Backdoor Roth IRA question

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Topic Author
ThisDinosaur
Posts: 54
Joined: Wed Mar 08, 2017 1:53 pm

Backdoor Roth IRA question

Post by ThisDinosaur » Sat Nov 30, 2019 3:50 pm

Should I move funds from my Traditional IRA into my employer-sponsored 401(k), so that I can take advantage of the Backdoor Roth IRA?

Details:

I am currently employed as a W2, and my income makes me ineligible to contribute directly to a Roth IRA.

My retirement assets include:

401(k) valued at ~ 132K - [employer sponsored]
IRA#1 = 62K [composed entirely of funds rolled over from a Previous employer-sponsored 401(k)]
IRA#2 = 17K [composed entirely of nondeductible after tax money]
IRA#3 = 35K [in my non-working Spouse's name, also from my after tax money]

I haven't been using the Backdoor Roth option because of the existence of those IRAs. Someone recently told me that I should move all funds from IRA #1 into my current employer sponsored 401(k), and then move IRA#2 and IRA#3 into Roth IRAs.

Do you agree with this plan? Why or why not?

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whodidntante
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Re: Backdoor Roth IRA question

Post by whodidntante » Sat Nov 30, 2019 3:54 pm

I would unless your 401k is incredibly expensive (high ERs, high plan fees paid by you). If you don't currently max your pre-tax contributions, and you do not currently max an HSA (if eligible), doing those things would be more impactful at your marginal tax rate.

HomeStretch
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Re: Backdoor Roth IRA question

Post by HomeStretch » Sat Nov 30, 2019 3:57 pm

A backdoor Roth can be advantageous for high earners.
https://www.bogleheads.org/wiki/Backdoor_Roth

If your 401k accepts rollovers in and has good low-cost fund choices, your plan to rollover IRA #1 into your 401k makes sense. Converting the basis in IRA #2 and #3 to Roth IRAs also makes sense as Roth accounts grow tax-free.

MarkBarb
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Re: Backdoor Roth IRA question

Post by MarkBarb » Sat Nov 30, 2019 4:02 pm

Your spouse can convert their IRA to a Roth without worrying about your IRAs. They can also contribute to a non-deductible IRA and convert it to a Roth every year. They can do this all with money that you have earned.

That leaves the other two. Your plan to move your rollover IRA into your 401K will work. The two things you need to consider are whether the tax hit on the conversion of IRA #2 is worth opening up another backdoor path. The other thing to consider is whether you could accomplish what you want via a Megabackdoor Roth and not worry about IRA #2. In fact, you should check on the mega before moving the rollover. Some plans require distributions from money transferred into the plan before distribution after-tax contributions. In that case, moving IRA #1 into the 401K would get in the way of doing a mega.

Topic Author
ThisDinosaur
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Joined: Wed Mar 08, 2017 1:53 pm

Re: Backdoor Roth IRA question

Post by ThisDinosaur » Sat Nov 30, 2019 5:09 pm

MarkBarb wrote:
Sat Nov 30, 2019 4:02 pm
The other thing to consider is whether you could accomplish what you want via a Megabackdoor Roth and not worry about IRA #2. In fact, you should check on the mega before moving the rollover. Some plans require distributions from money transferred into the plan before distribution after-tax contributions. In that case, moving IRA #1 into the 401K would get in the way of doing a mega.
Tell me more about the Mega Backdoor Roth. Not familiar with it.


Also, not to sidetrack my own thread, but:

I understand 401(k)s have stronger creditor protection than IRAs. Will going through with this plan [transferring IRA#1 into 401(k)] "contaminate" the whole 401(k) and open me up to any future lawsuits?
Remember, IRA#1 was a rollover from an old 401(k), and I've never put after tax money in there for the above reason.

lakpr
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Re: Backdoor Roth IRA question

Post by lakpr » Sat Nov 30, 2019 5:37 pm

ThisDinosaur wrote:
Sat Nov 30, 2019 5:09 pm
Tell me more about the Mega Backdoor Roth. Not familiar with it.
A Mega Backdoor Roth is a maneuver where, you contribute After-tax (not Roth!! Important distinction) money to the 401k plan, and then immediately convert to Roth 401k or Roth IRA. Just like non-deductible money in traditional IRA gets converted to Roth IRA in backdoor Roth, so does non-deductible after-tax contributions to 401k plan get converted to Roth 401k or Roth IRA. The difference is the limit.

Several requirements:

1. The 401k plan must allow after-tax contributions. Not all plans do. You need to get hold of the Summary Plan Document for your specific employer plan, and assuming it is in a PDF or other electronic form, search for the words "after-tax" or "after tax" in it.
2. You must be eligible for it. The after-tax contribution facility is very likely to be used only by high-earners, and therefore subject to ADP (Anti Discrimination Provision) testing even in Safe-Harbor plans. The dice may fall just that way to possibly exclude you from participating.
3. There should be a provision to either convert the funds to a Roth 401k sub account within the plan (Mega Backdoor Flavor 1)
OR
there should be a provision to roll the after-tax funds to an external Roth IRA (Mega Backdoor Flavor 2)

The term to search for in your Summary Plan Document for condition 3 is "In Plan Roth Rollover" or "In Service Distribution". Note that with In-Service Distribution, there are again two flavors, one is where for folks aged more than 55 distributions from the plan are permissible. That's not the provision you should be looking for, look if your plan allows in-service distributions of after-tax contributions to external Roth IRAs, for people of all ages. You might also get lucky with the key words "Distributable Assets" or "Distributable Funds"

The amount you can contribute to after-tax 401k is limited by the IRS. The sum total of all your pre-tax contributions + Roth contributions + Employer match which is always pre-tax + After-tax contributions = $57k. Your own plan may limit the after-tax contributions further, for example my MegaCorp does not allow more than 10% after-tax contributions.

