401k to Roth IRA indirect rollover conversion - urgent question

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MrRE
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Re: 401k to Roth IRA indirect rollover conversion - urgent question

Post by MrRE »

retiredjg wrote: Wed Jan 12, 2022 5:45 pm
MrRE wrote: Wed Jan 12, 2022 4:50 pm Thank you so much retiredjg :happy

I greatly appreciate your kind, thorough explanations, and your patience.

You can tell I'm struggling to communicate clearly sometimes, especially when things go off-topic for me, like mega backdoor.
You may think mega backdoor is off-topic...but what you are doing ACTUALLY IS the mega-backdoor.

It is important that you understand that because this is one of the things that might be stopped in the future, depending on legislation being considered. In other words be sure to ask about that before doing this again.

The mega-backdoor is usually done by a direct rollover but an in-direct rollover will work as well
Thank you retiredjg :happy

Below is a picture showing exactly what I am doing
so it can be compared to
the Bogleheads Mega-Backdoor-Roth Diagram.


This is exactly what I'm doing:
Image


This is the Bogleheads Mega-Backdoor-Roth-Diagram:
Image
Last edited by MrRE on Wed Jan 12, 2022 11:22 pm, edited 1 time in total.
Topic Author
MrRE
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Re: 401k to Roth IRA indirect rollover conversion - urgent question

Post by MrRE »

celia wrote: Tue Jan 11, 2022 11:30 pm Here you go:
MrRE wrote: Tue Jan 11, 2022 5:37 pm
So my 2 big questions holding me back are:

1) Am I breaking any IRS rules by rolling over a partial 401k distribution that contains after-tax contributions into a Roth IRA?

2) Why does the IRS rollover chart just say "pre-tax" for allowed rollovers from 401k's to Roth IRA?
First, any kind of Roth account can be rolled into any other Roth account. And any kind of pre-tax account can be rolled into any other pre-tax account.

(Take a minute and look at the IRS Rollover chart to confirm this is true.)

Then any kind of pre-tax account can be rolled over to a Roth account in what is called a Roth conversion and taxes will be due.

(Confirm this on the chart.)

The only thing that is disallowed is rolling Roth or After-tax funds into a pre-tax account. But why would anyone want to do that since taxes were already paid on that money?)

(Confirm this on the chart.)


Now, let’s look at your money.

There are 3 possible kinds of 401K contributions and an employer plan can allow one, two, or all three of these:
Tax-deferred contributions are pre-tax. Employer contributions are always in this category. All growth from these are also pre-tax.
Roth contributions are post-tax. All growth from these contributions are also post-tax. Some plans allow you to convert pre-tax contributions and growth to post-tax Roth.
After-tax contributions are post-tax too but the growth on them is pre-tax. Many plans that allow these also allow you to transfer out the After-tax contributions to Roth IRAs frequently to enable tax-free growth instead.

I think some others were like me in not knowing if you were referring to “after-tax contributions” or “After-tax contributions” where the first (lower-case) is an adjective referring to both the Roth and After-tax (second and third categories) or you were referring to After-tax (the last category only). This choice of terminology in the field of finances is unfortunate. This is possibly why it is not in the IRS chart—because it could be mis-read easily.

But everyone familiar with IRAs and 401Ks pretty intuitively know what the chart will say. I think it was created to avoid disagreement on the lesser-known types of rollovers.


I will also admit that I almost always hear of someone withdrawing from a 401K with 2 checks, one to be deposited in a Roth IRA, and one to be deposited in a Rollover (traditional) IRA. But you spoke upfront about requesting one check for both types of money. Between that and trying to understand your terminology, I started thinking the one check was due to not being able to do 2 INDIRECT distributions in the same year. (I thought your 401K administrator was sharp in preventing you from making a rollover error.) But now I see that I was wrong on the “INDIRECT” issue.

1) You can rollover either After-tax or after-tax to a Roth IRA. But the first will be partly a Roth conversion if there is any pre-tax money going in. If you are rolling over post-tax money, that part will be an untaxed rollover.

2) In my opinion, it would lead to lots of confusion if there was a row in the chart for “After-tax 401K” as I described.

The chart also has 401Ks split between two lines. The pre-tax parts are included in "Qualified plan (pre-tax)" and are taxed (footnote 3) while the post-tax parts are included in "Designated Roth Account" as a clean rollover (not taxed). Since the chart is flagging when the rollover (ie, Roth conversion) will be taxed, the Traditional 401K would be included in "Qualified plan (pre-tax)", the Roth 401K would be included in "Designated Roth Account", but how would the "After-tax 401K" (upper case) be shown in this chart when the contributions are rolled over tax-free but the growth is yet to be taxed? Is there any rationale for why it CAN'T be rolled over?

