Questions on Mega BackDoor Roth IRA

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catmeow
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Joined: Sat Sep 08, 2018 9:30 am

Questions on Mega BackDoor Roth IRA

Post by catmeow »

Hello all,

I've been doing some research on the Mega BackDoor Roth IRA but have a few questions about it.

1) It seems that the key here is you must contribute "After Tax" funds to your 401k. Some of the websites I looked at made it sounds like you must first max out your pretax money in order to contribute to the after tax category. However, if your employer/401k plan allows you to directly contribute to the after tax category, there's no need to contribute to anything else (ie requirement to max out pretax), correct?

2) It looks like the total 401k contribution limit is $55k. This would include any pre-tax, post-tax, and Roth 401k contributions. However, does this limit also include employer contributions?

3) Once I have my post tax 401k money invested in the 401k, I ultimately now want to transfer it to a Roth IRA. I've been reading about the Roth IRA backdoor. Do I first need to transfer the 401k post tax money to a traditional IRA and then later to a Roth IRA? Or can the transfer directly be done to a Roth IRA?

4) In either of the above scenarios, I must at this time pay taxes on any earnings that the investment has made, correct? Taxes on the principal were already paid at 401k post-tax contribution time so they have already been handled, correct?

5) The combined (traditional and Roth) IRA limits for 2018 are $5,500 (https://www.irs.gov/retirement-plans/pl ... ion-limits ($6,500 for those 50 and older). I'm confused when reading people talking about how they seem to put in more money to their IRA with the backdoor than this. Whatever we do, aren't we still subject to this limit?

6) Finally, are there limits on how often these contributions/transfers can be made? In order to minimize taxes, it would seem ideal to transfer the money immediately upon it being placed in the 401k (to avoid taxes on gains). Can this be done, say, every two weeks?
CppCoder
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Re: Questions on Mega BackDoor Roth IRA

Post by CppCoder »

catmeow wrote: Sat Sep 08, 2018 9:53 am Hello all,

I've been doing some research on the Mega BackDoor Roth IRA but have a few questions about it.

1) It seems that the key here is you must contribute "After Tax" funds to your 401k. Some of the websites I looked at made it sounds like you must first max out your pretax money in order to contribute to the after tax category. However, if your employer/401k plan allows you to directly contribute to the after tax category, there's no need to contribute to anything else (ie requirement to max out pretax), correct?
Correct, you don't have to contribute to the pretax first if your plan allows designated after tax contributions. However, is that measurably better to you than just contributing to a Roth 401k account instead of messing with the after tax account and in-service withdrawal? Yes, they are different, and you may prefer the IRA route (e.g., if your 401k funds are really expensive). Keep in mind that some plans match the Roth election but not the after tax contribution.
2) It looks like the total 401k contribution limit is $55k. This would include any pre-tax, post-tax, and Roth 401k contributions. However, does this limit also include employer contributions?
The $55k is everything you + employer contribute. Be aware there are also income limits if your salary exceeds $275k/year.
3) Once I have my post tax 401k money invested in the 401k, I ultimately now want to transfer it to a Roth IRA. I've been reading about the Roth IRA backdoor. Do I first need to transfer the 401k post tax money to a traditional IRA and then later to a Roth IRA? Or can the transfer directly be done to a Roth IRA?
Assuming your plan allows it, you can send the whole after tax to the Roth IRA and pay taxes on any gains, or you can send the earnings to a tIRA and the contribution to a Roth IRA.
4) In either of the above scenarios, I must at this time pay taxes on any earnings that the investment has made, correct? Taxes on the principal were already paid at 401k post-tax contribution time so they have already been handled, correct?
See above. You can split earnings from contributions. If your plan is nice, you can even roll your tIRA back into your 401k to avoid polluting the "regular" backdoor IRA.
5) The combined (traditional and Roth) IRA limits for 2018 are $5,500 (https://www.irs.gov/retirement-plans/pl ... ion-limits ($6,500 for those 50 and older). I'm confused when reading people talking about how they seem to put in more money to their IRA with the backdoor than this. Whatever we do, aren't we still subject to this limit?
The $5,500 limit is for annual contributions to the IRA (tIRA or Roth IRA). The mega backdoor is not a contribution to an IRA; it is a rollover. The contributions are limited by the (e.g., $55k) 401k limits.
6) Finally, are there limits on how often these contributions/transfers can be made? In order to minimize taxes, it would seem ideal to transfer the money immediately upon it being placed in the 401k (to avoid taxes on gains). Can this be done, say, every two weeks?
This is based on your plan, not the law. Check with your 401k provider.
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FiveK
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Re: Questions on Mega BackDoor Roth IRA

