Backdoor roth and megaback door questions

[Retireby45ish]

Ok, so somehow until just recently the backdoor roth seemed off the table until a co-worker mentioned it. Then my company’s 401k company said they would open the door for after-tax contributions so employees could do a mega backdoor for up to 28k more.

So I have some questions. Maybe I’m thinking about things wrong. Or from the perspective of someone who will ER in about 3-4 years at age 46ish.

DW and I are in a very high tax bracket now. But because we will retire early will be in a low one (50-60k MAGI at that point vs 500k now).

1. 6k iRA to Roth backdoor:
this is something that most people say is a no brainer to do. But i have 25k in an existing IRA so if I do the 6k it seems like because of the “pro rata rule” only 6/25=24% of that is non taxable when you do the rollover. So I’d still owe taxes on most of it. I’d be taxed at a high rate (35%+ bracket). Maybe it’s better if I put the after tax money into the IrA now (and every year for next few) but don’t convert now, but instead wait until I’m in a much lower bracket in a few years to do the conversions? But, since this ira is after tax I would assume that when I convert it to a Roth that I would only owe taxes on the gains? Do I just keep track of the cost basis? Do people open a new IrA every year to do so? Certainly mixing this after tax money with my other IRA which is pre-tax (rolled over 401k) would be complex. Hmmm.

2. Mega Back door Roth from 401k: this seems like it would work and you can put 28k into the 401k Via some paychecks (they suggest a lump sum but I’d put it in something low volatility to keep gains to a minimum) and then convert to roth. Are there really no tax implications of that conversion? I don’t understand that and it seems too good to be true.
A rep of the holding company held a q&A session and it seemed legit but the rep did get squirmy and say to talk to accountants (which I will) about specific tax implications.

3. Finally, If the IRA is hurting me in that first 6k conversion, can I ask my 401k provider if I can roll my IRA into my 401k? That helps all future back door conversions.

Anything else I’m missing?

Thanks so much in advance.

 

[2017ish]

Some miscellaneous thoughts in response.

We chose not to do conversions in our high income years; figured that we'd be able to convert a whole lot at lower tax rates once retired (we retired 10 years older than you plan). The one exception was a conversion to start our first five year clock on withdrawing from Roths.... Not fun to pay the taxes in retirement, but even converting to top of 32% bracket, we have effective tax rate of 21%--both of which are better than when we worked.

If you can roll the IRA monies to the 401k, that would clean things up a bit whilst working (well, maybe longer if you keep the $$ in 401k after you retire). The 8606 is not that bad of a tax form, but it gets near meaningless at times. (DW gets to exclude 0.4% of her withdrawals/conversions for 2021--whoop-de-doo!)

I have mixed feelings on Mega for high earners. Never was available to us, so didn't have to decide. One son and his wife make 7 figures and they take full advantage of the Mega option--even though they pay huge taxes between the feds and California. Their thinking is that by the time they retire, they'll be forever in very high bracket, so might as well diversify their holdings as much as they can.

Bottom line, no matter what you do, you'll be in good shape if you can save that much money. Could be slightly better one way or the other is all.

 

[SecondCor521]

Ok, so somehow until just recently the backdoor roth seemed off the table until a co-worker mentioned it. Then my company’s 401k company said they would open the door for after-tax contributions so employees could do a mega backdoor for up to 28k more.

So I have some questions. Maybe I’m thinking about things wrong. Or from the perspective of someone who will ER in about 3-4 years at age 46ish.

DW and I are in a very high tax bracket now. But because we will retire early will be in a low one (50-60k MAGI at that point vs 500k now).