If you still don't feel comfortable putting the pre-tax part in the Roth IRA, then put it a Rollover (traditional) IRA instead. But, that will make the distribution be tax-free. Then if you convert it to Roth the next day or in a few months, you will have a Roth conversion that will be taxed this year, instead of last year.

(edited to add to chart rationale)
Thank you very much celia :happy

I can try to understand your explanations about the chart and "Qualified Plan after-tax" being missing.
But the missing after-tax part isn't easy for me at all.


Like I said, the IRS rollover chart is worrying me a lot.

The chart is suppose to show what types of rollovers are allowed.


Besides what I am doing, many many other people want to do backdoor Roth conversions and mega backdoor Roth conversions with after-tax money.

But the chart doesn't say rollover is allowed for "Qualified Plan after-tax" contribution it seems.


My rollover contains "Qualified Plan after-tax" contribution money.

So when I look at the chart I get very worried that "Qualified Plan after-tax" is missing.

I thought maybe I should not rollover the "after-tax contribution" part of my distribution because the IRS chart say only says "Yes" for "Qualified Plan pre-tax".

The IRS chart doesn't even mention "Qualified Plan after-tax".


I emailed the IRS and complained about that several years ago. But they never replied or did anything about it.

I wonder if the IRS is being sneaky by leaving out "Qualified Plan after-tax". They could explain Qualified Plan after-tax in the chart easily. I think they left it out on purpose so people won't think to rollover "Qualified Plan after-tax".


Here is a picture of the chart for all to see.

Image


Below is a picture of exactly what I am rolling over.
Image

Thank you for all the insights. I greatly appreciate it :happy
Last edited by MrRE on Thu Jan 13, 2022 10:15 am, edited 2 times in total.
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retiredjg
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Re: 401k to Roth IRA indirect rollover conversion - urgent question

Post by retiredjg »

MrRE wrote: Wed Jan 12, 2022 9:18 pm Thank you retiredjg :happy

Below is a picture showing exactly what I am doing
so it can be compared to
the Bogleheads Mega-Backdoor-Roth Diagram.
What you have diagramed is a combination of two things - an ordinary Roth conversion and the thing called the mega-backdoor to Roth.

Both of these things are permitted. Your credit union said they will accept the money. I think it is time to put the money in the Roth IRA and move on.
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celia
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Re: 401k to Roth IRA indirect rollover conversion - urgent question

Post by celia »

MrRE wrote: Wed Jan 12, 2022 9:18 pm Below is a picture showing exactly what I am doing so it can be compared to the Bogleheads Mega-Backdoor-Roth Diagram.

This is exactly what I'm doing:
Image
Only your “After-tax account” is the Mega Backdoor Roth. Your “Tradtional (pre-tax)” part just becomes a regular Roth conversion and is covered in the chart under “Qualified Plan (pre-tax)”, which will be completely taxed.

“Qualified Plan (After-tax)” can’t be easily added to the chart because it is partly pre-tax and partly post-tax. How would you indicate the tax considerations in the chart? I think the pre-tax part should be under “Qualified Plan” because it is a Roth conversion (taxable) while the post-tax should be under “Designated
Roth account” (because that part is a rollover), but that is not quite correct either, since it didn’t start in Roth.

If you can come up with the clear, understandable text to add a whole row for “After-tax 401(K)” to the table so the tax considerations are correct and it does not get confused with the generic term “after-tax” which indicates any contributions to any account that were already taxed, I would submit the suggested change to the IRS for you. (I’ve been in contact with a third party company the IRS hired to survey taxpayers and make recommendations back to the IRS.)

But it could be years before it comes out in the chart. (This is very low priority compared to the backlog of processing returns, stimulus checks, lower staff due to Covid, not getting increased funding from Congress, and the very small number of taxpayers it would apply to).
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
Topic Author
MrRE
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Re: 401k to Roth IRA indirect rollover conversion - urgent question

Post by MrRE »

celia wrote: Thu Jan 13, 2022 2:59 pm
MrRE wrote: Wed Jan 12, 2022 9:18 pm Below is a picture showing exactly what I am doing so it can be compared to the Bogleheads Mega-Backdoor-Roth Diagram.

This is exactly what I'm doing:
Image
Only your “After-tax account” is the Mega Backdoor Roth. Your “Traditional (pre-tax)” part just becomes a regular Roth conversion and is covered in the chart under “Qualified Plan (pre-tax)”, which will be completely taxed.

