Roth conversion for backdoor: wait?

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bironology
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Roth conversion for backdoor: wait?

Post by bironology » Thu Dec 06, 2018 6:24 am

My wife's traditional IRA balance is about $40k. We cannot contrib pre-tax [Roth] due to income limits. We are mid-40s, quite a ways to retirement.

She has no 403b or 401k opportunity through an employer (part time).

I have successfully rolled my own tIRA into my 401k, so I can and have been executing backdoor Roth for the last couple of years. Neat and clean.

For DW, should we:

A) bite the bullet and convert the $40k to a Roth right now and pay the taxes (peak income years for me, high marginal rate),
B) contribute $5500 annually post-tax to her tIRA but not convert until we retire and are in a lower tax bracket?, or
C) don't bother with IRA for her at all.

If I go with B and contribute post-tax to the tIRA, when the day comes that we are ready to convert to Roth, will I be able to account for the pre-tax vs. post-tax contributions to the tIRA? It would seem logical, otherwise it would be double-taxed.

Also, since we're talking about a very small % of our overall nest egg, I'm inclined to go with option C and just pile more cash into our taxable account, invested in tax efficient index ETFs.

thoughts?

Carl53
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Re: Roth conversion for backdoor: wait?

Post by Carl53 » Thu Dec 06, 2018 6:35 am

If you are certain that in 20 years you will be in a lower bracket, then B might be best, otherwise go with A.
If I go with B and contribute post-tax to the tIRA, when the day comes that we are ready to convert to Roth, will I be able to account for the pre-tax vs. post-tax contributions to the tIRA? It would seem logical, otherwise it would be double-taxed.
You will owe taxes on the balance of the account less the basis (the sum of annual $6-$7k after tax contributions made henceforth and any previously made). You will owe taxes on any pretax contributions and all earnings.

Chip
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Re: Roth conversion for backdoor: wait?

Post by Chip » Thu Dec 06, 2018 8:04 am

Given the length of time to retirement I think I would just use the taxable account. I would definitely not convert at peak tax rates.

But do you see any chance that your wife will change jobs and get the opportunity to roll into a 401k?

clydewolf
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Re: Roth conversion for backdoor: wait?

Post by clydewolf » Thu Dec 06, 2018 2:59 pm

bironology wrote:
Thu Dec 06, 2018 6:24 am
For DW, should we:

A) bite the bullet and convert the $40k to a Roth right now and pay the taxes (peak income years for me, high marginal rate),
I would not suggest this action as it would likely be very tax inefficient.
B) contribute $5500 annually post-tax to her tIRA but not convert until we retire and are in a lower tax bracket?,
This could work. You would need to file form 8606 each year she makes the after tax contribution. This would keep track of your after tax basis in her IRA.
But then in conversion years, there may be other gotchas such as IRMAA.

You could also keep this IRA for making Qualified Charitalbe Contributions once you are 70-1/2 years of age.
or
C) don't bother with IRA for her at all.
This would be my choice.
If I go with B and contribute post-tax to the tIRA, when the day comes that we are ready to convert to Roth, will I be able to account for the pre-tax vs. post-tax contributions to the tIRA? It would seem logical, otherwise it would be double-taxed.
Form 8606 keeps track of your after tax contributions so they are not taxed a second time.

bironology
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Re: Roth conversion for backdoor: wait?

Post by bironology » Thu Dec 06, 2018 4:01 pm

Chip wrote:
Thu Dec 06, 2018 8:04 am
Given the length of time to retirement I think I would just use the taxable account. I would definitely not convert at peak tax rates.

But do you see any chance that your wife will change jobs and get the opportunity to roll into a 401k?
There is a chance she could eventually gain employment and a 403b/401k plan. There's also a chance she becomes self employed which would open other opportunities.

bironology
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Re: Roth conversion for backdoor: wait?