1. 6k iRA to Roth backdoor:
this is something that most people say is a no brainer to do. [A] But i have 25k in an existing IRA so if I do the 6k it seems like because of the “pro rata rule” only 6/25=24% of that is non taxable when you do the rollover. So I’d still owe taxes on most of it. I’d be taxed at a high rate (35%+ bracket). Maybe it’s better if I put the after tax money into the IrA now (and every year for next few) but don’t convert now, but instead wait until I’m in a much lower bracket in a few years to do the conversions? [C] But, since this ira is after tax I would assume that when I convert it to a Roth that I would only owe taxes on the gains? [D] Do I just keep track of the cost basis? [E] Do people open a new IrA every year to do so? Certainly mixing this after tax money with my other IRA which is pre-tax (rolled over 401k) would be complex. Hmmm.

2. Mega Back door Roth from 401k: this seems like it would work and you can put 28k into the 401k Via some paychecks (they suggest a lump sum but I’d put it in something low volatility to keep gains to a minimum) and then convert to roth. [A] Are there really no tax implications of that conversion? I don’t understand that and it seems too good to be true.
A rep of the holding company held a q&A session and it seemed legit but the rep did get squirmy and say to talk to accountants (which I will) about specific tax implications.

3. Finally, If the IRA is hurting me in that first 6k conversion, can I ask my 401k provider if I can roll my IRA into my 401k? That helps all future back door conversions.

[4] Anything else I’m missing?

Thanks so much in advance.

[Numbers and letters added.]

1A. Right, you would be subject to the pro rata rule, and right, it probably doesn't make sense to convert at a 35% tax rate. Most MBR people assume that you don't have an existing traditional IRA. (I'm assuming your $25K is in a traditional/SEP/SIMPLE IRA. If it's a Roth, then it wouldn't add to your pro rata rule problem.)

1B. Makes sense. Depending on how you invest, you could also just put it in taxable. If you put it in taxable in BRK.B or VTSAX or similar low-income investments and buy and hold, then it'd behave much like a Roth IRA.

1C. Yes.

1D. Yes, on Form 8606 Part I.

1E. Some might, but you don't have to, and the IRS doesn't care one way or the other.

2A. It would depend if the original contributions were to a traditional, Roth, or after-tax 401(k) sub-account.

Contributions to a traditional 401(k) that were rolled over to a Roth IRA would be treated like a Roth conversion and would be taxable.

If you're thinking about contributions to a Roth 401(k) then converting those contributions to a Roth IRA, I think that would be a tax free rollover, but I would read page 32 of Pub 575 carefully: https://www.irs.gov/pub/irs-pdf/p575.pdf

3. Yes, and that's really the only way to get out of pro rata land. Your 401(k) provider's plan has to allow for incoming rollovers. Not all do, but mine did.

4. Make sure you file Form 8606 when you are required to. Research and learn all about what you're considering doing before doing it. Oh, and if you want to do Roth 401(k) to Roth IRA rollovers, make sure your 401(k) plan allows that while you're still working if that's what you want to do - not all plans allow such a thing.

 

[still_working]

1A. Right, you would be subject to the pro rata rule, and right, it probably doesn't make sense to convert at a 35% tax rate. Most MBR people assume that you don't have an existing traditional IRA. (I'm assuming your $25K is in a traditional/SEP/SIMPLE IRA. If it's a Roth, then it wouldn't add to your pro rata rule problem.)

Can the pro rata rule be avoided by opening another traditional IRA specifically for the purpose of converting the $6k for Roth without commingling the funds?

 

[SecondCor521]

Can the pro rata rule be avoided by opening another traditional IRA specifically for the purpose of converting the $6k for Roth without commingling the funds?

No. The pro rata applies to all of an individual's IRAs collectively.

 

[Retireby45ish]

[Numbers and letters added.]

1A. Right, you would be subject to the pro rata rule, and right, it probably doesn't make sense to convert at a 35% tax rate. Most MBR people assume that you don't have an existing traditional IRA. (I'm assuming your $25K is in a traditional/SEP/SIMPLE IRA. If it's a Roth, then it wouldn't add to your pro rata rule problem.)