“Qualified Plan (After-tax)” can’t be easily added to the chart because it is partly pre-tax and partly post-tax. How would you indicate the tax considerations in the chart? I think the pre-tax part should be under “Qualified Plan” because it is a Roth conversion (taxable) while the post-tax should be under “Designated Roth account” (because that part is a rollover), but that is not quite correct either, since it didn’t start in Roth.

If you can come up with the clear, understandable text to add a whole row for “After-tax 401(K)” to the table so the tax considerations are correct and it does not get confused with the generic term “after-tax” which indicates any contributions to any account that were already taxed, I would submit the suggested change to the IRS for you. (I’ve been in contact with a third party company the IRS hired to survey taxpayers and make recommendations back to the IRS.)

But it could be years before it comes out in the chart. (This is very low priority compared to the backlog of processing returns, stimulus checks, lower staff due to Covid, not getting increased funding from Congress, and the very small number of taxpayers it would apply to).
Thank you very much celia :happy

I would suggest the IRS add a row to the Rollover Chart (with a "* note" in the notes section) that says:
Qualified Plan (after-tax-contributions*)

Notes section:
* omit after-tax-contribution earnings
Then put a "Yes" in the adjacent box for the "Roth IRA" column.

Thank you for asking :happy
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celia
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Re: 401k to Roth IRA indirect rollover conversion - urgent question

Post by celia »

MrRE wrote: Thu Jan 13, 2022 3:51 pm
I would suggest the IRS add a row to the Rollover Chart (with a "* note" in the notes section) that says:
Qualified Plan (after-tax-contributions*)

Notes section:
* omit after-tax-contribution earnings
Then put a "Yes" in the adjacent box for the "Roth IRA" column.
…but the earnings are taxable or can be rolled over to a pre-tax account.

And what about the rest of the row? And I guess you also need a column for what can roll into it, eg, another After-tax 401k.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
Alan S.
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Re: 401k to Roth IRA indirect rollover conversion - urgent question

Post by Alan S. »

I didn't see a dollar amount for the withholding. Mandatory 20% federal withholding only applies to the taxable portion of a distribution (23k in this case).

Therefore, the withheld amount should have been 4,600. It should NOT have been 10,600. Of course, if this error was made by the 401k administrator, the downside is that you will have to come up with far more than just 4,600 from your other funds to complete this rollover. The net effect of the plan overwithholding is that you are deprived off the use of your funds from the date of the distribution until the date you receive your refund or pay the amount due to the IRS for your full return.

There was also a question about the IRS rollover chart.
Qualified Plan
(Pre tax) The non Roth portion of a QRP can and often does include after tax contributions in addition to the
usual pre tax contributions, matching, and gains. Apparently, pre tax is shown in brackets to pair up with footnote 3 "must include in income". As such the pre tax portion must be included in taxable income, but only when rolled to a Roth account. Footnote 3 does not apply when the distribution is rolled to a non Roth account. The entire balance including after tax amounts can be rolled into either a TIRA or a Roth IRA, but it is a blunder to roll after tax amounts into a TIRA even though it is legal.
Topic Author
MrRE
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Re: 401k to Roth IRA indirect rollover conversion - urgent question

Post by MrRE »

Alan S. wrote: Thu Jan 13, 2022 6:34 pm I didn't see a dollar amount for the withholding. Mandatory 20% federal withholding only applies to the taxable portion of a distribution (23k in this case).

Therefore, the withheld amount should have been 4,600. It should NOT have been 10,600. Of course, if this error was made by the 401k administrator, the downside is that you will have to come up with far more than just 4,600 from your other funds to complete this rollover. The net effect of the plan overwithholding is that you are deprived off the use of your funds from the date of the distribution until the date you receive your refund or pay the amount due to the IRS for your full return.

There was also a question about the IRS rollover chart.
Qualified Plan
(Pre tax) The non Roth portion of a QRP can and often does include after tax contributions in addition to the
usual pre tax contributions, matching, and gains. Apparently, pre tax is shown in brackets to pair up with footnote 3 "must include in income". As such the pre tax portion must be included in taxable income, but only when rolled to a Roth account. Footnote 3 does not apply when the distribution is rolled to a non Roth account. The entire balance including after tax amounts can be rolled into either a TIRA or a Roth IRA, but it is a blunder to roll after tax amounts into a TIRA even though it is legal.
Thank you very much Alan S. :happy

Regarding the withholding on the taxable amount:
Fortunately, the 20% withholding was done correctly for just the pre-tax $23K part of the $53K total distribution.

