The Mega Backdoor Roth is a strategy that could allow you to contribute an extra $37,000 to your Roth IRA every year!
Before we dive into the details, some background info is required first…
When contributing to a 401(k), there are three different types of contributions that you can make:
Pre-Tax Contributions
For a normal 401(k), the amount that automatically gets contributed from your paycheck is a pre-tax contribution.
Pre-tax contributions are tax-free going in and they grow tax free but you have to pay tax on the money when you withdraw it.
Taxation on Pre-Tax 401(k) Contributions
The limit on the amount of pre-tax 401(k) contributions you can make in 2019 is $19,000.
Note: If your employer matches a portion of your contributions, these employer contributions are also pre-tax but they do not affect the $19,000 annual personal limit.
If you plan to retire early, it makes sense to take advantage of as many pre-tax contributions as you can (click here to learn why).
Roth Contributions
If you have a Roth 401(k) instead, the contributions you make are considered Roth contributions.
Taxation on Roth 401(k) Contributions
Roth contributions are made with after-tax money (i.e. you paid tax on the money before putting it into the Roth) but the contributions are allowed to grow tax free and all principal and earnings can be withdrawn tax free when you reach standard retirement age.
After-Tax Contributions
The least-known type of contribution you can make is an after-tax contribution.
After-tax contributions are made with money you’ve already paid tax on (like Roth contributions) and can grow tax-free but the growth will be taxed upon withdrawal.
Taxation on After-Tax 401(k) Contributions
Depending on how much your employer contributes to your retirement account, you could potentially contribute up to $37,000 extra into your 401(k) every year with after-tax contributions.
The total 401(k) contribution limit for 2019 is $56,000 so to figure out how much in after-tax contributions you could make, simply subtract your personal pre-tax/Roth contributions and your employer contributions from $56,000.
For example, if someone maxes out their 401(k) in 2019 and their employer contributes $7,000, their after-tax contribution limit would be $56,000 – $19,000 – $7,000 = $30,000.
Now that we’ve established the type of contributions you can make to your 401(k), you may be wondering what this has to do with the Mega Backdoor Roth IRA strategy?
Let’s dive in…
Moving Money from Your 401(k) to Your IRA
The IRS has stated that when transferring money from you 401(k) into your IRAs, you are able to divert the pre-tax portion of your 401(k) (and all the investment growth) to your Traditional IRA and the after-tax portion to your Roth IRA, without paying any tax.
This is a big deal for people who can make in-service distributions (i.e. 401(k)-to-IRA transfers while still employed) or those of us who plan to leave our full-time employer soon because this allows us to dramatically boost our Roth IRA contributions!
Suboptimal Example
Assume that you read my article on front-loading and on January 1st, 2019 you decide to max out your pre-tax 401(k) contributions, you convince your employer to contribute $7,000 immediately, and you max out your after-tax contributions as well.
Here’s what your 401(k) would look like on January 1st:
Next, assume you just leave it there and when you eventually leave your job, you find that the market has increased your 401(k) balance by 30%!
Here’s what your 401(k) would look like:
Since all pre-tax contributions and all growth within the 401(k) will be taxed, here’s the money that would be subject to tax once you decide to tap into the account:
As you can see, you don’t really have tax-free gains on the after-tax contributions, you have tax-deferred gains instead (because you eventually have to pay tax on the money).
Let’s take a look at a better way to handle after-tax contributions…
Mega Backdoor Roth Example
Assume the same scenario but rather than leave everything in the 401(k) to grow, you instead immediately rollover your entire balance to two separate IRAs using an in-service withdrawal on January 1st, 2019.
According to the IRS guidance, the pre-tax contributions can go directly into a Traditional IRA and the after-tax contributions can go directly into a Roth IRA.
Here’s what your two IRA accounts would look like when you finally decide to take your money out:
You can see that the $9,000 of gains on the after-tax contributions that would have been taxed in the suboptimal scenario are now protected in the Roth IRA and will be tax free whenever you decide to withdraw the money!
Conclusion
If you are already maxing out your pre-tax 401(k) contributions (see this post for why I believe pre-tax contributions are better than Roth contributions for early retirees) and are also maxing out your IRA, you should check with your 401(k) custodian to see if you can start making after-tax contributions as well.
After-tax 401(k) contributions could allow you to contribute up to $37,000 extra to your Roth IRA every year (in addition to the normal $6,000 IRA contribution limit for 2019).
If you are able to perform in-service withdrawals, you can minimize the amount of growth that takes place before the conversion, which will shield even more of your money from taxes!
What do you think? Do you have the ability to make after-tax contributions? How about in-service withdrawals? Are you going to take advantage of this strategy?
Great write-up, MF. One additional and important point is that the new guidance also clarifies that you can split off the earnings from the after-tax 401k account and send them into a traditional IRA (while sending the contributions to a Roth IRA). This is important for people who don’t have the ability to take in-serve distributions. In addition, I believe for some frugal aspiring early retirees, the approach of letting earnings build up in the after-tax 401k account and then separately rolling the earnings into a tIRA (instead of taking immediate in-service rollovers into a Roth IRA) may be the optimal strategy, because that still shelters the earnings from taxes during the high-income earning years, but allows earlier access to those earnings (as early as five years after retirement, if you fold them into a Roth conversion pipeline immediately upon retirement)–and the loss of Roth tax-avoidance on those earnings during retirement does not matter to the frugal early retiree who isn’t subject to taxes in any event. We were having a debate about this recently over in the MMM forums.
Can you point to a source that says you can convert the gains on your after-tax 401K to a Traditional IRA (and thus defer taxes even longer). I’ve talked to my plan administrator and Vanguard and nobody had seen/heard of this provision in the IRS Clarification 2014-54.
What each of them said is that any contributions made to the after-tax 401K can be converted to a Roth IRA, but gains on these funds would be taxed once I requested the rollover.