1B. Makes sense. Depending on how you invest, you could also just put it in taxable. If you put it in taxable in BRK.B or VTSAX or similar low-income investments and buy and hold, then it'd behave much like a Roth IRA.

1C. Yes.

1D. Yes, on Form 8606 Part I.

1E. Some might, but you don't have to, and the IRS doesn't care one way or the other.

2A. It would depend if the original contributions were to a traditional, Roth, or after-tax 401(k) sub-account.

Contributions to a traditional 401(k) that were rolled over to a Roth IRA would be treated like a Roth conversion and would be taxable.

If you're thinking about contributions to a Roth 401(k) then converting those contributions to a Roth IRA, I think that would be a tax free rollover, but I would read page 32 of Pub 575 carefully: https://www.irs.gov/pub/irs-pdf/p575.pdf

3. Yes, and that's really the only way to get out of pro rata land. Your 401(k) provider's plan has to allow for incoming rollovers. Not all do, but mine did.

4. Make sure you file Form 8606 when you are required to. Research and learn all about what you're considering doing before doing it. Oh, and if you want to do Roth 401(k) to Roth IRA rollovers, make sure your 401(k) plan allows that while you're still working if that's what you want to do - not all plans allow such a thing.

Thank you SecondCor for the following things:

1) organizing your responses with numbers and letters. I should really have taken more care in laying out my questions in a more organized way. It was a bit rambly and unorganized.

2) Thanks for your responses. They were clear and really helped me understand these nuanced rules better.

I think I’m going to end up contributing 6k to the IRA each year for me and DW and then just do conversions in a few years when we are in a lower bracket. we only have 10% of our assets in tax sheltered IRA/401k at this point, with most of those in bond funds to keep the tax drag low.

I’m hoping the tax code doesn’t change much with respect to cap gains on investments so we can take out most at a low rate (0% with low income) when we need it upon FIRE. This seems to be almost as good as the ROTH route if you understand the cap gains rates for lower MAGIs.
In that case, as you say, it makes sense to keep stock index funds in non tax sheltered accounts rather than go through converting through the mega backdoor at our current high income tax rate.

One follow up to question (3): do spouse IRA balances also count towards the pro rata rule? For example if i move my IRA into my company 401k then can I do the IRA to Roth conversion on the 6k and pay zero tax EVEN IF MY WIFE HAS IRAs?
If so it might be worth the hassle of moving

Thanks again

 

[SecondCor521]

One follow up to question (3): do spouse IRA balances also count towards the pro rata rule? For example if i move my IRA into my company 401k then can I do the IRA to Roth conversion on the 6k and pay zero tax EVEN IF MY WIFE HAS IRAs?

A spouse's IRAs would not count towards the pro rata rule for you. Each of you have your own 8606 ledger with your own IRA basis amounts.

 

[old medic]

I'm no were near the smarts of others on here, But from what I've learned, here is our approach.
Open Roth IRA accounts for you both, and put in the standard amount you can, no conversions. Keep putting the other funds in your 401K/Tira to save on taxes.
After you retire, start doing the Roth conversions up to your max of the 12% bracket.

 

[Retireby45ish]

[Numbers and letters added.]

1A. Right, you would be subject to the pro rata rule, and right, it probably doesn't make sense to convert at a 35% tax rate. Most MBR people assume that you don't have an existing traditional IRA. (I'm assuming your $25K is in a traditional/SEP/SIMPLE IRA. If it's a Roth, then it wouldn't add to your pro rata rule problem.)

1B. Makes sense. Depending on how you invest, you could also just put it in taxable. If you put it in taxable in BRK.B or VTSAX or similar low-income investments and buy and hold, then it'd behave much like a Roth IRA.

1C. Yes.

1D. Yes, on Form 8606 Part I.

1E. Some might, but you don't have to, and the IRS doesn't care one way or the other.

2A. It would depend if the original contributions were to a traditional, Roth, or after-tax 401(k) sub-account.

Contributions to a traditional 401(k) that were rolled over to a Roth IRA would be treated like a Roth conversion and would be taxable.