Post by bironology » Thu Dec 06, 2018 4:02 pm

clydewolf wrote:
Thu Dec 06, 2018 2:59 pm
or
C) don't bother with IRA for her at all.
This would be my choice.
Agreed. other options don't seem worth the trouble.
Thanks everyone.

lakpr
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Re: Roth conversion for backdoor: wait?

Post by lakpr » Thu Dec 06, 2018 5:20 pm

If I were you, I would not foreclose the option of contributing to a non-deductible IRA. The opportunity to contribute would not come again once the tax deadline (April 15th) passes.

Just make sure that you will not commingle the IRA with basis and IRA without basis. I suggest you open an IRA at a different custodian altogether, where you don’t have any assets currently. Mentally earmark this as your non-deductible IRA that you plan to convert to Roth later on.

When your wife gets that new job that allows rollovers or becomes self employed, roll over the IRA account that has zero basis in its entirety, then convert the IRA with basis to Roth all at once.

lakpr
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Re: Roth conversion for backdoor: wait?

Post by lakpr » Thu Dec 06, 2018 5:24 pm

Wanted to add, this is what I followed in my own case. In our case the gains in my wife’s account over three years came to more than $4000 due to the bull market. Same case as you, her previous job wouldn’t allow incoming rollovers.

Spirit Rider
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Re: Roth conversion for backdoor: wait?

Post by Spirit Rider » Thu Dec 06, 2018 6:54 pm

lakpr wrote:
Thu Dec 06, 2018 5:20 pm
Just make sure that you will not commingle the IRA with basis and IRA without basis. I suggest you open an IRA at a different custodian altogether, where you don’t have any assets currently. Mentally earmark this as your non-deductible IRA that you plan to convert to Roth later on.
This is misinformation and will not help at all!

Pre-tax balances in all traditional, SEP and SIMPLE IRA accounts are treated as one account. See Form 8606 Line 6.

Making the non-deductable contributions to a separate traditional IRA account will still result in pro-rata Roth conversions.

clydewolf
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Re: Roth conversion for backdoor: wait?

Post by clydewolf » Thu Dec 06, 2018 7:00 pm

lakpr wrote:
Thu Dec 06, 2018 5:20 pm
If I were you, I would not foreclose the option of contributing to a non-deductible IRA. The opportunity to contribute would not come again once the tax deadline (April 15th) passes.
That is right! After April 15, 2019 you can not make a 2018 contribution to your IRA.
2018 maximum IRA contribution is $5,500 plus $1,000 if age 50 or greater in 2018.
2019 maximum IRA contribution is $6,000 plus $1,000 if age 50 or greater in 2019.
Just make sure that you will not commingle the IRA with basis and IRA without basis. I suggest you open an IRA at a different custodian altogether, where you don’t have any assets currently. Mentally earmark this as your non-deductible IRA that you plan to convert to Roth later on.

When your wife gets that new job that allows rollovers or becomes self employed, roll over the IRA account that has zero basis in its entirety, then convert the IRA with basis to Roth all at once.
These 2 paragraphs are misleading.

When you make an after tax contribution to a TIRA, you also complete form 8606 showing the after tax amount (basis). This will be added to later year basis contributions on the later year form 8606. This form keeps track of your basis in your IRA.

When you make a Roth Conversion you must consider all of your TIRAs as one TIRA. Doing the Conversion you need to pay tax on the amount of money that is converted and has not been taxed. One thing that comes into play is the Pro-Rata Rules. This is the ratio of basis vs tax deferred money in all of your TIRAs. An example may help: All of your TIRAs have a value of $100,000. The basis in those IRAs is $20,000. You want to do Roth Conversion of $10,000. The conversion will consist of $2,000 (basis) tax free and $8,000 (tax deferred) taxable. The total of your TIRAs would now be $90,000 with $18,000 basis.

The idea of transferring your IRA to a 401k plan is good. 401k plans can not accept any basis (after tax) money. So it does not matter which TIRA is transferred to a 401k. Note that not all 401k plans accept this type of transfer.

