributions, but to Roth conversions from traditional pre-tax retirement accounts, and determines whether Roth conversion principal will be penalty-free.
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bikechuck
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Re: Mega Backdoor Roth: Conversion or Rollover?

Post by bikechuck » Fri Jan 12, 2018 3:46 pm

Spirit Rider wrote:
Fri Jan 12, 2018 3:11 pm
Yes, employee after-tax contribution earnings are subject to ordinary income tax.

The best option to avoid this is a split rollover. After-tax contributions -> Roth IRA, earnings -> traditional IRA.

Of course this doesn't work if you are also doing a backdoor Roth. If this is true you have two possible options:
  1. Roll the traditional IRA back in to the plan if they allow it. Believe it or not, many do.
  2. Generate some self-employment income, adopt a one-participant 401k that accepts rollovers (not Vanguard) and roll any taxable IRA assets into the one-participant 401k.
If neither of these are a viable option, you are left with paying the taxes.
This was clearly worded and it made me think of a question.

If you do a split rollover only, without doing a backdoor, do you have to report that on your tax return in the year that you do the split rollover? I do not think so because there is no taxable event but I am not sure.

Adding that I do know that there is an IRS form that must be filed whilst doing a backdoor Roth.

pancake19
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Re: Mega Backdoor Roth: Conversion or Rollover?

Post by pancake19 » Fri Jan 12, 2018 4:03 pm

tfb wrote:
Fri Jan 12, 2018 3:40 pm

Whether the "principal" is pre-tax or after-tax makes a difference. If it's pre-tax it's subject to the 10% penalty. If it's after-tax then only the pre-conversion earnings are subject to the 10% penalty. The Kitces blog post talks about a regular Roth conversion of pre-tax money.
Never understood that, okay thanks!

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Re: Mega Backdoor Roth: Conversion or Rollover?

Post by Spirit Rider » Fri Jan 12, 2018 7:47 pm

bikechuck wrote:
Fri Jan 12, 2018 3:46 pm
If you do a split rollover only, without doing a backdoor, do you have to report that on your tax return in the year that you do the split rollover? I do not think so because there is no taxable event but I am not sure.
You report the sum of both rollovers on line 16a, write rollover next to b and because neither rollover is taxable enter $0 in 16b.
Adding that I do know that there is an IRS form that must be filed whilst doing a backdoor Roth.
Form 8606 is only required for non-deductible traditional IRA contributions and tIRA -> rIRA Roth conversions. It is not used for qualified plan rollovers even if those involve a Roth conversion.

bikechuck
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Re: Mega Backdoor Roth: Conversion or Rollover?

Post by bikechuck » Fri Jan 12, 2018 10:48 pm

Thanks for clarifying the tax reporting!

Mimmz
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Re: Mega Backdoor Roth: Conversion or Rollover?

Post by Mimmz » Sat Jan 13, 2018 12:16 am

Is it correct that none of this applies to a 60-day "Roth IRA loan" withdrawal that is subsequently repaid in full? The whole kit and caboodle can come out, as long as it all gets back in somehow within 60-days?

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Re: Mega Backdoor Roth: Conversion or Rollover?

Post by Spirit Rider » Sat Jan 13, 2018 1:00 pm

Since IRS Notice 2014-54 allowed split rollovers. There is never a good reason to do this by indirect rollover that would be subject to the 60 day rule.

Your should always do direct rollovers of after-tax contributions and earnings.

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Re: Mega Backdoor Roth: Conversion or Rollover?

Post by Alan S. » Sat Jan 13, 2018 2:11 pm

pancake19 wrote:
Thu Jan 11, 2018 1:45 pm
Tried searching for this but couldn't find. People frequently use the terminology of "rollover" and "conversion" interchangeably when it comes to Mega Backdoor Roth.

However, is the move from 401K after tax to rIRA a rollover or conversion?

It's a qualified rollover contribution.

The IRS terminology leaves much to be desired and creates considerable confusion. There is different meaning for the same terms, and "qualified rollover contribution" is one of the worst.

A qualified rollover contribution includes:
1) Roth IRA to Roth IRA
2) Qualified non Roth plan to Roth IRA
3) Non Roth IRA to Roth IRA (this transaction ONLY is also known as a conversion).

The above transactions all result in a Roth IRA destination, may range from non taxable to fully taxable, and never have a penalty.

The term does NOT include:
1) An IRR (in plan Roth rollover)
2) Rollover of designated Roth (Roth 401k) to Roth IRA (this is simply a rollover).

IRR is the only term that fully identifies the type of originating account and the destination account. As shown above the term "conversion" or "Roth conversion" only applies to the portion of qualified rollover contributions where a non Roth IRA is the distributing account.

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