If you're thinking about contributions to a Roth 401(k) then converting those contributions to a Roth IRA, I think that would be a tax free rollover, but I would read page 32 of Pub 575 carefully: https://www.irs.gov/pub/irs-pdf/p575.pdf

3. Yes, and that's really the only way to get out of pro rata land. Your 401(k) provider's plan has to allow for incoming rollovers. Not all do, but mine did.

4. Make sure you file Form 8606 when you are required to. Research and learn all about what you're considering doing before doing it. Oh, and if you want to do Roth 401(k) to Roth IRA rollovers, make sure your 401(k) plan allows that while you're still working if that's what you want to do - not all plans allow such a thing.

I’m revisiting this again since I found out I can roll my IRA into my 401k. This opens up the ability to do the 6k per year IRA deposit and immediate rollover to Roth.

Q1. There are zero taxes on this, correct?. No pro-rata rule problem since I have no IRA once I roll to a 401k.

Q2. If I do the rollover in 2022 can I do the 6k ira->Roth in 2022 or do i have to wait until 2023?

It also opens up the mega backdoor conversion, though SecondCor521 in 2A you seem to hint at there being tax implications on this.

As I understand it i would be contributing to a 401k account and then shifting that right out to a Roth IRA account.

Q3. The big question is, will I pay any taxes on this conversion??

Thanks! Don’t want any surprises with this stuff.

 

[SecondCor521]

I haven't done this in a while, but my recollection is:

A1. You might owe some taxes on any gains while the money is in your traditional IRA. Some people who do this kind of thing park the money in a money market and just leave it there a day or two so they can avoid gains and having to hassle with the math.

You still should report the nondeductible IRA contribution on a Form 8606 part I in the year of the contribution, and the Roth conversion on Form 8606 part II in the year of the conversion.

A2. I think you're talking about rolling the IRA into your 401(k) here. I think you can do both in 2022. Take a careful look at a Form 8606 and look at which year-end balances matter in Part I for the pro rata stuff. When reading for this sort of thing, understand that Form 8606 references specific years in the instructions for various lines and each year the IRS updates Form 8606 to increment those year references. So if you're looking at a 2021 Form 8606 and thinking about 2022, you'll need to add one to the various year references.

What I did was do the traditional IRA -> 401(k) step first and make sure that was 100% complete before doing the backdoor Roth. At the time I remember thinking that I didn't want to do the backdoor Roth assuming I could do the IRA -> 401(k) step later and then find out that the rules changed, or I misunderstood something, or whatever. It's also just cleaner mechanically to have a zero balance traditional IRA before doing the backdoor Roth.

A3. Only on a pro rated basis on any tiny gain as alluded to in A1, which can generally be minimal or zero.

 

[Retireby45ish]

I haven't done this in a while, but my recollection is:

A1. You might owe some taxes on any gains while the money is in your traditional IRA. Some people who do this kind of thing park the money in a money market and just leave it there a day or two so they can avoid gains and having to hassle with the math.

You still should report the nondeductible IRA contribution on a Form 8606 part I in the year of the contribution, and the Roth conversion on Form 8606 part II in the year of the conversion.

A2. I think you're talking about rolling the IRA into your 401(k) here. I think you can do both in 2022. Take a careful look at a Form 8606 and look at which year-end balances matter in Part I for the pro rata stuff. When reading for this sort of thing, understand that Form 8606 references specific years in the instructions for various lines and each year the IRS updates Form 8606 to increment those year references. So if you're looking at a 2021 Form 8606 and thinking about 2022, you'll need to add one to the various year references.

What I did was do the traditional IRA -> 401(k) step first and make sure that was 100% complete before doing the backdoor Roth. At the time I remember thinking that I didn't want to do the backdoor Roth assuming I could do the IRA -> 401(k) step later and then find out that the rules changed, or I misunderstood something, or whatever. It's also just cleaner mechanically to have a zero balance traditional IRA before doing the backdoor Roth.