Spirit Rider
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Re: Roth conversion for backdoor: wait?

Post by Spirit Rider » Thu Dec 06, 2018 7:19 pm

bironology wrote:
Thu Dec 06, 2018 6:24 am
For DW, should we:

A) bite the bullet and convert the $40k to a Roth right now and pay the taxes (peak income years for me, high marginal rate),
This does not make sense with high marginal rates.
B) contribute $5500 annually post-tax to her tIRA but not convert until we retire and are in a lower tax bracket?, or
This is ill-advised unless you have insufficient space in your asset allocation for tax-inefficient investments. You will be turning investments taxed at capital gains tax rates into being taxed at your high marginal ordinary tax rates.
C) don't bother with IRA for her at all.
This is better than options A or B. You can instead invest the $5500 in tax-efficient investments such a total stock market index fund. However, there is a better fourth option.

D) Find a way, anyway for your wife to generate a few hundred dollars in self-employment income. You are reasonably intelligent people. Put your heads together. Surely, you can find a way.

Then she can adopt a one-participant 401k that accepts IRA rollovers (not Vanguard) and rollover the pre-tax IRA assets.

It is probably too late to generate the income for this year and adopt the one-participant 401k by 12/31, but it is not really necessary. If you are sure she will have self-employment income by tax time you can go ahead and make a 2018 non-deductible contribution for her. As long as you have adopted the one-participant 401k and rolled over the pre-tax IRA balances by 12/31/19, you can do a Roth conversion in 2019 with little to no tax liability.]

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TomatoTomahto
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Re: Roth conversion for backdoor: wait?

Post by TomatoTomahto » Thu Dec 06, 2018 7:40 pm

Nothing to add, except that in a similar situation, we’ve been doing C.
Zero Net Carbon by 2019.

lakpr
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Re: Roth conversion for backdoor: wait?

Post by lakpr » Thu Dec 06, 2018 8:47 pm

clydewolf wrote:
Thu Dec 06, 2018 7:00 pm
Just make sure that you will not commingle the IRA with basis and IRA without basis. I suggest you open an IRA at a different custodian altogether, where you don’t have any assets currently. Mentally earmark this as your non-deductible IRA that you plan to convert to Roth later on.

When your wife gets that new job that allows rollovers or becomes self employed, roll over the IRA account that has zero basis in its entirety, then convert the IRA with basis to Roth all at once.
These 2 paragraphs are misleading.

When you make an after tax contribution to a TIRA, you also complete form 8606 showing the after tax amount (basis). This will be added to later year basis contributions on the later year form 8606. This form keeps track of your basis in your IRA.

When you make a Roth Conversion you must consider all of your TIRAs as one TIRA. Doing the Conversion you need to pay tax on the amount of money that is converted and has not been taxed. One thing that comes into play is the Pro-Rata Rules. This is the ratio of basis vs tax deferred money in all of your TIRAs. An example may help: All of your TIRAs have a value of $100,000. The basis in those IRAs is $20,000. You want to do Roth Conversion of $10,000. The conversion will consist of $2,000 (basis) tax free and $8,000 (tax deferred) taxable. The total of your TIRAs would now be $90,000 with $18,000 basis.

The idea of transferring your IRA to a 401k plan is good. 401k plans can not accept any basis (after tax) money. So it does not matter which TIRA is transferred to a 401k. Note that not all 401k plans accept this type of transfer.
clydewolf,

I understand that we have to report the basis within the IRA on Form 8606. Not disputing that. My suggestion of keeping the "non-deductible" IRA at a separate custodian than the "deductible" IRA is that, should the opportunity arise in the future where the 401(k) or 403(b) plan will accept an incoming rollover, the entire "deductible" IRA can be rolled in.

Until that time, keep contributing to the non-deductible IRA, but do NOT convert to Roth.

