Mega Backdoor Roth - No In Service Distribution Option

[diydocwifejd]

My company's mega backdoor roth does not offer an in service distribution option, although we can set up automatic conversions. I'm trying to understand what this means, and whether I should participate.

Our HHI is roughly $1M - we already max out all of our tax advantaged spaces, HSA, backdoor roth, and approx $120,000 per year in a taxable. We are 36 and 37 and plan to work until we are both 50 at the latest. We have $1M in investments. We are already in the highest bracket and we save roughly $300k/year. Since we will be retired by 50, we will use our taxable account to get us to 59.5.

My work plan offers a mega backdoor roth. We can do automatic in plan conversions (which I have set up - have not started contributing yet until I max out my trad 401k). I plan to contribute roughly $40k to MBR this year.

What are the benefits of an MBR even if we are only allowed to do in plan conversions instead of the option of in service distributions? My plan is to roll that money to a Roth IRA once I leave the company (although I think - plz confirm) that I would be taxed on the earnings once I did that.

1) Should I still contribute to the MBR in my circumstances even though I don't have the option to do in service distribution to IRA? What are the pros/cons?
2) Once I leave my company in 5-10 years, should I still roll that money to an IRA even if taxed on the earnings?
3) Is the main benefit of rolling to Roth IRA versus 401k so that I don't have RMDs? Is that the main benefit?
4) If I left that money in the roth 401k when I retire, would the earnings still be taxable?

I'm getting super confused by all of this. I think in my circumstances it would have been WAY easier if my company offered in service distribution. Alas, they don't, so now I'm very very very confused.

[MrJedi]

If you have good fund options, then in plan conversion to Roth 401k is just as good as rollover to Roth IRA, sometimes even better. Earnings are not taxed in a Roth 401k.

Also Roth 401k does not have RMD anymore due to the new SECURE 2.0

I have access to both strategies but choose the Roth 401k route because automatic conversions are super convenient and really minimize any potential taxable earnings before the conversion. I have good fund options in my 401k.

[Alan S.]

What are the benefits of an MBR even if we are only allowed to do in plan conversions instead of the option of in service distributions? My plan is to roll that money to a Roth IRA once I leave the company (although I think - plz confirm) that I would be taxed on the earnings once I did that.

1) Should I still contribute to the MBR in my circumstances even though I don't have the option to do in service distribution to IRA? What are the pros/cons?

Yes, but perhaps not as much if there is a decent chance you will need to tap this money while still working there. Or if the plan offers loans, you might apply if the need is that great.

2) Once I leave my company in 5-10 years, should I still roll that money to an IRA even if taxed on the earnings?

To a Roth IRA. A Roth to Roth rollover is not taxed even if there are earnings in the rollover. But you must update your Roth IRA basis so you will be able to report any distribution you need to take from the Roth IRA before it is qualified. Your Roth IRA basis is increased by the amount you contributed to the Roth 401k including IRRs (in plan Roth rollovers), which is the technical term for MBR.

3) Is the main benefit of rolling to Roth IRA versus 401k so that I don't have RMDs? Is that the main benefit?

Those RMDs have been eliminated, but another benefit is that if you need a distribution, a NQ Roth 401k distribution pro rates the earnings with the basis resulting in the earnings being taxed and subject to penalty if under 59.5. With a Roth IRA the taxation rules known as the "ordering rules" treats your contributions as distributed first and earnings last. So if you take out a modest portion, that distribution will be tax free. Again, you must keep track of your Roth IRA basis, whether you rolled a Roth 401k into it or not.

4) If I left that money in the roth 401k when I retire, would the earnings still be taxable?

Yes, until the Roth 401k became "qualified". That occurs after you reach 59.5 and have first contributed at least 5 years ago.

[Spring garden]

Have no fear. Your workplace plan is very good assuming it has a couple good fund options. I would use it for MBR.
Once you contribute to the posttax plan, the earnings on those contributions will be subject to tax until they are converted to roth 401k, then they will never be taxed again assuming you don't retire/begin withdrawing in the next 5 years. With automatic conversions this should be trivial additional tax liability

It sounds like you are planning on switching from pretax to posttax/roth once you have reached pretax limit for the year. Sounds like a pain each year.
One alternative option is to divide your pretax contributions and posttax/roth contributions up to be a fixed amount each month. For example if paid monthly, $1875 pretax and $3,333 posttax/eventual roth conversions.

