Questions about conversion of after-tax 401k to Roth IRA

[lindalou]

I am considering making after-tax contributions to my 401k which I would convert to a Roth IRA at retirement, aka mega back door Roth (I already contribute the maximum tax-deferred amount as well as the over 50 catch up dollars). I am weighing making the after-tax 401k contributions vs investing in a normal taxable account (I have a traditional IRA, so I don't think I can do the back door Roth).

My plan allows in-service withdrawals of after-tax contributions, but with a big catch. If I do this, then I forfeit 6 months of company matching contributions (I'm assuming that I can't make an in-service withdrawal early in the year, stop my pre-tax contributions for 6 months, then resume my pre-tax contributions at a higher rate to still capture all of the company match, but I'll call and ask). So for the purposes of this question, please assume that I will leave the after-tax contributions in my 401k until I retire, which I am tentatively planning on doing in 9 years when I am 60 years old.

As I understand the rollover, I can roll my after-tax contributions into a Roth IRA, and the earnings as well as all of the pre-tax dollars into a traditional IRA and avoid paying taxes at the disbursement. So the 9 years of earnings on the after-tax money will be taxed as income vs long term capital gains if I invest the money in my Vanguard taxable account.

I want to make sure that I am understanding the tax implications correctly. Also, if you have an opinion on what you think I should do, I would appreciate that as well. I expect to be in the 25% tax bracket in retirement (with my DH).

Here is a thread where I give some background:
http://www.early-retirement.org/forums/f28/how-to-invest-after-tax-money-401k-after-tax-84244.html

Thanks,
Linda

 

[Big_Hitter]

remember, the sum of all of your tax-qualified pre, post and employer contributions (except for the catch up) can't exceed $54K in 2017

 

[thefinancebuff]

So for the purposes of this question, please assume that I will leave the after-tax contributions in my 401k until I retire, which I am tentatively planning on doing in 9 years when I am 60 years old.

As I understand the rollover, I can roll my after-tax contributions into a Roth IRA, and the earnings as well as all of the pre-tax dollars into a traditional IRA and avoid paying taxes at the disbursement. So the 9 years of earnings on the after-tax money will be taxed as income vs long term capital gains if I invest the money in my Vanguard taxable account.

I have a calculator for this. You still come out ahead even if you keep the after-tax money in the plan and you pay tax on the earnings. Your first year's contributions will stay for 9 years, second year's contributions will stay for 8 years, ... ... and your last year's contributions will only stay for one year. On average it's more like 5 years worth of earnings. You can also consider doing a rollover after 4-5 years and losing the match just once for liberating a larger sum. If you switch jobs in the next 9 years, you have another out.

 

[gauss]

The tricky part of this comes when you actually take the distribution of your after-tax contributions and growth from your 401k. Ideally you will be able to rollover the after-tax contributions to a Roth IRA and separately roll the growth portion (ie the taxable amount) to a traditional IRA.

What makes this tricky is that in the past to do this you needed NOT to do a direct rollover, but rather you needed to do a 60-day rollover where you received the check from the 401k, along with 20% withheld and deposit this to your bank account. You would then send in two separate checks (in the proper order) to your traditional and roth IRAs. You would need to make up the difference (ie the 20% withholding) from other funds to avoid taxes and penalties.

They have liberalized the rules somewhat since I have done this and you may be able to accomplish the same thing with a direct rollover but I would need to research this first to tell you anything conclusively.

I usually recommend that people practice by moving a small portion (ie $1000) from their after-tax 401k to the Roth to verify that everything goes properly when taxes are filed the next year before moving the large portion. With the rules on your 401k this may seem to be problematic.

We (DW and I) have been using this technique since 2010 to funnel a large portion of our savings into Roth IRAs without paying any upfront taxes, but the devil is in the details.

-gauss

 

[travelover]

The tricky part of this comes when you actually take the distribution of your after-tax contributions and growth from your 401k. Ideally you will be able to rollover the after-tax contributions to a Roth IRA and separately roll the growth portion (ie the taxable amount) to a traditional IRA.

.......

I did this a few years back when it was still a grey area of IRS law. Fidelity held my hand and made it all happen.