Once the rollover of the pre-tax amounts (from the deductible IRA) are rolled over, then we have only the non-deductible IRA with a clear idea of the basis and the current balance, so that account can be converted into Roth IRA. Ideally the conversion step is done in the year after the rollover is completed.

At least, this is what I had done.

nolesrule
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Re: Roth conversion for backdoor: wait?

Post by nolesrule » Thu Dec 06, 2018 8:55 pm

lakpr wrote:
Thu Dec 06, 2018 8:47 pm

Once the rollover of the pre-tax amounts (from the deductible IRA) are rolled over, then we have only the non-deductible IRA with a clear idea of the basis and the current balance, so that account can be converted into Roth IRA. Ideally the conversion step is done in the year after the rollover is completed.

At least, this is what I had done.
Two points:
1) If your investments lose money, the basis could exceed the balance of what you are calling the non-deductible account. You can't just assume the balance of the one account is less than the pre-tax balance of your IRAs in aggregate at any particular point in time

2) Your basis tracked per Form 8606 is what gives you a clear idea of your basis. Your pre-tax balance is everything else, regardless of the account, which means you can roll everything else into a workplace plan. No need to convert any of the pre-tax growth.

bironology
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Re: Roth conversion for backdoor: wait?

Post by bironology » Fri Dec 07, 2018 5:36 am

nolesrule wrote:
Thu Dec 06, 2018 8:55 pm
lakpr wrote:
Thu Dec 06, 2018 8:47 pm

Once the rollover of the pre-tax amounts (from the deductible IRA) are rolled over, then we have only the non-deductible IRA with a clear idea of the basis and the current balance, so that account can be converted into Roth IRA. Ideally the conversion step is done in the year after the rollover is completed.

At least, this is what I had done.
Two points:
1) If your investments lose money, the basis could exceed the balance of what you are calling the non-deductible account. You can't just assume the balance of the one account is less than the pre-tax balance of your IRAs in aggregate at any particular point in time

2) Your basis tracked per Form 8606 is what gives you a clear idea of your basis. Your pre-tax balance is everything else, regardless of the account, which means you can roll everything else into a workplace plan. No need to convert any of the pre-tax growth.
Upon further reflection, while it would be simpler for me to say "heck with it" and just invest the $6,000 per year (as of 2019) into a taxable brokerage, the tax savings I'd be leaving on the table are significant.

With the following assumptions:

CAGR: 6.5%
annual contribution: $6,000
long term gains rate while in retirement : 20%
years: 20

For the trouble of converting to Roth (after tracking pre-tax vs. post-tax contributions, filing Form 8606 for 20 years, etc.), I'd save $25,000 in taxes.

That's worth doing, IMO. Perhaps my tax rate in retirement will be less. Perhaps it will be more. Either way, it will be more than the 0% that would be enjoyed with Roth. If it takes me an hour a year to file the right forms and track things accurately, it's a pretty good hourly rate, IMO.

bironology
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Re: Roth conversion for backdoor: wait?

Post by bironology » Fri Dec 07, 2018 5:40 am

Spirit Rider wrote:
Thu Dec 06, 2018 7:19 pm
D) Find a way, anyway for your wife to generate a few hundred dollars in self-employment income. You are reasonably intelligent people. Put your heads together. Surely, you can find a way.

Then she can adopt a one-participant 401k that accepts IRA rollovers (not Vanguard) and rollover the pre-tax IRA assets.

It is probably too late to generate the income for this year and adopt the one-participant 401k by 12/31, but it is not really necessary. If you are sure she will have self-employment income by tax time you can go ahead and make a 2018 non-deductible contribution for her. As long as you have adopted the one-participant 401k and rolled over the pre-tax IRA balances by 12/31/19, you can do a Roth conversion in 2019 with little to no tax liability.]
Hmmm... Fantastic idea! I found this article: https://www.whitecoatinvestor.com/where ... solo-401k/

Starting the business idea brainstorming this weekend!

bironology
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Re: Roth conversion for backdoor: wait?