A3. Only on a pro rated basis on any tiny gain as alluded to in A1, which can generally be minimal or zero.

Thanks. That all makes sense.

Yes I will definitely complete the transfer first and let that all settle before doing the mega backdoor part. Plenty of year left.

I’ll have a look at that 8606 form to make sure they reference balances at year end and not beginning of the year.

Seems like a lot of hassle but to get another 28k (my plan amount) + 6k into a Roth (with no tax consequences) every year seems pretty good to me and worth the efforts.

 

[SecondCor521]

Thanks. That all makes sense.

Yes I will definitely complete the transfer first and let that all settle before doing the mega backdoor part. Plenty of year left.

I’ll have a look at that 8606 form to make sure they reference balances at year end and not beginning of the year.

Seems like a lot of hassle but to get another 28k (my plan amount) + 6k into a Roth (with no tax consequences) every year seems pretty good to me and worth the efforts.

Form 860 definitely references the end of the year. I'm just not sure if the 2022 version will reference the end of 2022 or the end of 2021. I think it's the end of 2022, but it would be wise for you to check.

And the traditional IRA -> 401(k) thing should be just a one time hassle.

 

[Retireby45ish]

Form 860 definitely references the end of the year. I'm just not sure if the 2022 version will reference the end of 2022 or the end of 2021. I think it's the end of 2022, but it would be wise for you to check.

And the traditional IRA -> 401(k) thing should be just a one time hassle.

I see in line 6, “enter the value of all IRAs as of Dec 31,2021”. So I think if next years forms are the same then I’m fine to roll my IRA to 401k this year and have a zero balance by the end of the year.

 

[SecondCor521]

I see in line 6, “enter the value of all IRAs as of Dec 31,2021”. So I think if next years forms are the same then I’m fine to roll my IRA to 401k this year and have a zero balance by the end of the year.

Yeah, that sounds right. I just wanted you to confirm for yourself rather than rely on me when it's been about 10 years since I did what you're about to do.

Good luck!

 

[Exit 2024]

Retireby45ish, I think you got your answers, we do that every year at least last 10 years, mechanics are pretty simple after you complete it first time.

I also had Traditional IRA with tax deductible money that have been rolled into in my 401k to get around Pro-rata rule, that was simple but triggered questions from IRS 2 years later.

They got 1099-R for money going out of Traditional IRA aka withdrawn, but no info on where they landed as 401ks are not required to send any forms to IRS about incoming balances.
So IRS assumed that we just took money out and owe taxes and penalties on that transaction. It was quickly resolved by replying to their letter with attachment of 2 documents - statement from IRA with amount and date when money were taken out and statement from 401k showing amount and date of the deposit, span between dates should not exceed 60 days. So makes sure to save those 2 statements right way as it took me some time to dig them out.
Other then that - it is a smooth ride, totally worth the trouble of submitting 2 additional IRS forms every year.

 

[Retireby45ish]

Retireby45ish, I think you got your answers, we do that every year at least last 10 years, mechanics are pretty simple after you complete it first time.

I also had Traditional IRA with tax deductible money that have been rolled into in my 401k to get around Pro-rata rule, that was simple but triggered questions from IRS 2 years later.

They got 1099-R for money going out of Traditional IRA aka withdrawn, but no info on where they landed as 401ks are not required to send any forms to IRS about incoming balances.
So IRS assumed that we just took money out and owe taxes and penalties on that transaction. It was quickly resolved by replying to their letter with attachment of 2 documents - statement from IRA with amount and date when money were taken out and statement from 401k showing amount and date of the deposit, span between dates should not exceed 60 days. So makes sure to save those 2 statements right way as it took me some time to dig them out.
Other then that - it is a smooth ride, totally worth the trouble of submitting 2 additional IRS forms every year.

Thanks. Now I know how some people have so much sacked away in those Roths!