Once you have these building blocks in place, all you need to do is contribute to after-tax sub-account in your 401k plan, and just days after the contribution, convert it to Roth (either via In-Plan Roth Rollover or via In-Service-Distribution to an external Roth IRA). Note that your plan can ALSO limit the number of such Roth-Rollovers or Distributions-to-Roth, and also impose fees (such as $25 for each external Roth-IRA rollover).
ThisDinosaur wrote:
Sat Nov 30, 2019 5:09 pm
Also, not to sidetrack my own thread, but:

I understand 401(k)s have stronger creditor protection than IRAs. Will going through with this plan [transferring IRA#1 into 401(k)] "contaminate" the whole 401(k) and open me up to any future lawsuits?
Remember, IRA#1 was a rollover from an old 401(k), and I've never put after tax money in there for the above reason.
Nope, no "contamination". Once you are able to successfully rollover the IRA#1 to your current employer 401k plan, the funds accrue the characteristics of the target account, in this case the 401k. So those IRA funds, now in 401k, will also be afforded the ERISA creditor protections.

Your plan will have to track these roll overs separately within the plan. Remember that if the funds within the 401k are less than $5000 and you leave the job, the ex-employer CAN force you out of the plan. IRS rules prohibit employers from doing so (expelling ex-employees from 401k plan) if the balance is $5001 or more. The plan can choose NOT to count the rollover assets towards the $5000 balance, and require that the $5000 must be contributed while employed there.

That is about the only thing I can see different between the in-plan contributions and rollovers-to-the-plan funds. In every other aspect, they confirm to the rules of the 401k plan.

Topic Author
ThisDinosaur
Posts: 54
Joined: Wed Mar 08, 2017 1:53 pm

Re: Backdoor Roth IRA question

Post by ThisDinosaur » Mon Dec 02, 2019 12:38 pm

lakpr wrote:
Sat Nov 30, 2019 5:37 pm
A Mega Backdoor Roth is a maneuver where, you contribute After-tax (not Roth!! Important distinction) money to the 401k plan, and then immediately convert to Roth 401k or Roth IRA. Just like non-deductible money in traditional IRA gets converted to Roth IRA in backdoor Roth, so does non-deductible after-tax contributions to 401k plan get converted to Roth 401k or Roth IRA. The difference is the limit.
Thank you, lakpr, for the explanation. As it happens, I am doing this. But I didnt know it was called a Mega Backdoor. Specifically, I am contributing 2% of my salary After Tax to the 401(k) in addition to the maximum employee contribution. (No employer match is offered.)
I haven't rolled the funds into a Roth yet, but was planning on doing so before year end. While ALSO doing the IRA#1=>401k rollover.

Which brings me back to:
MarkBarb wrote:
Sat Nov 30, 2019 4:02 pm
In fact, you should check on the Mega before moving the rollover. Some plans require distributions from money transferred into the plan before distribution after-tax contributions. In that case, moving IRA #1 into the 401K would get in the way of doing a mega.
So, does that mean I have to do Either/Or? I can't (or shouldn't) do both?
Last edited by ThisDinosaur on Tue Dec 03, 2019 9:50 am, edited 1 time in total.

lakpr
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Joined: Fri Mar 18, 2011 9:59 am

Re: Backdoor Roth IRA question

Post by lakpr » Mon Dec 02, 2019 12:48 pm

ThisDinosaur wrote:
Mon Dec 02, 2019 12:38 pm
lakpr wrote:
Sat Nov 30, 2019 5:37 pm
A Mega Backdoor Roth is a maneuver where, you contribute After-tax (not Roth!! Important distinction) money to the 401k plan, and then immediately convert to Roth 401k or Roth IRA. Just like non-deductible money in traditional IRA gets converted to Roth IRA in backdoor Roth, so does non-deductible after-tax contributions to 401k plan get converted to Roth 401k or Roth IRA. The difference is the limit.
Thank you, lakpr, for the explanation. As it happens, I am doing this. But I didnt know it was called a Mega Backdoor. Specifically, I am contributing 2% of my salary After Tax to the 401(k) in addition to the maximum employee contribution. (No employer match is offered.)
I haven't rolled the funds into a Roth yet, but was planning on doing so before year end. While ALSO doing the IRA#2=>401k rollover.

Which brings me back to:
MarkBarb wrote:
Sat Nov 30, 2019 4:02 pm
In fact, you should check on the Mega before moving the rollover. Some plans require distributions from money transferred into the plan before distribution after-tax contributions. In that case, moving IRA #1 into the 401K would get in the way of doing a mega.
So, does that mean I have to do Either/Or? I can't (or shouldn't) do both?
You CAN do both, but with the Mega Backdoor Roth, you are not constrained by a pro-rata rule. The bigger limits also are usually big enough to absorb every bit of investment dollar for a vast majority of folks. Given that you have the availability, why are you contributing only 2%? Why not 10%? 20%? What's the limit that your plan has for after-tax contributions?

Topic Author
ThisDinosaur
Posts: 54
Joined: Wed Mar 08, 2017 1:53 pm

Re: Backdoor Roth IRA question

Post by ThisDinosaur » Tue Dec 03, 2019 10:11 am

@lakpr

2% is the max the employer allows for after tax 401K contributions.

Okay, so I am going to do both:

1)Backdoor Roth:
Transfer old pretax IRA into pretax current 401k.
Then convert all post tax IRAs to Roths, taking a tax hit on the gains there.

2)Mega Backdoor Roth:
Convert After Tax 401K funds to new Roth IRA, paying tax on any gains there as well.

Assuming no employer restrictions on in service rollovers.

Am I missing anything?

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