Post by bironology » Fri Dec 07, 2018 5:57 am

Thinking about the solo 401k...

DW is a nurse. Currently she is a part-time W2 employee. She gets no benefits, literally just a paycheck. Since that's the case, if she asked her employer to pay her via 1099, then boom - she just became a sole proprietor with real business income and qualifies for a Solo 401k, with no change other than how we file taxes and the fact that she'd need to make estimated quarterly tax payments.

Am I missing anything from this scenario?

bironology
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Re: Roth conversion for backdoor: wait?

Post by bironology » Fri Dec 07, 2018 6:06 am

Getting more excited about the solo 401k option. E*TRADE actually has a Roth option for their Individual 401k plan, and they accept incoming rollovers!

If I'm thinking about this correctly, she would then be able to contribute $19,000 (2019+) after-tax into such a plan. She could also roll her current tIRA into this account, and then additionally backdoor $6,000 into a Roth IRA. This would be fantastic.

Sound right?

marcopolo
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Re: Roth conversion for backdoor: wait?

Post by marcopolo » Fri Dec 07, 2018 7:46 am

bironology wrote:
Fri Dec 07, 2018 5:57 am
Thinking about the solo 401k...

DW is a nurse. Currently she is a part-time W2 employee. She gets no benefits, literally just a paycheck. Since that's the case, if she asked her employer to pay her via 1099, then boom - she just became a sole proprietor with real business income and qualifies for a Solo 401k, with no change other than how we file taxes and the fact that she'd need to make estimated quarterly tax payments.

Am I missing anything from this scenario?
She would then have to pay both halves of Soc Sec and Medicare taxes.

Might also need her own insurance, professional liability, Errors an omissions?

You would have to weigh the costs of those relative to benefit from solo401k.
Once in a while you get shown the light, in the strangest of places if you look at it right.

ivk5
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Re: Roth conversion for backdoor: wait?

Post by ivk5 » Fri Dec 07, 2018 8:11 am

bironology wrote:
Fri Dec 07, 2018 6:06 am
If I'm thinking about this correctly, she would then be able to contribute $19,000 (2019+) after-tax into such a plan.
No. Solo 401k contribution is also limited to ~20% of her self-employment earnings.
Corrected by Spirit Rider below
bironology wrote:
Fri Dec 07, 2018 6:06 am
She could also roll her current tIRA into this account, and then additionally backdoor $6,000 into a Roth IRA.
Yes, assuming you use a Solo 401k that allows inbound rollovers, this part is correct.
Last edited by ivk5 on Fri Dec 07, 2018 10:03 am, edited 1 time in total.

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TomatoTomahto
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Re: Roth conversion for backdoor: wait?

Post by TomatoTomahto » Fri Dec 07, 2018 8:11 am

Don’t let the Roth tail wag the retirement dog.
Zero Net Carbon by 2019.

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gasdoc
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Re: Roth conversion for backdoor: wait?

Post by gasdoc » Fri Dec 07, 2018 8:42 am

My wife is also a nurse- she became certified as a BLS instructor many years ago, and occasionally teaches BLS classes. Your wife could potentially do something like that as a side business.

gasdoc

Spirit Rider
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Re: Roth conversion for backdoor: wait?

Post by Spirit Rider » Fri Dec 07, 2018 10:01 am

ivk5 wrote:
Fri Dec 07, 2018 8:11 am
bironology wrote:
Fri Dec 07, 2018 6:06 am
If I'm thinking about this correctly, she would then be able to contribute $19,000 (2019+) after-tax into such a plan.
No. Solo 401k contribution is also limited to ~20% of her self-employment earnings.
No, the OP might have been incomplete, but you are incorrect. The maximum contributions to self-employed one-participant 401k plan are:

100% of net self-employment earnings (business profit - 1/2 SE tax) up to the employee elective contribution limit (2019 = $19K) and an employer contribution up to 20% of net self-employment earnings not to exceed (net self-employment earnings - employee elective contributions) / 2.

ivk5
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Re: Roth conversion for backdoor: wait?