Post by FiveK »

For most people who can afford to contribute the $55K, using the first $18.5K for pre-tax (aka traditional) contributions will work best in the long run.
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Earl Lemongrab
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Re: Questions on Mega BackDoor Roth IRA

Post by Earl Lemongrab »

Plans certainly can allow after-tax before hitting the limit for deferrals, or even skipping the latter. That can be good for those who have used some or all of the 18.5k for a prior plan or solo plan for side work.

Some plans have a cap on contributions per pay period. At Megacorp it was 30% of salary. That prevented me from maxing the Mega. What I used to do was put contributions to pretax at 30%. When the deferral limit was reached it would switch to after-tax automatically. I could have done a mix through the year, but I preferred to have the AT accumulate at the end of the year for rollover early the next year.

Some plans charge a fee for generating the rollover. Depending on how much, that can make frequent rollovers detrimental.
Spirit Rider
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Re: Questions on Mega BackDoor Roth IRA

Post by Spirit Rider »

  1. If and under what circumstances you can make employee after-tax contributions is at the discretion of the employer plan.
  2. Yes, the annual addition limit (2018 = $55K) includes all employee + employer contributions. Ask about uncommon but complicating employer forfeitures and QNEC contributions.

    Note: It is best if you use the IRS terminology for employee contributions to avoid confusion: employee deferrals (pre-tax), employee Roth contributions (post-tax) and employee after-tax contributions. While employee after-tax contributions are also technically "post-tax", employee after-tax contributions are what they are called.
  3. No, this is the beauty of employee after-tax contributions. They can be rolled over directly to a Roth IRA. The earnings on after-tax contributions can either also be rolled to a Roth IRA (subject to taxation) or rolled over to a traditional IRA or another employer's plan. Also, if your plan allows an In-plan Roth Rollover (IRR), the after-tax contributions and earnings (subject to taxation) can both be rolled over to your Roth 401k account.
  4. You have a tax liability at the time of a rollover of earnings on after-tax contributions subject to standard withholding and estimated tax requirements.
  5. Rollovers are never subject to ordinary contribution limits.
  6. The ability to even do rollovers and their frequency are subject to plan rules. Some plans charge for rollovers and/or limit the frequency to once/year. Frequent rollovers can be a challenge when a check has to be mailed to your IRA custodian. It is best if your plan custodian and your IRA custodian are the same or when doing IRRs. They can often be accomplished quickly with a phone call.
JBTX
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Re: Questions on Mega BackDoor Roth IRA

Post by JBTX »

Spirit Rider wrote: Sat Sep 08, 2018 1:33 pm
  1. If and under what circumstances you can make employee after-tax contributions is at the discretion of the employer plan.
  2. Yes, the annual addition limit (2018 = $55K) includes all employee + employer contributions. Ask about uncommon but complicating employer forfeitures and QNEC contributions.

    Note: It is best if you use the IRS terminology for employee contributions to avoid confusion: employee deferrals (pre-tax), employee Roth contributions (post-tax) and employee after-tax contributions. While employee after-tax contributions are also technically "post-tax", employee after-tax contributions are what they are called.
  3. No, this is the beauty of employee after-tax contributions. They can be rolled over directly to a Roth IRA. The earnings on after-tax contributions can either also be rolled to a Roth IRA (subject to taxation) or rolled over to a traditional IRA or another employer's plan. Also, if your plan allows an In-plan Roth Rollover (IRR), the after-tax contributions and earnings (subject to taxation) can both be rolled over to your Roth 401k account.
Does this mean that if you have a plan that allows after tax contributions, but also has pre tax and Roth options, that you can roll the after tax contribution directly into the Roth 401k? I've always assumed it has to roll/convert to an external Roth.

[*]You have a tax liability at the time of a rollover of earnings on after-tax contributions subject to standard withholding and estimated tax requirements.
[*]Rollovers are never subject to ordinary contribution limits.
[*]The ability to even do rollovers and their frequency are subject to plan rules. Some plans charge for rollovers and/or limit the frequency to once/year. Frequent rollovers can be a challenge when a check has to be mailed to your IRA custodian. It is best if your plan custodian and your IRA custodian are the same or when doing IRRs. They can often be accomplished quickly with a phone call.
[/list]


As we have discussed in other threads I'm helping friend set up a small company 401k. We are likely going with vanguard Ascensus and a local 401k advisor. Are there any downsides to allowing personal IRAS to be rolled into the plan, or to allow In service withdrawals to facilitate mega back door Roths?