 

[kaneohe]

a useful link: Isolating Basis for a Roth Conversion - Fairmark.com Fairmark.com

be sure to read the cautions at the end: "The Solution: pts I & II"

"Note the importance of scheduling the transfers to occur at the same time! If you make two separate transfers at different times, you don’t get the benefit of this change in the rules. " (the transfers are to the TIRA and to the Roth which need to happen at the same time)

"Note the importance of telling the company in advance which dollars (pre-tax or after-tax) are going to which IRA! This may seem like a trivial matter, but you haven’t followed the rules if you simply say, “Pay $30,000 to my traditional IRA and $10,000 to my Roth.” You need to say, “Pay the pre-tax dollars to my traditional IRA and the after-tax dollars to my Roth.” "

 

[lindalou]

Wow - you all are awesome. Thanks so much for helping me out.

Yes, I am aware of the $54k limit for 2017, although I didn't know that the catch up was not included in that limit, so thanks, big hitter for pointing that out.

Thanks for crunching the numbers, theFB. That's great that you have a calculator to help with the decision. And the 5 year avg makes sense.

It's great to hear from others with experience doing this type of rollover, so thanks for the advice and link, gauss, travelover and kaneohe.

It sounds like the actual conversion may be tricky. DH and I have decided to to each put 1500 a month in the 401k after-tax. I'm hoping that when the time comes to retire that this type of conversion will be more common and/or Vanguard will hold my hand, as Fidelity did for travelover (is it travel over or travel lover, or both?).

Thanks again!

 

[NgineER]

Have you looked into rolling your after tax contributions into a Roth 401k? If possible, you could do it right away so that all earnings would also be tax free.
It should not affect your contribution limits.

 

[jebmke]

The tricky part of this comes when you actually take the distribution of your after-tax contributions and growth from your 401k. Ideally you will be able to rollover the after-tax contributions to a Roth IRA and separately roll the growth portion (ie the taxable amount) to a traditional IRA.

What makes this tricky is that in the past to do this you needed NOT to do a direct rollover, but rather you needed to do a 60-day rollover where you received the check from the 401k, along with 20% withheld and deposit this to your bank account. You would then send in two separate checks (in the proper order) to your traditional and roth IRAs. You would need to make up the difference (ie the 20% withholding) from other funds to avoid taxes and penalties.

They have liberalized the rules somewhat since I have done this and you may be able to accomplish the same thing with a direct rollover but I would need to research this first to tell you anything conclusively.

I usually recommend that people practice by moving a small portion (ie $1000) from their after-tax 401k to the Roth to verify that everything goes properly when taxes are filed the next year before moving the large portion. With the rules on your 401k this may seem to be problematic.

We (DW and I) have been using this technique since 2010 to funnel a large portion of our savings into Roth IRAs without paying any upfront taxes, but the devil is in the details.

-gauss

I did a direct rollover of a 401(k) to ROTH & TIRA in 2013 at Fidelity. They held the 401(k) and it took 15 minutes to move the after-tax money to a ROTH IRA and all the pre-tax money (including earnings on AT money) to a TIRA. What probably made it easy was keeping the IRA at the same custodian as the 401 -- they were motivated to do it correctly and report it correctly on the 1099-Rs. A couple of years later I transferred both accounts to Vanguard.

 

[NgineER]

Have you looked into rolling your after tax contributions into a Roth 401k? If possible, you could do it right away so that all earnings would also be tax free.
It should not affect your contribution limits.

I have that option in my plan to convert both regular 401k to a Roth and also roll after tax over to a Roth 401k within the plan.

 

[Huston55]

I have a separate but, related question.

My understanding is that 'after tax' 401k $ rolled into a Roth IRA becomes subject to the same rules as the Roth IRA. (We've done this a few times over the past several years.). So, no taxes on w/d and no RMD worries

MY QUESTION: If/when I roll my old employer (I'm FIREd) Roth 401k into my Roth IRA, what are the RMD rules? I ask because, a Roth 401k is subject to RMDs but, a Roth IRA is not.

 

[travelover]

I have a separate but, related question.

My understanding is that 'after tax' 401k $ rolled into a Roth IRA becomes subject to the same rules as the Roth IRA. (We've done this a few times over the past several years.). So, no taxes on w/d and no RMD worries

MY QUESTION: If/when I roll my old employer (I'm FIREd) Roth 401k into my Roth IRA, what are the RMD rules? I ask because, a Roth 401k is subject to RMDs but, a Roth IRA is not.

It appears that a Roth 401(k) can be rolled into a Roth IRA and then no RMDs are required during the life of the owner.

Avoiding Required Minimum Distributions from Roth 401(k)s