Post by ivk5 » Fri Dec 07, 2018 10:04 am

Spirit Rider wrote:
Fri Dec 07, 2018 10:01 am
ivk5 wrote:
Fri Dec 07, 2018 8:11 am
bironology wrote:
Fri Dec 07, 2018 6:06 am
If I'm thinking about this correctly, she would then be able to contribute $19,000 (2019+) after-tax into such a plan.
No. Solo 401k contribution is also limited to ~20% of her self-employment earnings.
No, the OP might have been incomplete, but you are incorrect. The maximum contributions to self-employed one-participant 401k plan are:

100% of net self-employment earnings (business profit - 1/2 SE tax) up to the employee elective contribution limit (2019 = $19K) and an employer contribution up to 20% of net self-employment earnings not to exceed (net self-employment earnings - employee elective contributions) / 2.
D'oh. Thanks for the correction; noted above.

lakpr
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Re: Roth conversion for backdoor: wait?

Post by lakpr » Fri Dec 07, 2018 1:32 pm

nolesrule wrote:
Thu Dec 06, 2018 8:55 pm
lakpr wrote:
Thu Dec 06, 2018 8:47 pm

Once the rollover of the pre-tax amounts (from the deductible IRA) are rolled over, then we have only the non-deductible IRA with a clear idea of the basis and the current balance, so that account can be converted into Roth IRA. Ideally the conversion step is done in the year after the rollover is completed.

At least, this is what I had done.
Two points:
1) If your investments lose money, the basis could exceed the balance of what you are calling the non-deductible account. You can't just assume the balance of the one account is less than the pre-tax balance of your IRAs in aggregate at any particular point in time

2) Your basis tracked per Form 8606 is what gives you a clear idea of your basis. Your pre-tax balance is everything else, regardless of the account, which means you can roll everything else into a workplace plan. No need to convert any of the pre-tax growth.
Keep in mind that no 401(k) plan will accept any incoming funds with any basis. Yes what you said is true, but I think you are implying there is no specific advantage to having a separate account for non deductible contributions. I think that is a dangerous assumption if the ultimate end goal is to roll the pretax amounts into a 401(k). I had to certify under penalty of perjury to my plan administrator that all funds I am rolling in are pretax amounts.

nolesrule
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Re: Roth conversion for backdoor: wait?

Post by nolesrule » Fri Dec 07, 2018 10:17 pm

lakpr wrote:
Fri Dec 07, 2018 1:32 pm
nolesrule wrote:
Thu Dec 06, 2018 8:55 pm
lakpr wrote:
Thu Dec 06, 2018 8:47 pm

Once the rollover of the pre-tax amounts (from the deductible IRA) are rolled over, then we have only the non-deductible IRA with a clear idea of the basis and the current balance, so that account can be converted into Roth IRA. Ideally the conversion step is done in the year after the rollover is completed.

At least, this is what I had done.
Two points:
1) If your investments lose money, the basis could exceed the balance of what you are calling the non-deductible account. You can't just assume the balance of the one account is less than the pre-tax balance of your IRAs in aggregate at any particular point in time

2) Your basis tracked per Form 8606 is what gives you a clear idea of your basis. Your pre-tax balance is everything else, regardless of the account, which means you can roll everything else into a workplace plan. No need to convert any of the pre-tax growth.
Keep in mind that no 401(k) plan will accept any incoming funds with any basis. Yes what you said is true, but I think you are implying there is no specific advantage to having a separate account for non deductible contributions. I think that is a dangerous assumption if the ultimate end goal is to roll the pretax amounts into a 401(k). I had to certify under penalty of perjury to my plan administrator that all funds I am rolling in are pretax amounts.
No 401k plan will knowingly accept after-tax funds. But that doesn't mean you can't make the mistake, regardless of certifying under penalty of perjury. My point was that your method doesn't guarantee anything.

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