Rollover of after-tax account from 401(k) to IRA Accounts

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engineer101
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Rollover of after-tax account from 401(k) to IRA Accounts

Post by engineer101 »

I have a 401(k) with my current employer, which includes an after-tax subaccount. This subaccount consists of after-tax contributions and pre-tax earnings on those contributions. Note, the after-tax contributions are NOT Roth 401(k) contributions.

I've initiated a rollover of the entire after-tax subaccount, with the after-tax portion going to a Roth IRA and the pre-tax portion going to a Traditional IRA that I've just opened for this purpose. I have no other Traditional IRA accounts.

My questions are (a) is the rollover of the after-tax amount effectively a backdoor Roth, and (b) if the answer to (a) is yes, do I have to roll the Traditional IRA back into my 401(k) before year-end to avoid the pro-rata rule on the Roth rollover?

Thanks
RetiredAL
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Re: Rollover of after-tax account from 401(k) to IRA Accounts

Post by RetiredAL »

engineer101 wrote: Tue Nov 16, 2021 11:35 pm I have a 401(k) with my current employer, which includes an after-tax subaccount. This subaccount consists of after-tax contributions and pre-tax earnings on those contributions. Note, the after-tax contributions are NOT Roth 401(k) contributions.

I've initiated a rollover of the entire after-tax subaccount, with the after-tax portion going to a Roth IRA and the pre-tax portion going to a Traditional IRA that I've just opened for this purpose. I have no other Traditional IRA accounts.

My questions are (a) is the rollover of the after-tax amount effectively a backdoor Roth, and (b) if the answer to (a) is yes, do I have to roll the Traditional IRA back into my 401(k) before year-end to avoid the pro-rata rule on the Roth rollover?

Thanks
When I retired 6-1/2 yrs ago, the after-tax portion of my 401K was "rolled over" into my Roth and the before-tax portion was rolled over into my roll-over IRA. Being it was a roll-over, not a conversion, the pro-rata rule did not apply.
starfury
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Re: Rollover of after-tax account from 401(k) to IRA Accounts

Post by starfury »

engineer101 wrote: Tue Nov 16, 2021 11:35 pm is the rollover of the after-tax amount effectively a backdoor Roth
Nope, Mega Backdoor Roth. Similar name, different procedure. Pro-rata doesn't apply.
MrJedi
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Re: Rollover of after-tax account from 401(k) to IRA Accounts

Post by MrJedi »

This is mega backdoor Roth.

You don't need to roll traditional IRA back into 401k for this. But you will want to do that if you do the regular backdoor Roth where you contribute to the traditional IRA and the convert it to Roth. Mega backdoor Roth and backdoor Roth are separate strategies and can be done in the same year.
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engineer101
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Re: Rollover of after-tax account from 401(k) to IRA Accounts

Post by engineer101 »

All - thanks for the replies. I should have read the wiki, it's laid out pretty clearly there. So, my rollover is a mega backdoor Roth conversion and pro rata rules don't apply. Since I'm not planning on doing a regular backdoor Roth conversion this year, I'll leave the new Traditional IRA alone for now. But if I want to do a backdoor Roth in the future, the Traditional IRA should be rolled back into my 401(k) first.

Thanks again!
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engineer101
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Re: Rollover of after-tax account from 401(k) to IRA Accounts

Post by engineer101 »

Update - so, I initiated the rollover, with the after-tax contributions going to me as an indirect rollover (check made to me for deposit in a Fidelity Roth IRA) and the after-tax earnings as a direct rollover (check made to Fidelity for deposit in a Fidelity Rollover IRA). Both checks were sent to me.

And...I think they screwed up the indirect rollover. The check stub shows the total amount of after-tax contributions but for some reason includes a small amount flagged as taxable (ordinary income), with 20% of the taxable amount withheld as federal tax. The amount on the check is then the total contribution amount less the taxes withheld. But the amount identified as "nontaxable" is the total amount less the amount flagged as ordinary income. So, I have a check that is mostly, but not entirely, nontaxable, which means I cannot simply deposit the check as-is into the Roth IRA. And to make matters even more confusing, the original after-tax subaccount in my 401(k) now shows nontaxable contributions in the exact amount that was identified on the check as ordinary income.

So, now I'm kind of stuck. I've already contacted my 401(k) plan administrator and they're looking into it, but I'm not confident they'll be able to figure out what happened, and even less sure how they can fix this - the money is already out of the account, and even though I have 60 days to complete the rollover, with Thanksgiving and Christmas coming...I thought I would have plenty of time having started this in early November, but now I get why there's a 60-day limit on the rollover.

For illustration purposes, I'll use the following numbers:
Before rollover:
* Total balance in 401(k) after-tax subaccount = $50000
* Nontaxable contributions in after-tax subaccount = $15000 (this amount for indirect rollover to Roth IRA)
* Earnings = $50000 - $15000 = $35000 (this amount for direct rollover to Rollover IRA)
After rollover:
* "Taxable" portion of indirect rollover check = $75 (flagged as "ordinary income" on check stub)
* Nontaxable portion of indirect rollover check = $15000 - $75 = $14925
* Tax withheld on ordinary income = $15 (20% of $75)
* Check for indirect rollover = $15000 - $15 = $14985
* Check for direct rollover = $35000 (no issues with this part)
* Amount of nontaxable contributions remaining in 401(k) = $75 (same amount as "ordinary income" flagged on indirect rollover check)
* Total amount in 401(k) after-tax subaccount = $50 (same proportion relative to nontaxable as before rollover - $50000/$15000 = $50/$15 = 3.33x)

So, what's the problem?
* The 401(k) now shows $75 as nontaxable contributions, but that same amount was included in the indirect rollover check (though flagged as income) - if this amount was removed from the 401(k), how can it still be in there?! Not to mention that it isn't "income" at all, it's after-tax contributions.
* As noted above, the indirect rollover check includes $75 of "taxable" amounts, so I cannot send this check to the Roth. Do I deposit this in my checking account and write another check for the "correct" amount, i.e., $15000 - $75 = $14925?
* I *think* I can go ahead with the direct rollover, as this amount is not messed up...

