Solo 401k, pro rata rule and after-tax non-Roth to Roth IRA rollover

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Topic Author
polylily
Posts: 6
Joined: Mon Oct 01, 2012 12:45 am

Solo 401k, pro rata rule and after-tax non-Roth to Roth IRA rollover

Post by polylily »

Let's say there is a custom Solo 401k plan that allows after-tax non-roth contribution and in-service distribution, and that the funds in the Solo 401k are kept in separate sub-accounts, i.e. separately brokerage accounts for Pre Tax, Roth, and After-Tax Non-Roth.

It's a little confusing to me if the Roth IRA conversion of the after-tax funds requires distribution from the entire Solo 401k, if there are also funds in the Pre Tax bucket.

Per IRS (https://www.irs.gov/retirement-plans/ro ... ment-plans):
No, you can’t take a distribution of only the after-tax amounts and leave the rest in the plan. Any partial distribution from the plan must include some of the pretax amounts. Notice 2014-54 doesn’t change the requirement that each plan distribution must include a proportional share of the pretax and after-tax amounts in the account. To roll over all of your after-tax contributions to a Roth IRA, you could take a full distribution (all pretax and after-tax amounts)
Fidelity seems to say that this is not true (https://www.fidelity.com/viewpoints/ret ... r-guidance) but I can't find an IRS source that confirms it:
If the plan allows partial withdrawals and does track each source balance separately, one could take a rollover of just the after-tax source balance, which includes both the after-tax contributions and all of the associated earnings. Again, the after-tax balance would go to a Roth IRA while earnings would go to a traditional IRA.
Question: does this mean that in order to roll over all the after-tax non-Roth fund to Roth IRA, one has to also take a distribution from the pre-tax bucket? Or in another word, does mega backdoor Roth only works if the Solo 401k only contains after-tax funds?

Another unrelated Solo 401k question: the pre-tax portion of Solo 401k can have sources with different distributable natures, i.e. employee elective, employer cost sharing, rollover from other 401k accounts. How do people typically separate earnings from different sources, if the funds are used to buy the same stock? Is it beneficial to opening more sub-accounts for these different sources as well, or would it be an overkill and unnecessary hassle? What are bad things that could happen if the funds from these different sources are mixed together?

I've learned a lot from reading about Solo 401k in this forum. Thanks for helping out more :sharebeer
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Tamarind
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Re: Solo 401k, pro rata rule and after-tax non-Roth to Roth IRA rollover

Post by Tamarind »

There's no contradiction between your two docs. The earnings on the after-tax funds are "pre-tax amounts" even though they are in the after tax account. The IRS is saying you may not move only your after-tax contributions, but must include earnings in that distribution.

If you perform your in-service distributions regularly, there will not be much in earnings.
retiredjg
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Joined: Thu Jan 10, 2008 12:56 pm

Re: Solo 401k, pro rata rule and after-tax non-Roth to Roth IRA rollover

Post by retiredjg »

That IRS wordage has been discussed many times. I don't know if it is wrong or poorly written or what.

What is apparent is that you are allowed to roll out to Roth or roll over to Roth 401k your after-tax account (which includes after-tax contributions and pre-tax earnings that may have occurred) without disturbing the rest of the plan. Numerous posters have reported doing just that for years.

For your second question, I've seen people list different accounts they set up for this purpose, but I'm not sure they have gone as far as that many different sources. Good question for your TPA if you have one. Since you are asking here, I suspect you don't. :happy
ef11
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Joined: Sat Mar 10, 2012 10:39 pm

Re: Solo 401k, pro rata rule and after-tax non-Roth to Roth IRA rollover

Post by ef11 »

I have the exact setup you describe with three separate Fidelity accounts for Pre-tax, Roth, and After-tax.

I simply move a lump sum amount to After-tax, and then move from After-tax to Roth in the same day so there is absolutely no earnings on the money to simplify things.

When I was at a MegaCorp, I always rolled from After-tax to Roth IRA, but now that I have a Solo I have started moving from After-tax to Solo 401k Roth in case I want to self-direct some of those funds in the future. At some point I may switch back to After-tax to Roth IRA for friendlier Roth distributions at a later point. I am only 32, so I have plenty of time to beef up both Solo 401k Roth and Roth IRA. I think having large balances in both Roth accounts will give me more flexibility later in life.
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Kookaburra
Posts: 486
Joined: Thu Apr 02, 2020 11:14 pm

Re: Solo 401k, pro rata rule and after-tax non-Roth to Roth IRA rollover

Post by Kookaburra »

ef11 wrote: Mon Jan 11, 2021 10:58 am I have the exact setup you describe with three separate Fidelity accounts for Pre-tax, Roth, and After-tax.

I simply move a lump sum amount to After-tax, and then move from After-tax to Roth in the same day so there is absolutely no earnings on the money to simplify things.

When I was at a MegaCorp, I always rolled from After-tax to Roth IRA, but now that I have a Solo I have started moving from After-tax to Solo 401k Roth in case I want to self-direct some of those funds in the future. At some point I may switch back to After-tax to Roth IRA for friendlier Roth distributions at a later point. I am only 32, so I have plenty of time to beef up both Solo 401k Roth and Roth IRA. I think having large balances in both Roth accounts will give me more flexibility later in life.
I thought Fidelity didn’t offer a Roth solo 401k option. Did that change recently?
ef11
Posts: 304
Joined: Sat Mar 10, 2012 10:39 pm

Re: Solo 401k, pro rata rule and after-tax non-Roth to Roth IRA rollover

Post by ef11 »

Kookaburra wrote: Mon Jan 11, 2021 11:32 am
ef11 wrote: Mon Jan 11, 2021 10:58 am I have the exact setup you describe with three separate Fidelity accounts for Pre-tax, Roth, and After-tax.

I simply move a lump sum amount to After-tax, and then move from After-tax to Roth in the same day so there is absolutely no earnings on the money to simplify things.

When I was at a MegaCorp, I always rolled from After-tax to Roth IRA, but now that I have a Solo I have started moving from After-tax to Solo 401k Roth in case I want to self-direct some of those funds in the future. At some point I may switch back to After-tax to Roth IRA for friendlier Roth distributions at a later point. I am only 32, so I have plenty of time to beef up both Solo 401k Roth and Roth IRA. I think having large balances in both Roth accounts will give me more flexibility later in life.
I thought Fidelity didn’t offer a Roth solo 401k option. Did that change recently?
My plan is not actually through Fidelity. I use MySolo401k to establish my plan and the Fidelity accounts are all "Non-prototype Retirement Accounts" with separate designations for Pre-tax, Roth, and After-tax. So it is not the standard Fidelity Solo 401k, as the standard Fidelity plan does not allow for the Mega Backdoor or self-directing as far as I know.
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Topic Author
polylily
Posts: 6
Joined: Mon Oct 01, 2012 12:45 am

Re: Solo 401k, pro rata rule and after-tax non-Roth to Roth IRA rollover

Post by polylily »

That IRS wordage has been discussed many times. I don't know if it is wrong or poorly written or what.
Good to know that I'm not the only getting tripped up on the language!
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