Finally, if it is a safe harbor plan, will additional after tax contributions by HCEs potentially cause plan to fail discrimination testing?
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FiveK
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Re: Questions on Mega BackDoor Roth IRA

Post by FiveK »

JBTX wrote: Sat Sep 08, 2018 2:23 pm Does this mean that if you have a plan that allows after tax contributions, but also has pre tax and Roth options, that you can roll the after tax contribution directly into the Roth 401k?
Yes, assuming the plan itself allows.
Spirit Rider
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Re: Questions on Mega BackDoor Roth IRA

Post by Spirit Rider »

Oops, hit submit without realizing it.
Last edited by Spirit Rider on Sat Sep 08, 2018 3:23 pm, edited 1 time in total.
JBTX
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Re: Questions on Mega BackDoor Roth IRA

Post by JBTX »

Thanks to both of you. I've forwarded a list of these nice to haves to the 401k advisor/broker. I think they are always amazed at the complexity of these questions/ requests based upon what I have learned in here.

My last question above was whether additional non deductible traditional contributions over $18.5k employee limit would subject a safe harbor plan to additional testing. Any idea?
Spirit Rider
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Re: Questions on Mega BackDoor Roth IRA

Post by Spirit Rider »

JBTX wrote: Sat Sep 08, 2018 2:23 pm Does this mean that if you have a plan that allows after tax contributions, but also has pre tax and Roth options, that you can roll the after tax contribution directly into the Roth 401k? I've always assumed it has to roll/convert to an external Roth.
Yes, that is what the IRR feature allows. Then you can also allow in-service rollovers of the after-tax contributions and earnings.
JBTX wrote: Sat Sep 08, 2018 2:23 pm As we have discussed in other threads I'm helping friend set up a small company 401k. We are likely going with vanguard Ascensus and a local 401k advisor. Are there any downsides to allowing personal IRAS to be rolled into the plan, or to allow In service withdrawals to facilitate mega back door Roths?

Finally, if it is a safe harbor plan, will additional after tax contributions by HCEs potentially cause plan to fail discrimination testing?
There is now very little downside to plans accepting IRA rollover contributions.

A plan may only accept IRA rollovers that exclusively contain pre-tax balances, but IRS Rev. Rul. Rev. Rul. 2014–9,
Rollovers to Qualified Plans. Provides that as long the plan receives a self-certification from the participant that the rollover only contains pre-tax assets and verifies the assets are from a pre-tax IRA account. The plan is granted a safe harbor to accept those rollover contributions as long as it distributes those contributions with earnings within a reasonable amount of time after discovering an error.

One downside to offering after-tax contributions and in-service rollovers is that there may be administrative costs associated with setting up the plan, separate accounting for after-tax contributions and earnings and actually doing the in-service rollovers.

Regardless if it is a safe harbor plan. Employee after-tax contributions are still subject to their own Actual Contribution Percentage (ACP) testing. The after-tax contributions, but only the after-tax contributions may very well fail ACP testing. This could cause HCEs, but only HCEs to be restricted in there contribution percentages.

The employer can mitigate this several ways. First, do not place unreasonably low contribution limits on all employees (nothing less than 75%). This allows some NHCEs to increase the average NHCE ACP. Allow company matching on employee after-tax contributions. After the first year, limit HCE employee after-tax contribution percentage based on the previous year's ACP test results.

I am not going to win many BH friends with this suggestion, but it gets the employees the real benefit, minimizes the in-service rollover costs and HCE ACP testing failure hassles. With frequent in-service rollovers and HCE testing failure the excess contributions are already in the Roth IRA.