Thoughts/advice? As noted above, I have opened a ticket with the 401(k) plan administrator, but they likely won't reply until early Dec.
retiredjg
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Re: Rollover of after-tax account from 401(k) to IRA Accounts

Post by retiredjg »

This is tough to follow. A couple of thoughts come to mind.

It does seem like a mistake on their part, but that is not certain at this point.

Is it possible there is a $75 fee to do this rollover? Some plans do have a fee for this (although $75 seems a little bit high to me). However, that would not explain why the $75 is still in the account (is it still there today?) or why it is considered taxable. This might be something you can look for in your plan's Summary Plan Description over the TG holiday.

I'd hold onto the direct rollover check at least until you hear back from them.

Things do move slowly at this time of year, but the IRS seems to be fairly forgiving (from what I have read) on the 60 day limit if one can show a reason for a delay.
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engineer101
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Re: Rollover of after-tax account from 401(k) to IRA Accounts

Post by engineer101 »

Thanks retiredjg - agree it's hard to follow. The main issue is that a small amount of the after-tax contributions in my 401(k) was flagged as "ordinary income" but was still included in the amount of the check for the indirect rollover. This prevents me from depositing the check as-received from my 401(k) plan into my Roth IRA. There's a related issue that the same amount as the "ordinary income" was left behind in the 401(k).

Good observation on the possibility of fees charged for the rollover. There are no fees shown in the Summary Plan Description for rollovers, although there could still be fees somewhere. I can poke around on the plan website to see if I find anything there. Note that the amounts I used for illustration aren't the actual figures, but they're proportionally the same. The "ordinary income" was not a nice round number, and it's larger than the $75 I used in my previous post.

None of the amounts in question are really that large - I'm mostly concerned about doing something that will cause a big(ger) mess down the road. Agree that I should hold off on the direct rollover until I hear back from the plan.

Thanks again,
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retiredjg
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Re: Rollover of after-tax account from 401(k) to IRA Accounts

Post by retiredjg »

One of the reasons I thought it might be a fee was the nice round number. :happy But most people have reported something closer to $25....so maybe scratch that idea.

Something does seem out of whack. Please let us know what you find out.
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engineer101
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Re: Rollover of after-tax account from 401(k) to IRA Accounts

Post by engineer101 »

Sorry about that - I tried to simplify the post with nice round numbers, but that was probably a little misleading. :o

I did find a separate annual fee disclosure on the plan website - it shows a $5 payment processing fee for loans, withdrawals, or distributions. Not sure if rollovers fall under withdrawals or distributions, but that's still a nice round number and much smaller than the mysterious "ordinary income."

Anyway, I'll post back when this is resolved.
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Eagle33
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Re: Rollover of after-tax account from 401(k) to IRA Accounts

Post by Eagle33 »

Why did you ask for an indirect rollover of the after-tax contribution? My guess for some of the taxable earnings in the indirect rollover amount is gains from start of November to the actual day the check was cut.
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retiredjg
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Re: Rollover of after-tax account from 401(k) to IRA Accounts

Post by retiredjg »

It probably was not "asked for". It may just be the way the plan does it.

As I understand it, the plan must to do a split rollover if requested (after-tax to Roth and pre-tax to tIRA). But they are not required to do a direct rollover for both amounts. So many plans do not...for whatever reason (I don't know why).

It is quite common for the pre-tax portion to be done as a direct rollover and the after-tax amount as an indirect rollover.

It is done that way, instead of the opposite way, because withholding federal taxes would be required for an indirect rollover of pre-tax money. No withholding is required for a rollover of after-tax money.

I think you may be onto something about the earnings and the day the checks were cut.
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engineer101
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Re: Rollover of after-tax account from 401(k) to IRA Accounts

Post by engineer101 »

Agree - the indirect rollover was not something I asked for. They told me the nontaxable portion would be an indirect rollover, but maybe I could have asked for a direct rollover for that part also - next time...

I think eagle33 may be right about the "ordinary income" being earnings on the contributions for a few days between when I made the order and when it was executed. My first thought was why wouldn't this amount just be included in the direct rollover, i.e., taxable portion of the rollover. But I think this didn't happen because they required me to identify the specific amount for the direct rollover to be included in the Rollover IRA.

I don't understand why the plan administrator would insist on a specified amount for the rollover that is by definition not precise, i.e., earnings that would change by the market close every day? The contributions were fixed - I wasn't making any more of them. If they had specified the amount for the indirect rollover (contributions), then the earnings for the direct rollover would just be the total after-tax balance on the day of execution minus the contributions.

But now I wonder if maybe the indirect rollover check is ok after all. The amount of this check is the total after-tax contributions less the taxes paid on the "ordinary income." But since I've just paid taxes on this income, then isn't this amount after-tax along with the after-tax contributions?

Thanks!
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