Appreciate the help and/or source for this information. Thanks!
The source is Notice 2014-55 itself, which says that in a situation where there is a direct rollover
to two or more plans, “then the recipient can select how the pretax amount is allocated
among these plans. To make this selection, the recipient must inform the plan
administrator of the allocation prior to the time of the direct rollovers.” (Example # 4 in the Notice illustrates this in the situation where the direct rollover is done to a Roth IRA and a traditional IRA.) When you take a distribution from an after-tax 401k account, the portion representing contributions is “after-tax” and the portion representing gains is “pretax,” so you can apply this guidance in the context of a rollover of funds from an after-tax 401k account to allocate the amounts accordingly between a Roth IRA and a traditional IRA. The IRS guidance is still new and hasn’t been implemented yet by all plan administrators, but the transition rules at the end of the guidance make it clear that you can rely on the guidance immediately (and even retroactively).
Thanks for the quick reply. I read through the example, and it’s still a little unclear to me. The problem is that in my plan I have a pre-tax 401K (Traditional 401K) and then the after-tax voluntary option. I understand that the gains from the securities in the after-tax voluntary are technically pre-tax, but they are not in a pre-tax account.
Each person I spoke with was aware of 2014-54, but none of them interpreted the gains in the after-tax voluntary account as transferable to a traditional IRA under this rule. Since it is still early days, I hope there will be more case examples or clearer language/examples to make this easier to understand.
Thanks again!
Hi Ethan, as Eric said, the new guidance specifies that you can direct your pre-tax contributions and the earnings on all of your contributions to your Traditional IRA while directing only the after-tax contributions to your Roth IRA. Whether your 401(k) custodian makes that an easy task for you or not, that’s another story. If I were you, I’d probably just keep calling until you get someone who really knows what they’re talking about. As Eric mentioned, this ruling is very new so maybe some administrators haven’t caught on yet but even if yours hasn’t, I’m sure it will eventually. Good luck!
Hi – I am little confused by this article too. I can understand that the IRS guidance says that after tax contributions can be rolled over to a Roth IRA. The guidance does not appear to state the the “gains from the after-tax contributions can be rolled over to a Roth IRA.
The pictures in the article itself seem to imply that both after-tax contributions and its associated gains can be rolled over into a Roth IRA – which I don’t think is true.
Great article, but can you please clarify?
Thanks!
There are two accounts in a 401(k):
1. Before-tax contributions, before-tax gains, after-tax gains (non-Roth)
2. After-tax contributions, Roth after-tax contributions, Roth after-tax gains
The first account can be rolled over into a traditional IRA without tax implications. The second can be rolled over into a Roth IRA without tax implications.
The new guidance says you can split up the withdrawal so the gains go into a traditional IRA and the principal goes into the Roth IRA. The guidance doesn’t say anything about converting the gains to Roth because that isn’t a new thing. Putting the gains into your Roth IRA has previously been allowed as long as you’re willing to pay tax on them that year, and is still allowed today.
vinod,
The key to understanding the last picture is in the wording preceding it: “Assume the same scenario but rather than leave everything in the 401(k) to grow, you instead immediately rollover your entire balance to two separate IRAs…”
The KEY word is “immediately.” Since you are rolling over the contributions immediately, they do not have time to generate gains while inside the 401k. The $7,500 gains shown in the Trad IRA bucket are earned AFTER the in-service distribution, and are earned within the Trad IRA account (not the 401k account). Same for the $9,000 gains shown in the Roth IRA bucket, they are earned within the Roth IRA account AFTER the $30,000 After-Tax contributions are converted from the 401k to the Roth IRA. Thus all gains are classified under the account in which they are earned. The key to maximizing this strategy is the ability to take in-service distributions, which allow you to minimize the amount of gains earned while the money is in the 401k account.
Good points, Eric! I should put together a calculator or something to help people plan their Traditional-to-Roth conversions so that they know how long it will take to convert, how much tax they’d have to pay, how much they can withdraw every year, etc. That way, they can determine whether they should do the rollover as soon as possible or, as you suggested, wait so that they could access the after-tax earnings earlier, if needed.
That sounds like an interesting debate you were having over on the MMM forums so feel free to link over to the thread so that people (me included) can check it out!
That sounds like it would be a powerful tool if you could do it! There are a ton of variables at play though.
Here’s the link to the thread I was referring to:
http://forum.mrmoneymustache.com/investor-alley/did-the-irs-just-give-an-extra-$35kyr-of-tax-free-growth-saving-space/
Yeah, I haven’t thought about how I’d do it yet but it would be cool if I could come up with something useful!
Thanks for the link to the forum post. I’m going to go check it out now…
Yes! A calculator would be great. I understand the post but it seems like a heck of a lot to keep track of between tax paperwork and tracking everything, then using this to actually help plan if retirement can happen earlier.
I know this thread is a bit old, but now it pertains to me so I have a question!
I have spent the last couple of years paying off ~$100k in student loan debt (I’m 32) but now am ready to put retirement savings into my main financial focus. I currently have ~$50k in my 401k (no match, but profit sharing that comes out to ~$7k/yr) – of that amount there is $5500 in the after-tax (non-Roth, not offered) portion.
Here are my questions:
I make $160k/yr and will be getting a ~$36k bonus check in early February. I have been reading a lot on the MBR strategy and I want to partake since I cannot make Roth IRA contributions. My knee-jerk reaction was to front-load my pretax 401k (50% max contribution rate would put me right at the $18k limit here and not too concerned with DCA at my age/in this scenario) and then use my remaining salary for the year to fund the after-tax 401k at 15% or so. I have the ability to make in-service withdrawals and would likely do so every month as to minimize non-Roth protected growth.