Regarding my questions about the IRS rollover chart:
Thank you very much for the insights regarding why the IRS might have paired both
1) "Qualified Plan (pre-tax)"
and
2) footnote 3 "must include in income".

That helps me understand better why the IRS may have made the chart the way they did.

I can now see the chart in a new context that hadn't occurred to me originally.
Topic Author
MrRE
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Re: 401k to Roth IRA indirect rollover conversion - urgent question

Post by MrRE »

celia wrote: Thu Jan 13, 2022 4:13 pm
MrRE wrote: Thu Jan 13, 2022 3:51 pm
I would suggest the IRS add a row to the Rollover Chart (with a "* note" in the notes section) that says:
Qualified Plan (after-tax-contributions*)

Notes section:
* omit after-tax-contribution earnings
Then put a "Yes" in the adjacent box for the "Roth IRA" column.
…but the earnings are taxable or can be rolled over to a pre-tax account.

And what about the rest of the row? And I guess you also need a column for what can roll into it, eg, another After-tax 401k.
Thank you very much celia :happy

1) By having a row for "Qualified Plan (pre-tax)", the pre-tax contributions to the 401k and pre-tax earnings are taxed and put in a Roth IRA.

2) By having a row for "Qualified Plan (after-tax-contributions without earnings)", the after-tax contributions to the 401k are put in a Roth IRA without any tax because it's already after-tax and there are no earnings included in that part.


The combination of the two rows 1) and 2) above are what I am doing with my indirect rollover from my 401k distribution to Roth IRA.


Without a row 2) added, I wonder how are people can look at the chart and see that "Qualified Plan (after-tax-contributions without earnings)" is allowed to rollover into a Roth IRA.

So, by adding the row for "Qualified Plan (after-tax-contributions without earnings)", the chart would have the information it is missing now, unless I'm misinterpreting why they list just "Qualified Plan (pre-tax)".


However, maybe I'm just misreading the IRS's intent. Maybe I just need to see things as Alan S. said in his reply above. I'm trying to see the wording in the context he explained. It's a bit challenging for me though. I'll keep trying. :happy
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MrRE
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Re: 401k to Roth IRA indirect rollover conversion - urgent question

Post by MrRE »

retiredjg wrote: Wed Jan 12, 2022 8:35 am At this point, your plan has distributed some money to you. Some is pre-tax and some has already been taxed. I can only think of three things for you to do with it. Only one of these options accomplishes what you want to do.

1. Deposit the check in your bank account and do nothing further. The pre-tax portion will be taxable with your 2021 taxes.

2. Deposit the check in your bank account. Within 60 days, deposit an amount equal to the distribution (including the withholding) into a Roth IRA. This will be an indirect rollover to Roth IRA. The pre-tax portion will be taxable with your 2021 taxes.

3. Deposit the check in your bank account. Within 60 days, deposit an amount equal to the distribution (including the withholding) into a traditional IRA. This will be an indirect rollover to traditional IRA and will also place some basis (already taxed money) in your tIRA. No taxes will be due for 2021. If you then do a Roth conversion of part or all of your tIRA, pro-rating between the pre-tax and after-tax portions will occur and taxes will be due for the year you do the Roth conversion. Pro-rating will occur every time you withdraw or convert money from IRA until your IRA is empty.
Hi retiredjg :happy

I just realized, I now think I have a major major pro-rata issue to consider!!! :oops:


My 401k partial withdrawal I received had a mandatory mix of pre-tax and after-tax that was automatically calculated by my 401k custodian.

My 401k custodian took the number I asked to withdraw and then based the pre-tax/after-tax ratio per my most recent contributions it seems.


Because I had been making after-tax contributions mostly just before I retired, apparently a lot of that after-tax money was in my $53K withdrawal.

It seems the 401k custodian uses a last in, first out kind of rule regarding the type of pre-tax and after-tax mix.


So I think the IRS would be very upset due to their pro-rata rules if I put my entire after-tax part of my recent withdrawal into a Roth IRA.

My withdrawal has way too much after-tax in it compared to my total 401k
:oops:


I think the IRS wants any mix going into a Roth IRA to have the same or lower mix of after-tax divided by total 401k account.


Because my 401k mix is mostly pre-tax, the amount the IRS would allow me to put into the Roth IRA is too small to make it worth bothering.

So I think I should just move the taxable part of my withdrawal into my Roth IRA that came from Qualified Plan (pre-tax).

Then, my rollover will be acceptable per the IRS Rollover Chart for Qualified Plan (pre-tax) to Roth IRA.


