In Plan 401k Roth Conversions

[Stwicky]

My company has our 401k plan with Vanguard. The plan allows for in-plan conversion from traditional 401k to Roth 401k.

Within the plan, it is set up to show you where all of the contributions have come from. At the moment, I have a substantial amount of after-tax contributions in this plan (like $275,000). Vanguard is able to tell me what the cost basis is for these after-tax contributions ($199,000), with the balance being gains.

What I would like to do is to roll the cost basis from this account into a Roth 401k (backdoor roth). Naturally I would like this to be a non-taxable event.

What Vanguard is telling me (although it seems that they are not exactly sure) is that they are not able to split my after-tax cost basis from the from the gains and, as such, any backdoor Roth conversion would draw down this account proportionally from contributions and from gains. Again, they don't sound all that convinced themselves.

If this is the case, my understanding is that this would then be a taxable event.

Has anyone else had any luck with Vanguard in-plan conversions to Roth 401k such as this without creating a tax problem? If so, has Vanguard been able to split your after-tax contributions from the gains to allow you to roll just the contributions into a backdoor Roth?

Any thoughts would be appreciated.

[KingB]

Quote:

Originally Posted by Stwicky What Vanguard is telling me (although it seems that they are not exactly sure) is that they are not able to split my after-tax cost basis from the from the gains and, as such, any backdoor Roth conversion would draw down this account proportionally from contributions and from gains. Again, they don't sound all that convinced themselves.

I think this is correct.
My spouse has an in-plan Roth 401k conversion and she had been converting some of her 401k to Roth 401K. This year is her first RMD year and she requested that her RMD be computed and taken out of just her 401K leaving the Roth 401k intact for further growth. NO DICE. Her RMD includes portions of her Roth 401K too. Good thing is that the 401K portion will not be included for income tax purposes as taxes were already paid when she converted. Another good thing is a check was issued for her Roth 401K amount which facilitates rolling over to an external Roth IRA account. One bad thing though is that the RMD is split into 4 quarterly payments and I read somewhere that rollover is only allowed once a year. I hope that is not correct because that will prevent her from rolling over the 3 future Roth 401k distributions.

[jazz4cash]

I am pretty sure Vanguard just follows the rules set out by your employer. Some employers mandate more flexibility in their plans than others. There is a lot of variation from plan to plan. You really need to get a copy of the Summary Plan Description (SPD) or the Plan Prospectus and ask Vanguard to show you in writing what is permitted by your plan. I have similar issues with my plan managed by Fido but they have become more familiar with our plan since it is a big customer. Worst case scenario is for you to consider an IRA Rollover and I believe they must separate tax deferred funds from Roth funds.

[bingybear]

I never looked at roth 401k conversions, but with a roth conversion you can't separate them. You have to take prorated tax. It would be much easier if you could select the shares based on tax basis, but you can't even with a backdoor roth. I'm not sure why you'd expect the 401k would be different.

[gauss]

Slow down Stwicky!

Although your plan offers a Roth 401k and in-plan conversions, going that path may have significant irreversible side effects that are not obvious up front.

Since you have what appears to be a traditional 401k with significant after-tax contributions, you may still have some very attractive options available to accomplish your goal.

Does your plan allow partial withdrawals-distributions from the 401k before age 59 1/2 while you are still employed? If so great.

What you probably will need to do is to setup a series of transactions where the money ends up in a traditional IRA (ie the taxable porition) and a Roth IRA (the non-taxable portion). Note that a Roth IRA is a very different animal than a Roth 401k.

Back shortly after 2010 when the rules changes for Roth IRAs (with regards to income), I did a series of transactions from the 401k to the IRAs and also from the IRAs to the 401k to "isolate my basis". You can read up on this more at fairmark.com. They are experts in these strategies over there.

When I started doing this, it always required Indirect 60-day rollover(s) from the 401ks to the IRAs. I had to front the money for any tax withholding.

Since then, the regulations have changed and allowed for direction rollovers to accomplish the task. I have confirmed this recently in it was much easier.

My advice to you is
#1) Don't try to do this too quickly -- it takes research and understanding/following the rules
#2) study about this with resources such as fairmark.com
#3) Study the IRS "model language" (ie 402(f) notice) that employer plans are required to offer before a plan distribution. See a publicly available version here.

#4) Understand your history -- Be sure to understand why 60-day rollovers were not allowed prior to a few years ago. This will give you better context to understand if you can take advantage of the new rules that allow direct 60-day rollovers to accomplish this strategy.

#5) when you think you understand the process, do a test with only a small amount - say $2,000. Then wait until you do your taxes the following year to confirm that you understood everything properly - ie no tax bill and your test money in your IRAs (traditional and Roth)

#6) Understand that laws can/do change. Take any recommendations you see on a web site with a grain of salt. Verify that the technique is still valid by verifying with current law/regulations and your own plan SPD.

In my case, the research paid off and I have been able to move $100,000's to our Roth IRAs (our employer plans allowed after-tax contributions to our traditional 401ks up to a total of ~ $50,000 each every year). I have since ER'd and DW is soon to follow.

Just realize that this is a benefit to those who can read/understand the rules and carefully take advantage of them.

-gauss