After doing some reading, I am now a little confused as to how a different scenario would work out – that is to skip the pretax 401k all together, put the 50% into the after-tax portion, roll this over to Roth immediately, and then max out the $53k/yr limit (minus profit sharing) all with after-tax contributions to be MBR’ed in a Roth IRA. Is this legal? If so, worth doing?
The second, smaller question is if I roll over the ~$5.5k I already have in the after-tax portion of my 401k as well this year, that shouldn’t count toward any contribution limits correct?
Thanks all for any help you can provide!
Eric – I can only answer one part of your post, but you can make Roth IRA contributions, via the backdoor method (http://www.rothira.com/what-is-a-backdoor-roth-ira). Income limits don’t apply.
I did this for years, until I made the mistake of rolling over a previous employer’s 401k to a rollover IRA. I could still do the backdoor conversion, but I would end up getting taxed on a portion of that, which doesn’t make it worthwhile.
Does the prorata tax issue apply when youre doing an in service withdrawal from a 401k?
You could roll over the IRA into your current employers 401k.
Howard,
I am in the same situation as you. I have previously rolled over 401Ks into a rollover IRA and so I wasn’t sure about how to approach the MBR without getting hit with a tax. I did some research and what El is suggesting seems feasible; roll over the IRA into the current 401K (if you have one), then do the MBR from thereon. Were you able to test this?
Jbird,
The pro rate doesnt seem to be an issue when you make an in-service withdrawal from the 401K based on the article at the link below:
https://seekingalpha.com/article/4182164-new-twist-roth-ira-conversions
In the very last paragraph, it says “The mega Roth applies to employer-sponsored salary deferral plans such as 401(k)s……….many plans allow employees to elect an in-plan Roth transfer. This transaction is the 401(k)-equivalent of a Roth IRA conversion……There is, however, one important distinction. The pro-rata rule does not apply with these Roth conversions and plans may allow employees the ability to pick which sub-accounts or buckets they wish to transfer to the plan’s Roth option.”
Eric, first you need to find out if your employer 401k plan allows you to have after-tax contributions, as some plans don’t and some have limits lower than what IRS allows. Second, you need to evaluate pre-tax 401K vs. Roth, and the most important determining factor is your tax rate between now and after you retire. If you believe your tax rate is higher now than what it will be in your retirement (when you withdraw the money), then it is better to pay tax later, therefore pre-tax contribution is better, and vice versa.
I am lucky that my employer’s 401K plan is probably the most flexible out there, I can tell you how it works for me. I front load my 401K each year, directing 100% of my pay to pre-tax and after-tax 401K, until it hits the IRS limit ($54K in 2017 including employer match). My employer matches 50% of pre-tax (or Roth 401k) contributions, and it vests as soon as it hits the account. So I get it at the beginning of the year and it has nearly a full year to grow. For after-tax contribution, the plan offers in-plan Roth conversion (through Vanguard), so I just click a few buttons and the after-tax money becomes Roth asset in my 401K. I could leave it there to grow tax free, but I chose to transfer it to my Roth account at Fidelity so I have full brokerage investment choices, and it takes a phone call to Vanguard to do that. To minimize the number of phone calls to Vanguard and the hassle, I contribute 100% pay and annual bonus in the first few months, so it does not spread through the whole year.
Wow.Just finding this thread, but what amazing retirement benefit you have!!
Has anyone had any issues with Vanguard in doing this rollover from a non-Vanguard 401k? Basically I started funding my after-tax in my 401(k) every two weeks to the maximum that my company allows. The next day after each pay day I take an in-service withdrawal and they send me a check in the mail to Vanguard as requested. I then send this check to Vanguard with a letter explaining to add these funds to my Roth IRA and every two weeks Vanguard calls me up to confirm that I really want to do this warning me that this will be a “taxable event” and I need to be careful and contact a tax professional. Am I misunderstanding this new rule and doing something wrong or do they just not understand this new law do you think?
I am not entirely sure of the benefits of after tax 401(k). While the gains may grow tax deferred, it is not much different from an after tax investment account where you can also let the gains compound tax free as long as you don’t sell the assets. Sure, there will be dividends along the way that are taxable but choosing an index fund with reinvest option would still give an investor lot of flexibility with a regular after tax mutual fund or brokerage account for these additional savings. If there is a likelihood of higher tax rates in the future, then having sizable assets in after tax accounts is better than relying mostly on tax-deferred accounts in my view.
It is because of this: According to the new guidance, the pre-tax contributions can go directly into a Traditional IRA and the after-tax contributions can go directly into a Roth IRA.
Do you think that Roth investments are worth it? Making your investment growth tax free? With my former employers plan, I could roll out after-tax 401k investments into a Roth IRA every 6 months. This meant that instead of the $5,500 limit, I could put more than $25,000 into the Roth IRA every year. That seems like a pretty great benefit to me, but your employers rules may vary.
Is this type of rollover subject to the 5 year delay for withdrawal like the traditional IRA to Roth IRA conversion?
I asked my 401k plan administrator this question. She did seem to think that, at least for in-service post-tax rollovers, that the 5 year seasoning is still required for withdrawal of that lump sum rollover. From what I’ve read so far in the IRS regs, that seems to be the case.
As always, check with your accountant before taking internet advice though :-) This is all still pretty fluid.
And if you don’t have an accountant, asking prospective accountants about their opinions / recommendations of this sort of rollover is a great filter for those who keep up with this stuff vs. those who aren’t paying attention. It’s harder than I thought to find a modern accountant who was interested in helping my with tax strategy. But they do exist!
Yes, a rollover from an after-tax 401k account to a Roth IRA is subject to the same five year holding period before you get penalty-free access the funds as a conversion of a traditional IRA to a Roth IRA. Take a look under “Additional Tax on Early Distributions” in IRS Publication 590:
http://www.irs.gov/publications/p590/ch02.html#en_US_2013_publink1000231071
Also, be mindful of the ordering rules (discussed in the same IRS publication) that force you to withdraw funds from a Roth IRA in a particular order (which in turn determines the tax and penalty treatment of each withdrawal). So if you do a mega backdoor Roth rollover, but your existing Roth IRA already has other funds in it that the ordering rules will force you to withdraw first and that are subject to penalty, you will not be able to access the funds from your mega backdoor Roth rollover without first withdrawing (and paying the penalty on) those preexisting funds.