Finally I think I have the answer to avoid breaking the IRS rules! :D

I wonder what you all will think about my pro-rata concern and solution :confused
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retiredjg
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Re: 401k to Roth IRA indirect rollover conversion - urgent question

Post by retiredjg »

MrRE wrote: Fri Jan 14, 2022 12:43 pm
retiredjg wrote: Wed Jan 12, 2022 8:35 am At this point, your plan has distributed some money to you. Some is pre-tax and some has already been taxed. I can only think of three things for you to do with it. Only one of these options accomplishes what you want to do.

1. Deposit the check in your bank account and do nothing further. The pre-tax portion will be taxable with your 2021 taxes.

2. Deposit the check in your bank account. Within 60 days, deposit an amount equal to the distribution (including the withholding) into a Roth IRA. This will be an indirect rollover to Roth IRA. The pre-tax portion will be taxable with your 2021 taxes.

3. Deposit the check in your bank account. Within 60 days, deposit an amount equal to the distribution (including the withholding) into a traditional IRA. This will be an indirect rollover to traditional IRA and will also place some basis (already taxed money) in your tIRA. No taxes will be due for 2021. If you then do a Roth conversion of part or all of your tIRA, pro-rating between the pre-tax and after-tax portions will occur and taxes will be due for the year you do the Roth conversion. Pro-rating will occur every time you withdraw or convert money from IRA until your IRA is empty.
Hi retiredjg :happy

I just realized, I now think I have a major major pro-rata issue to consider!!! :oops:


My 401k partial withdrawal I received had a mandatory mix of pre-tax and after-tax that was automatically calculated by my 401k custodian.

My 401k custodian took the number I asked to withdraw and then based the pre-tax/after-tax ratio per my most recent contributions it seems.


Because I had been making after-tax contributions mostly just before I retired, apparently a lot of that after-tax money was in my $53K withdrawal.

It seems the 401k custodian uses a last in, first out kind of rule regarding the type of pre-tax and after-tax mix.


So I think the IRS would be very upset due to their pro-rata rules if I put my entire after-tax part of my recent withdrawal into a Roth IRA.
This is not a problem. You can put anything you want into Roth IRA. You will pay tax on whatever has not been taxed before. You have been told how much is pre-tax and how much is after-tax so you know what to expect to pay tax on.

My withdrawal has way too much after-tax in it compared to my total 401k[/b] :oops:
It is unlikely they have made a mistake. What is most likely is that this check represents a partial withdrawal but it is only from your after-tax account. Remember that the after-tax account contains earnings which are pre-tax. Those earnings MUST come out - in a pro-rated manner - with the after-tax contributions.

I think the IRS wants any mix going into a Roth IRA to have the same or lower mix of after-tax divided by total 401k account.
No. The IRS does not care what goes into your Roth IRA. They only care if you pay tax on whatever has not been taxed before.

Finally I think I have the answer to avoid breaking the IRS rules! :D
Sorry, but no. You have created in your own mind a problem that does not exist.

I wonder what you all will think about my pro-rata concern and solution :confused
There is no pro-rata problem. Just deposit a check in your Roth IRA and stop worrying about this.
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celia
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Re: 401k to Roth IRA indirect rollover conversion - urgent question

Post by celia »

No. Nothing to pro-rate here.

Every pre-tax dollar will be taxed, whether going into Roth or taxable.

Every post-tax dollar can be rolled over to Roth tax-free (or put in taxable).

If you put the money in taxable (checking account) and leave it past the 60-day point, there might be a 10% early withdrawal penalty if you are under 59.5.

Why wouldn’t you want to put it all in Roth as originally planned where it can continue to grow tax-free in the future? I’m afraid you might be thinking of this as just “cash” since you’re moving it temporarily to a credit union, but Roth are the most valuable dollars you have since they have the ability to grow tax-free while they stay in the Roth.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
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celia
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Re: 401k to Roth IRA indirect rollover conversion - urgent question

Post by celia »

OP, you seemed obsessed with the IRS. They don’t lie awake at night worrying about what MrRE is doing. All they care about is if you paid the correct tax owed on your yearly income.

Your custodians will report the distributions (for 2021), confirm the amount of the Roth rollover and the amount of Roth conversions. You or your tax preparer will report the correct amounts and the tax withholding has already been done for 2021.

Why don’t you relax and go for a walk to clear your head. You are imaging things that are not problems. The IRS is not out to get you. Their role is to just collect the correct amount of taxes that you owe, nothing more, just like for the rest of us.

The worst that happens is likely that your 2021 tax return will be mixed in with all of ours in a huge backlog and your tax refund (if one is owed to you) will be delayed just like everyone else’s.

Welcome to today’s normal tax paying season.
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