There are two other pitfalls you didnt ask about but should be aware of if you are not already.

1) maximum 401k contribution limit for this employer (415(c)(1)(A) limit) is I think 66K for 2023. This means the sum of your pretax/traditional 401k, employer contributions, posttax contributions (which you convert to roth) and roth contributions (which you aren't making directly) can't exceed that limit. If you put in 22.5k traditional and 40k posttax/MBR that only leaves 3.5k for employer contributions. How much do you expect your employer match to be for this employer for 2023? If higher than 3.5K you may need to decrease your posttax just a little. If you have multiple employers and retirement plans the rules are more complex and seek to learn more about this.

2) posttax contributions may be subject to nondiscrimination testing even if your plan is not otherwise due to safe harbor provisions. It is common to have limit for posttax contribution for "highly compensated employees (HCE)". This is highly variable by company. Some companies are proactive and have rules that say you can only contribute 6% or some percentage of compensation posttax. They do this because if all the HCE contributed more it would fail nondiscrimination testing and some portion of your contributions would need to be returned to you. Good news, with your compensation a % limit may not limit your contributions that much if at all.
Ask your HR rep if your plan has a limit on posttax contributions for HCE, or if the plan has ever failed testing requiring posttax contributions to be returned to you.

[retiredjg]

1) Should I still contribute to the MBR in my circumstances even though I don't have the option to do in service distribution to IRA? What are the pros/cons?

Yes. Roth is better than taxable.

2) Once I leave my company in 5-10 years, should I still roll that money to an IRA even if taxed on the earnings?

Yes, you should do this rollover. No you will NOT be taxed on the earnings at the time of the rollover. If you leave the earnings in Roth IRA long enough, you will not be taxed on them at all.

3) Is the main benefit of rolling to Roth IRA versus 401k so that I don't have RMDs? Is that the main benefit?

Not the main benefit. There is no downside to rolling to Roth IRA. The main benefit is that Roth IRA has more favorable rules for withdrawing money.

4) If I left that money in the roth 401k when I retire, would the earnings still be taxable?

You are off on the wrong track here. There is no need to leave the money in Roth 401k although you can if you want to wait for the Roth 401k to be "qualified".

I'm getting super confused by all of this. I think in my circumstances it would have been WAY easier if my company offered in service distribution. Alas, they don't, so now I'm very very very confused.

What your company is doing is to your benefit, not to your detriment.



Roth IRA has 3 buckets of money. You take from bucket 1, when all that is exhausted, you go to bucket 2. When that is exhausted, you go to bucket 3.

bucket 1 = direct contributions (and contributions to Roth 401k if rolled into Roth IRA)

Bucket 2 = conversions

Bucket 3 = earnings that occur inside the Roth IRA


When your money gets rolled into Roth IRA, the contributions roll into the contributions bucket of the Roth IRA (bucket 1). The earnings are rolled into earnings (bucket 3).

The earnings will not be taxed unless you withdraw them before your Roth IRA is "qualified". For Roth IRA, "qualified" means you are over 59.5 years old and your first contribution to Roth IRA was more than 5 tax years ago.

[neurosphere]

What are the benefits of an MBR even if we are only allowed to do in plan conversions instead of the option of in service distributions? My plan is to roll that money to a Roth IRA once I leave the company (although I think - plz confirm) that I would be taxed on the earnings once I did that.

Others may have addressed this, but for the purposes of "mega" backdoor Roth the "in-service distribution" element is essentially identical as an "in-service" conversion.

It's the "in-service" part that's the beneficial part. Whether the Roth money ends up in an IRA (i.e. outside of the plan) or stays in a Roth account within the plan is relatively incidental/meaningless from a financial standpoint.

Once the after-tax money ends up in the Roth 401k and/or Roth IRA, all future earnings are tax free. I actually PREFER to keep the Roth dollars "in-plan" because that helps with corrections should mistakes happen (e.g. excess contributions, HCE corrections, etc).

By my definition, you have a "MBR".