The five-year rule does apply, but an important thing to note about it is that the 10% early withdrawal penalty only applies to money you paid tax on at the time of the Roth conversion. If you use this new guidance to split your rollover so the after-tax principal goes to your Roth IRA and the tax-deferred earnings go to your traditional IRA, you could withdraw the principal from the Roth at any time with no penalty.
However you need to take this in the context of any other Roth conversions you have made in the past. There’s a set of ordering rules that determine what money comes out of the Roth IRA first for the purpose of calculating taxes and penalties on that money. Direct contributions always come out first and are always tax-free and penalty-free. Then rollovers come out (first in, first out). So if you paid tax on a traditional-to-Roth conversion two years ago and you rolled over some after-tax money this year, you wouldn’t be able to get the after-tax money back until you first withdraw the money you rolled over two years ago and paid any applicable penalties on those funds.
Thank you for clarifying this. I was not sure how the 5 year conversion rule would apply in this after-tax 401(k) contribution to roth ira rollover case since there are no taxes paid at the time of the rollover. So basically even though the 5-year conversion rule applies, if you take out the roth ira money corresponding to the after-tax 401(k) rollover within the first 5-years, there should be no taxes whatsoever. This is a great way to boost the roth ira balance.
Thanks for this article. I have one question: normal contributions to a Roth IRA are only allowed when one does not exceed a certain income level. Does this also apply to the 401(k) -> Roth IRA conversion? Any limits here? Thanks! F
Hi Fubek,
No, the income limits don’t apply to these types of conversions!
From what I’ve read elsewhere, if you have after-tax gains in your current 401k, they can be rolled into your traditional IRA. So if you couldn’t roll over while employed, you could still put the $8,700 in your example into a tax advantaged account. Am I on the right track with that?
Yes, you are right about that but the sooner you can roll those funds into the Roth, the less amount of tax you would need to pay on those gains (since gains in a Traditional IRA are eventually taxed, it’s better to have those gains be in a Roth instead so that they aren’t taxed). If you can’t do in-service withdrawals though, then waiting until you leave your job and then just putting those after-tax earnings into a Traditional IRA is the way to go.
Thanks for this intel! I’m maxing out my pre-tax 403(b) contributions and my backdoor Roth. As soon as I read this post, I called my 403(b) administrator and learned that after-tax contributions are allowed but not in-service rollovers. I plan to stay with this employer 5-7 years until FIRE. I wonder if I should take advantage of this strategy or if the inability for in-service rollovers would result in 1) too much tax on the growth as income at withdrawal and/or 2) too much risk that the Roth rollover would no longer be an option in 5-7 years. I’d be grateful for any thoughts.
On second thought, of course, my first question is not an issue as long as the Roth rollover is available at the time I separate. So that is my one concern.
Hi Dorothy,
If I were you, I’d still take advantage of it because you won’t accumulate too much in 5-7 years and what you do accumulate can just go into your Traditional IRA. As far as the risk that the rollover option won’t be available in 5-7 years, your guess is as good as mine but I tend to avoid trying to predict the future and instead just optimize things based on the rules available at the time. If things change, I’ll work on optimizing using the new rules then.
I think having some graphs which compare a couple different strategies (compared to taxable account alternative), over time, like in your previous posts below, would have more impact on how great this could be for FI-seekers.
https://www.madfientist.com/traditional-ira-vs-roth-ira/
https://www.madfientist.com/retire-even-earlier/
Good idea, BB. I thought the complicated nature of this topic required a more detailed explanation so I decided to omit those comparison graphs in favor of the graphs that you see above. It seems a lot of people are interested in this idea though so maybe I’ll do a follow-up post and include the type of graphs you suggested. Thanks for the suggestion!
Also, in your research, did you see a need to ever do a “roll-in” to avoid any tax complications or headaches (if you already have other trad/roth IRAs)?
I’m not sure I understand your question. Can you elaborate?
I can’t find the exact context and link I was thinking of.. but pretty sure it relates to the “pro rata rule.”
BB, you might be referring to rolling funds from an existing Traditional IRA into a qualified plan (i.e. 401k) to take full advantage of the backdoor Roth IRA contributions. By completing a rollover of the Traditional IRA into a qualified plan, you avoid the negative consequences of the pro-rata rules for Traditional IRA’s (i.e. more taxable income) when you convert a nondeductible Traditional IRA contribution to a Roth IRA. The pro-rata allocation is determined as of 12/31 each year so you would need to complete the rollover to the qualified plan by this date. You might check with your plan administrator to make sure they allow rollovers from Traditional IRA’s (Roth IRA’s are not permitted). This could allow you to take advantage of the backdoor Roth IRA contributions and mega backdoor Roth IRA contributions in the same year, depending on your situation. What do you think, Mad Fientist?
As always, Nick, your answer is clear and intelligent so thanks for chiming in!
Great! Thanks for the info. It should help others who want to do both bakdoors (they must be extremely lucky to take advantage!)
Initiating a rollover into my 401k from my tIRA now. 401k has some nice investment options and this should allow me to do do a backdoor Roth IRA if I am so inclined. Unfortunately not able to do a mega backdoor Roth IRA.
Nick, would you mind translating this for those of us who may not be at the expert level? I don’t know what the pro-Rata rules are. I am currently contributing to a non deductible Ira and rolling it into a Roth each year. Sounds like I could be doing something better? Or is the pro-Rata the calculation of what % of your funds are taxable vs non taxable? If so, I’d love more detail. I understand that total traditional Ira funds are divided up into what % are tax deductible and what percent are not. Then that percentage is applied to whatever portion you roll into a Roth. So you owe tax on some percentage of your rollover.