I suggest you adopt employee after tax contributions and the IRR feature without restriction if IRR rollovers are electronically supported. Then I suggest you only allow in-service rollovers of the employee after-tax account and IRRs from that account, once/year after the 3/15 ACP failure correction deadline, E.g. starting 4/1.
Last edited by Spirit Rider on Sat Sep 08, 2018 3:29 pm, edited 1 time in total.
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FiveK
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Re: Questions on Mega BackDoor Roth IRA

Post by FiveK »

JBTX wrote: Sat Sep 08, 2018 3:13 pm My last question above was whether additional non deductible traditional contributions over $18.5k employee limit would subject a safe harbor plan to additional testing. Any idea?
Apparently yes: see What’s Old Is New Again: “Mega Back Door” Roth IRA Contributions Spark New Interest in Old School After-Tax Contributions.
JBTX
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Re: Questions on Mega BackDoor Roth IRA

Post by JBTX »

Thanks to both of you. Very helpful info.
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Earl Lemongrab
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Re: Questions on Mega BackDoor Roth IRA

Post by Earl Lemongrab »

The reason Megacorp's plan reps gave me for the percentage limit on contributions had to do with testing.
Spirit Rider
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Re: Questions on Mega BackDoor Roth IRA

Post by Spirit Rider »

Earl Lemongrab wrote: Sat Sep 08, 2018 6:55 pm The reason Megacorp's plan reps gave me for the percentage limit on contributions had to do with testing.
If this a common percentage limit on all employees it is not true. If it was only on HCEs it would be true.

Individual contribution percentage limits on NHCEs inhibits NHCE average percentages making test failure more likely. Individual contribution percentage limits on HCEs inhibits HCE average percentages making test failure less likely.

Plan CSRs are seldom a good source of information on why something is done.
JBTX
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Re: Questions on Mega BackDoor Roth IRA

Post by JBTX »

Spirit Rider wrote: Sat Sep 08, 2018 3:22 pm
JBTX wrote: Sat Sep 08, 2018 2:23 pm Does this mean that if you have a plan that allows after tax contributions, but also has pre tax and Roth options, that you can roll the after tax contribution directly into the Roth 401k? I've always assumed it has to roll/convert to an external Roth.
Yes, that is what the IRR feature allows. Then you can also allow in-service rollovers of the after-tax contributions and earnings.
JBTX wrote: Sat Sep 08, 2018 2:23 pm As we have discussed in other threads I'm helping friend set up a small company 401k. We are likely going with vanguard Ascensus and a local 401k advisor. Are there any downsides to allowing personal IRAS to be rolled into the plan, or to allow In service withdrawals to facilitate mega back door Roths?

Finally, if it is a safe harbor plan, will additional after tax contributions by HCEs potentially cause plan to fail discrimination testing?
There is now very little downside to plans accepting IRA rollover contributions.

A plan may only accept IRA rollovers that exclusively contain pre-tax balances, but IRS Rev. Rul. Rev. Rul. 2014–9,
Rollovers to Qualified Plans. Provides that as long the plan receives a self-certification from the participant that the rollover only contains pre-tax assets and verifies the assets are from a pre-tax IRA account. The plan is granted a safe harbor to accept those rollover contributions as long as it distributes those contributions with earnings within a reasonable amount of time after discovering an error.

One downside to offering after-tax contributions and in-service rollovers is that there may be administrative costs associated with setting up the plan, separate accounting for after-tax contributions and earnings and actually doing the in-service rollovers.

Regardless if it is a safe harbor plan. Employee after-tax contributions are still subject to their own Actual Contribution Percentage (ACP) testing. The after-tax contributions, but only the after-tax contributions may very well fail ACP testing. This could cause HCEs, but only HCEs to be restricted in there contribution percentages.

The employer can mitigate this several ways. First, do not place unreasonably low contribution limits on all employees (nothing less than 75%). This allows some NHCEs to increase the average NHCE ACP. Allow company matching on employee after-tax contributions. After the first year, limit HCE employee after-tax contribution percentage based on the previous year's ACP test results.

I am not going to win many BH friends with this suggestion, but it gets the employees the real benefit, minimizes the in-service rollover costs and HCE ACP testing failure hassles. With frequent in-service rollovers and HCE testing failure the excess contributions are already in the Roth IRA.

I suggest you adopt employee after tax contributions and the IRR feature without restriction if IRR rollovers are electronically supported. Then I suggest you only allow in-service rollovers of the employee after-tax account and IRRs from that account, once/year after the 3/15 ACP failure correction deadline, E.g. starting 4/1.
I followed up directly with Vanguard Ascensus, and they told me:

1. They don't allow both after tax contributions and a Roth option in the same plan - so I guess that means they don't accommodate the IRR feature.
2. After tax contributions probably would not work here, because they would be primarily for the benefit of the owner- HCE, and it is highly unlikely in this case non_HCE's would do after tax, which would cause testing on after tax contributions to fail
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