Converting a portion of 401K to Roth

[chicago_meatball]

I talked with fidelity this week about opening up a back door Roth. And during the conversation they mentioned a portion of my 401k was transferable to the Roth. It felt like they were pushing me toward it so I broke off the conversation to do some research on my own. Working in megacorp, i like separation of duties and anytime it feels like I'm being sold I want to take a step back

I have roughly 120K in the 401k and they said that about 37K was transferable. They said the company match is transferable. Anyone know how this would impact me?

I can only assume at a minimum, on the hook for 37K added to W2 for the year. Would it also count as a 10% penalty for pulling from the 401k? Would it be possible for fidelity to withhold a taxable % as to avoid a massive tax implication?

 

[Shawn]

I do not know the specifics of your situation.

However, I have been making backdoor Roth IRA contributions from my 401k for the last several years. In my case, the 401k dollars that I convert are after-tax contributions (plus minimal earnings on the after-tax contributions). That is, I make $17.5K of before-tax contributions to my 401k. I make $5.5K of before-tax catchup contributions to my 401k. Then I make $34.5K of after-tax contributions to my 401k. I "immediately" roll the $34.5K of after-tax contributions to my Roth IRA. I am allowed to do this because my 401k allows in-service withdrawals of after-tax contributions.

Because I am rolling over after-tax contributions, the Roth conversion itself is tax free (except for minimal taxes on after-tax earnings while they are in the 401k). I do this all at Fidelity. They have been knowledgeable about the process.

In your case, it sounds like the $37K may be fully taxable, unless part of the $37K is from after-tax contributions that you made. Fidelity should be able to tell you how much of the $37K will be taxable due to the rollover. I do not know if Fidelity can withhold taxes. I was never faced with this situation since my rollovers have been essentially tax free. I do not believe you will be faced with a 10% penalty, since the money is going into a Roth IRA (although I do not know the ramifications of employer contributions). I am assuming that Fidelity is performing the transfer, and that the funds are going from a Fidelity 401k into a Fidelity Roth IRA.

 

[chicago_meatball]

I do not know the specifics of your situation.

However, I have been making backdoor Roth IRA contributions from my 401k for the last several years. In my case, the 401k dollars that I convert are after-tax contributions (plus minimal earnings on the after-tax contributions). That is, I make $17.5K of before-tax contributions to my 401k. I make $5.5K of before-tax catchup contributions to my 401k. Then I make $34.5K of after-tax contributions to my 401k. I "immediately" roll the $34.5K of after-tax contributions to my Roth IRA. I am allowed to do this because my 401k allows in-service withdrawals of after-tax contributions.

Because I am rolling over after-tax contributions, the Roth conversion itself is tax free (except for minimal taxes on after-tax earnings while they are in the 401k). I do this all at Fidelity. They have been knowledgeable about the process.

In your case, it sounds like the $37K may be fully taxable, unless part of the $37K is from after-tax contributions that you made. Fidelity should be able to tell you how much of the $37K will be taxable due to the rollover. I do not know if Fidelity can withhold taxes. I was never faced with this situation since my rollovers have been essentially tax free. I do not believe you will be faced with a 10% penalty, since the money is going into a Roth IRA (although I do not know the ramifications of employer contributions). I am assuming that Fidelity is performing the transfer, and that the funds are going from a Fidelity 401k into a Fidelity Roth IRA.

You are correct about it being fidelity to fidelity, and you make a very interesting thought on being able to transfer the over payment on the 401K into the Roth. So in your situation, you could potentially contribute 40K annually to your ROTH, 34.5 from 401K and 5500 from the IRA back door. Does your 401K limit you to 34.5K of after tax contributions?

 

[Shawn]

You are correct about it being fidelity to fidelity, and you make a very interesting thought on being able to transfer the over payment on the 401K into the Roth. So in your situation, you could potentially contribute 40K annually to your ROTH, 34.5 from 401K and 5500 from the IRA back door. Does your 401K limit you to 34.5K of after tax contributions?

Yes, currently I can make $41K in backdoor Roth contributions each year ($34.5K from the 401k, plus $6.5K from an IRA factoring in the $1K catch-up provision for those over age 50). This is money that would have otherwise gone into a taxable account. It is a free lunch.

The $34.5K is bound by the IRS 415c limit. For 2014, one can contribute up to $52K to a 401k (the sum of before-tax, after-tax, and employer contributions). This is the maximum. Specific 401k plans may have lower limits. People over age 50 can contribute an additional $5.5K.

Note that your term "over payment" is incorrect. After-tax contributions to a 401k are not over payments.

 

[obgyn65]

To the OP: have you read this http://www.bogleheads.org/wiki/Roth_IRA_conversion and the links at the bottom of the page?

 

[gauss]

@chicago_meatball

- You are not subject to the 10% penalty if all the funds are properly rolled over to an IRA of some type.

- I think you will need to come up with the taxes from your non-retirement funds, otherwise a 10% penalty will apply to any retirement funds used for this purpose.

- Make sure you understand how under withholding can cause IRS penalties. Quarterly tax payments is a related concept, although you might to check to see if you can increase your job's W2 withholding all year to cover the increased taxes due to any Roth conversions.

- Remember you don't need to roll over the entire $37k at one time. My advice would only to do maybe $1k the first year so that you understand the process (including filing your income tax the next year).

- You also may wish to do smaller rollovers over multiple years to avoid be pushed into a higher tax bracket if this is an issue.

- How long until you can RE? Once I was within 5 years of retirement, I held off on any taxable Roth conversions because of the lower tax rate (15%) that would apply in retirement due to lower income.



After-Tax Contributions
FWIW, both DW and my 401k plans also had the availability to make after-tax contributions like @Shawn describes. Since 2010 we were each maxing out the full IRS limit (~$100,000k combined). This built up our Roth IRAs nicely over the course of a few years without having to convert any of our pre-tax money. You do need to watch out for and manage the Pro-Rata rules, however.
If anyone has access to after-tax contributions in their 401k combined with the ability to do in-service withdrawals, this can be a huge benefit.

-gauss