Does rolling it into a 401k change that? OH!!!!! Are you saying that you can roll any tax deductible traditional Ira into a 401k that then only the non tax deductible is left and you can roll that into a Roth without any additional taxes due??
Only possible downside I see there is the typically more limited investment options available in 401ks and the potentially higher fees. But if your plan allows in service withdrawals you could just take it back out every year.
You’re brilliant!! Let me know if I am understanding correctly and please correct me if I’m off.
Thanks!
Also I have one big question. Somewhat unrelated. What about the total dollar limitation? I saw it was a little over 1M. Exactly what does that apply to? Your aggregate retirement funds? Just your Roth? Is it as a married couple or as an individual? Is it contributions or total value (including dividends and capital gains?). What happens if you exceed it? Would the tax benefits stop? Would I owe some kind of penalty? I am not near this limit right now but if I start amping up all these techniques it wouldn’t take long … I am especially concerned about contributing now, and letting it sit, and then having it become huge as it is likely to become if untouched over a long period of time.
Nicklaus,
I currently have $75K from in my TIRA (rolled over from my previous employer 401K). I’m in the process of moving the entire amount to a qualified plan (ie: My current employer 401K) and should be completed within the next 4 weeks.
My question here is, would I be able to contribute $6,000 through backdoor Roth IRA in CY2020 and not be subject to the IRS pro-rata rules? Or do I need to wait until Jan 1, 2021?
Thanks!
Well said, always enjoy reading your posts! Nice work, Mad Fientist!
Thanks a lot, Nick!
What’s your opinion on funding your tax advantaged accounts via funds from a taxable account in “cash short” years?
Due to a few unanticipated expenses, I was short of the cash to contribute to tax-advantaged accounts this year from income, however, would it be smart to make up this difference by transferring funds from a taxable account this year for the tax savings?
Also to add to my post. I have a SIMPLE-IRA program at my employer where the account is held at Edward Jones (less than ideal). I currently contribute to the match max (3%). Is it smart to be maxing this account given it is held at EJ? Do the the tax benefits outweigh the expense ratio/fee losses? I have a fear of giving more than the minimum to EJ, though this fear may be irrational given the tax savings.
For example, $7,000 (getting funds from my taxable account and putting into SIMPLE) at 25% saves $1,750 in taxes, way more than the fees I will incur (in the short-term anyway, though in the long run I fear the fees would catch up with me). I’m looking into a trustee-to-trustee transfer to get the money to Vanguard after a 2 year holding period (from what I’ve read on Bogleheads wiki)
In addition, the selling of taxable funds won’t trigger additional taxes due as I have enough in “losers”.
I should have read your follow-up comment because it answered both of my questions that I just asked you in my response to your first comment.
As you said, the tax savings will more than cover the fees so if you plan to get out of those funds anyway within two years, it makes sense to lower your taxes by $1,750 and reinvest that extra money in your taxable account. It sounds like you’ll also harvest some losses by selling so the tax savings resulting from those losses can also be invested.
You still have a month to go before the end of the year so why don’t you try to also sell some stuff you don’t need around the house and then use that to max out your IRA?
I’d also check again to see if there are any low-cost index funds you can invest in at Edward Jones. Usually these custodians have at least one semi-good offering that you can take advantage of until you move the money to Vanguard.
Good luck!
Kurt, would you be selling the funds in your taxable account at a loss or a gain? Would you be the contributing those funds to a pre-tax account like a Traditional IRA or 401(k)?
MF, you never cease to amaze me with how well you find and explain strategies to minimize tax burdens and how to execute a strong plan for financial independence. I wonder how many people at the IRS read your blog and think ‘damn, this guy is good!’
Haha, thanks for the very kind words, Kyle! I can’t imagine anyone from the IRS reads my blog but if there is anyone out there, I hope they speak up because I’d love to hear what they think!
I went from being really excited about this possibility, to then immediately sad, as my 401k neither allows for after tax contributions or in-service withdrawals (until I am 59.5).
Sad face.
The same exact thing happened to me, DB40. I was so pumped about this strategy but then after spending 30 minutes teaching the rep I was talking to all about it, he burst my bubble by saying that it wasn’t possible with my employer’s plan :(
Can you do the same rollover to your Roth 401k, or does it have to be a Roth IRA?
Presumably you could do the same with a Roth 401(k) but if someone out there with a Roth 401(k) has done it, please speak up because I’d be interested in hearing your experiences.
The rollover would be a bit different because the Roth contributions and their associated earnings would go to the Roth IRA, the after-tax contributions would also go to the Roth IRA, and the earnings on the after-tax contributions would go to the Traditional IRA.
Have you determined if this is correct? Or could the Roth 401k be rolled over entirely into a Roth IRA?
Yes I just did in-plan roth rollover by rolling after-tax 401k contribution to roth 401k. there is no fee associated with my plan. I did rollover after tax 401k contribution to an external roth ira too. but that costs me $25 per transaction. so I decided to roll after-tax 401k into the roth 401k instead of rolling into roth ira to save the transaction fee. one more thing I am unsure is should I max out the after tax contribution to take advantage of roth growth before I max out pre-tax 401k? all I read online is to max out pre-tax 401k first. I don’t understand why. If I am still going to max out pre-tax 401k but do it after maxing out after tax 401k in the same year, would it be better since I allow after tax contribution to grow tax free in roth 401k through in-plan roth rollover at an earlier time?
i literally just got off the phone and moved my aftertax to roth ira, so nice timing on the article!
why would you move your pretax portion of your 401k over to a Traditional IRA? why not leave it in the Trad-401k (pretax) bucket and just move the Aftertax-401k portion to Roth (401k or ira), especially if you might already have a good 401k plan, with say Vanguard?
Also, please correct me if i’m wrong, but if you have money in your Traditional IRA then you cannot do the Backdoor Trad>Roth IRA trick without paying some taxes there. (From http://www.bogleheads.org/wiki/Backdoor_Roth_IRA: If you have any other (non-Roth) IRAs, the taxable portion of any conversion you make is prorated over all your IRAs; you cannot convert just the non-deductible amount. )
Also, note when rolling over the AfterTax-401k bucket to Roth IRA, IF you have gains, you may be subject to tax. You can do this: move the aftertax contributions to Roth IRA without penalty AND also move the gains of the AfterTax401k into a Traditional IRA (I just asked Vanguard rep about this). But then you’d have the problem I mentioned previously where you’d have money in a Trad-IRA. In my case, I waited until the end of the year and now I have a small taxable event on the gains that were made this year.
Best way to minimize tax gains is to contribute to AfterTax401k and then IMMEDIATELY rollover that money into Roth (IRA/401k) such that you don’t have gains to pay taxes on. So for example, if you contribute to AfterTax401k on a monthly basis (monthly paychecks) throughout the year, you’ll have to do the rollover 12 times, and probably keep track of all those rollovers.
In regards to your second paragraph. Might the easiest way be to jack up your AfterTax401K contributions the final weeks, or months, of the current tax year and than rollover once?
For example, say I have budgeted for $10,000 of disposable income for the year. What I would do is divide 10,000 by my weekly paycheck. That would tell you at what point in the calendar year I should change my contributions to 100% Roth-401k contributions. Then, wait till the end of December and rollover into Roth IRA and pay minimal tax on the conversion.
Peter: you could, but you may not want to wait until the end of the year in the event you don’t work at the company at the end of the year (maybe highly unlikely for most?). secondly, let’s say you divide your $10,000 by 5 paychecks and deposit $2k every week into the aftertax 401k – that’s 5 weeks of time where gains could be made of which you’ll have to pay that tax on those gains. yes, 5 weeks is much shorter than say 5 months or 10 months so your gains will be potentially lower. just depends on how you want to handle it. some people i know at my company contribute $X from their Friday paychecks into AfterTax401k and then call Vanguard Monday morning and do the rollover every paycheck until they hit max. While this will reduce your gains, for some they may consider extra work to call every Monday to do the rollover.
Panda: Please don’t confuse the rules for the Mega-Backdoor Roth (using After-Tax 401(k) Contributions as the conduit) with the rules for the Backdoor Roth (using Nondeductible Contributions to a Traditional IRA as the conduit). In the former case, when the After-Tax Contributions are withdrawn from the After-Tax Subaccount of the 401(k) (and presumably rolled to a Roth IRA), the only amount subject to tax is any Gain on the After-Tax Contributions (with tax-deferral presumably retained by rolling these gains to a Traditional IRA). Any amounts you may have in other Traditional IRAs, pre-tax amounts in other subaccounts of the 401(k), or any other 401(k) accounts, simply don’t enter the calculation. See:
http://fairmark.com/retirement/roth-accounts/roth-conversions/isolating-basis-for-roth-conversion/basis-recovery-from-employer-plans/
Well according to this
http://fairmark.com/retirement/roth-accounts/roth-conversions/isolating-basis-for-roth-conversion/using-new-basis-isolation-rules/
I could just leave growing my After-tax 401(k) contributions until I decide to rollover. Then I would just separate my distribution to two accounts. My After-tax 401(k) contributions would go to my Roth IRA and the gains on the After-tax 401(k) contributions would be rolled over to traditional IRA.
So there is no need to immediately (January 2nd on the example) roll you contributions from your 401(k) to your Roth and traditional IRA.
And the beauty of it is that you don’t even have to quit your job. Your After-tax 401(k) contributions can be rolled over whenever you want.
Eduardo: You are correct. However, the advantage of rolling your after-tax contributions to your Roth sooner rather than later is that the more of the gains on the contributions will be tax free.
My understanding is that some who use this Mega-Backdoor Roth strategy may have the ability to place a standing order with their 401(k) administrator to roll the after-tax contribution to their Roth immediately after every paycheck. Then there are never any taxable gains associated with the after-tax contribution.
Despite what MF said regarding the hypothetical January 2 example: “the pre-tax contributions can go directly into a Traditional IRA and the after-tax contributions can go directly into a Roth IRA,” there is no need to frequently roll the pre-tax contributions. They and their associated gains are tax deferred either way and could just as well stay in the 401(k) if the investment choices/fees are reasonable.
right, agree on that After-Tax 401k contributions gets rolled Roth IRA without tax implication, but gains on any amount in the After-Tax 401k sub-account would be taxed – I had this exact situation yesterday since I waited until the end of the year to do this rollover and had been accruing gains in this AfterTax subaccount.
What I was trying to say which is separate from above statement, is that I think (and could be wrong) it doesn’t make sense to move the PreTax-401k portion to Trad-IRA per the MF article. My understanding is that I want to have a $0 balance in my Trad-IRA every year such that I can then perform the backdoor Trad>Roth IRA trick without tax implications. If I follow the MF article above and in 2014 move both AfterTax>RothIRA and PreTax>TradIRA (ignoring the gains), I will now have money in my TradIRA, let’s say I rolled over $95k for simpler math. NI now have a $95k in my Trad IRA (which came from the rollover PreTax401k) and in 2015 I contribute $5k into my TradIRA intending to do the conversion to Roth. But per the boglehead link I posted previously, I cannot do this TradIRA>RothIRA conversion tax free but rather it’d be subject to tax of 95% on the $5k (5 = 100 * [ $5000 / ($5000 + $95,000)]) or $4750 is subject to taxes.
Summary is what I would try to do every year:
1. Backdoor Roth : Contribute to TradIRA and immediately convert to RothIRA
2. Contribute to PreTax401k.
3. Contribute to AfterTax401k.
4. Contribute to HSA.
5. Perform AfterTax401k rollover to Roth (401k or IRA, up to you).
6. Leave PreTax401k money there such as to have a $0 balance TradIRA so I can repeat step #1 every year without tax implications in step #1. Secondly – what does it gain you to move PreTax401k to TradIRA anyways?
Okay, I understand now and agree totally. It seems MF confused the issue when he said, regarding the hypothetical January 2 example, “the pre-tax contributions can go directly into a Traditional IRA and the after-tax contributions can go directly into a Roth IRA.” There is no need to periodically roll the pre-tax contributions. They and their associated gains are tax deferred either way and would usually best stay in the 401(k), particularly if the investment choices/fees are reasonable.
I think I’m a bit confused here. Sorry I’m still very new to all this.
Correct me if I’m wrong ……what I’m getting is that you ONLY have tax implications because you are rolling over gains from after-tax account to tIRA that has NON-DEDUCTIBLE contributions?
So in other words….. if all my contributions in my tIRA were deductible contributions and I roll over gains from after-tax account to my tIRA then I don’t have to worry about taxes right???
Sick thread you guys. Tons of great things to consider here. This all pertains to exactly what I’ve been researching regarding this topic.
I have a question about whether or not you can take just the after tax out and not have to take the pre-tax out at the same time. It’s possible that you need to do them both at the same time in order to follow the new guidelines?
http://fairmark.com/retirement/roth-accounts/roth-conversions/isolating-basis-for-roth-conversion/
Lolarobot: The new guidelines tell us how to do the pro-rata treatment of a single withdrawal from the After-tax subaccount of the 401(k). The withdrawal generally includes After-tax Contributions and any taxable Gains on those After-Tax Contributions. You could take out money from a Pre-tax subaccount at that the same time, but most people would want to avoid that. Thus the only taxable money coming out could be the gain (if any) on the After-tax Contributions while they resided within the 401(k).
http://fairmark.com/retirement/roth-accounts/roth-conversions/isolating-basis-for-roth-conversion/separate-subaccount-treatment/
The new guidance, Notice 2014-54, issued on September 18, 2014 addresses how to handle a distribution including pre-tax and after-tax portions, but doesn’t change the existing tax law including the availability of subaccount treatment. As stated in the Fairmark article, you just have to be careful to designate your distribution as coming from the appropriate subaccount.
Great discussion, everyone. I understand what 1dirtypanda is saying…if you are happy with your 401(k) investment options and you need to use your Traditional IRA for other backdoor strategies, it makes sense to leave your pre-tax contributions and earnings in your 401(k) instead of transferring them to a Traditional IRA. I decided to transfer the funds to a Traditional IRA in the example because I wanted to show what would happen if you decided to rollover the entire thing after leaving your job (since I imagine most plans don’t allow in-service withdrawals).
Thank you for this! I have the same strategy but want to clarify my ability to withdraw contributions early without penalty. With that:
– If I max out my traditional 401k. And get the company match (also pre-tax)
– I then do a non-deductible contribution of $6k to a traditional IRA and immediately conver to a Roth IRA (Backdoor Roth)
1) can I withdraw my contributions (less earnings/growth) at anytime (without waiting 5 years) since this was after tax money in the first place?
– I then do after tax contributions to my 401k plan and immediately convert those to the same Roth IRA (mega Backdoor to the same Roth I just did the Backdoor
2) can I withdraw the contributions without taxes or penalties (and without waiting 5 years)?
If yes, I am thinking I should always try to max out the Backdoor and mega Backdoor Roth strategies knowing that if I lose my job or need the money before 59.5yrs old I can always access my capital without penalties and in the meantime it grows tax free.. am I missing something?
Can someone help clarify what we should be doing with the after-tax 401k GAINS? In the article it says you roll them into the Roth along with the after-tax 401k contributions. This comment mentions rolling them into a Traditional IRA. Do we have a choice? If so, which one is a better option? Do we pay taxes on the gains? How about just leaving the after-tax 401k gains in the 401k and just moving out the contributions?
What to do with the gains? You have two options. You can roll them into the Roth, which will cause you to owe some tax on that money this year. Alternatively, the new guidance from the IRS allows you to put the gains in a traditional IRA, in which case you won’t owe tax on that money until you withdraw it from the IRA.
I don’t believe leaving the gains in the 401(k) is an option. My understanding is that if you do a partial withdrawal from the after-tax subaccount of your 401(k), there’s a pro-rata rule that says an equal proportion of principal and gains is considered to have been withdrawn. Once you make a withdrawal you can split the pre-tax gains and post-tax principal, but you can’t just leave the gains where they are.
A downside of splitting the gains to a traditional IRA is that it invalidates the “backdoor Roth IRA” strategy, because that only works if you have no pre-tax funds in traditional IRA accounts. If you can afford to make maximum contributions to your after-tax 401(k) and your IRA, you may want to just pay the tax on the gains, especially if the amount is relatively small.
If the amount of gains is large enough, another possible option would be to roll the gains into a traditional IRA and then roll that IRA into the pre-tax portion of your 401(k).
I personally convert the whole balance to my Roth IRA a few times a year. By doing the rollovers frequently, there isn’t much time for gains to accumulate, so the amount of gains is relatively small. Also my company’s 401(k) plan allows you to roll over the full balance to a Roth IRA with a few clicks on the website, while any of the other strategies would require a phone call and paperwork. I’d rather pay a few extra dollars of tax than deal with that, but your situation may vary.
Thanks for the clarifying response. When I log into my 401k (Vanguard), they have an online tool that allows me to do an-in service rollover for my after-tax 401k. Curiously, the total amount I can do is exactly equal to the total amount of all my after-tax 401k contributions over the years. I have about $4k in after-tax 401k gains that don’t show up in the rollover amount. Even more weird, the target I can choose for the rollover is a Traditional IRA, not Roth.
1. So it seems like I can just rollover my after-tax 401k contributions by doing it online. My gains would be left behind. Although the tool allows me to do this, it sounds like I probably shouldn’t because it’s in violation of the pro-rata rule you mentioned. Maybe the Vanguard tool isn’t calculating the amount correctly and I should just call in to roll over the entire amount?
2. The target for the rollover is a Traditional Ira. This obviously wouldn’t make sense to do because I would be paying taxes on the withdrawal later. Why would Vanguard make this the target of the rollover? Is there a reason when this would ever make sense?
I called Vanguard. To answer my own questions in case anyone else is thinking about doing this with them, you can’t do it online yourself. They’ll mail you a form in which you have to mail back to do the in-service withdrawal. I’m not sure if this is for all Vanguard 401k’s, or just the way it’s set up with my employer.
A mail-in form is *not* required for all Vanguard 401(k) accounts. My wife and I both work for employers that use Vanguard for their 401(k)s. My employer allows you to roll over your after-tax 401(k) sub-account to a Vanguard Roth IRA with a few clicks on the website. For my wife’s 401(k), you need to contact customer support to do the rollover.
“If the amount of gains is large enough, another possible option would be to roll the gains into a traditional IRA and then roll that IRA into the pre-tax portion of your 401(k).”
Can you do that? i.e., roll over the pre-tax gain of the after-tax contribution to the pre-tax portion of the 401k?
Very awesome and concise summary. I’ve seen the “mega back door roth” discussed on reddit and the bogleheads sites, but your graphics convey the practical mechanics better than merely reading about it!
We weren’t able to take advantage of the mega back door roth, although we did have $72,000 of tax deferred/HSA space that knocked our federal tax liability to almost zero on our $150k combined incomes.
Thanks a lot, Justin! It took me a while to figure out how to best represent this strategy visually so I’m really glad to hear you think my efforts were successful :)
Hope you’ve been doing well!
Do you know if the TSP will allow after-tax contributions and immediate transfer into a roth IRA? Many thanks.
A brief search indicates it’s not a promising/viable option for TSP participants. The current TSP rules only allow for one age-based in-service withdrawal (plus one financial hardship in-service withdrawal): https://www.tsp.gov/planparticipation/inservicewithdrawals/ageBased.shtml. So you could only do it once, plus I haven’t been able to find any indication that we even have the ability to make after-tax contributions. :-( But it’s one more benefit to look at when considering future employment in the private sector.
Thanks jexy. I guess the best we can do via TSP is to max out the tax deferred contribution, then rollover to a traditional IRA upon retirement, and slowly convert over to a roth ira depending on our income and tax bracket at that time. Again, this strategy makes sense only if we are anticipating lower income during retirement than during working years.
I believe you can already make after-tax contributions to your TSP with the new Roth TSP option. Now you can max out your Traditional TSP with pre-tax plus employer matching ($18,000 + $6,000), and then put $29,000 in your Roth TSP, which can be rolled-over to a Roth IRA at anytime.
But I’m not quite seeing the benefit of rolling over to a Roth IRA from Roth TSP. What do you see as the benefits? Maybe better investment options? Or setting up an IRA conversion ladder for early retirement?
One drawback to the TSP Roth is that, come withdrawal time, all distributions from your TSP account will be divided between your Traditional TSP and Roth TSP, in according to the percentage of each; e.g., if your account is 74% Traditional and 25% Roth, a $1,000 distribution will be $750 from Traditional, $250 from Roth.
There have been hints from the FRTIB that they are looking to change this, but change comes very slowly with the TSP.
Is a rollover the same as a withdrawal? Or does a withdrawal become a rollover if I make a roth contribution within a certain time window after taking the distribution?Also, what happens if the value decreases? Can you still roll over the full contribution amount?
From the IRS: “A rollover occurs when the participant receives a distribution of cash or other assets from one qualified retirement plan and contributes all or part of the distribution within 60 days to another qualified retirement plan or traditional IRA.” (Source: http://www.irs.gov/Retirement-Plans/Plan-Sponsor/401(k)-Resource-Guide—Plan-Sponsors—General-Distribution-Rules)
If the value decreases below your contribution amount, you’d only be able to rollover what you have left.
This sounds exciting. I wish I understood it! Might try again tomorrow.
Haha, yeah this strategy is a bit tricky. Read over it again and feel free to ask questions here if things still aren’t clear!
Another great article and something I am going to look into! Thanks for sharing!
Glad you enjoyed it, Nick!
A few months I was going to email you to ask you if you would vet this backdoor – but then I found out that I can’t make after deposits either, and it seemed too good to be true. Other ideas:
1. Bargaining when you take a job to take an extra $10-20k as 401k instead or salary. This would work in select places.
2. I’m also wondering if a solo 401k, sep IRAs, and 457s can be used in create ways?
3. Finally, I’m considering moving into consulting instead of a good salary because of sep IRA/solo 401k max-out (and more time off between contracts).
Yeah, the SEP IRA is great. I just opened one up for myself last year so I’m hopefully going to be able to contribute more this year.
I am also interested to know if the TSP will allow for this. Thanks for the great article.
Hey Chris, see the comments above for more info on TSPs.
You can only rollover your TSP while employed if over 59 1/2 years old.
My husband is deploying next year so we will be taking advantage of tax free in and out Roth contributions and then getting as close to the $53,000 max as we can this year due to tax free combat zone rules but in a normal year the TSP will limit us to $18,000.
I’ve been a lurker for a few months, by first post. Thanks for all this great info MF!
Can we do this in 2014? A commenter above mentioned they just did it. All the examples in the article are about 2015, so I wanted to make sure. I would increase my contributions for the rest of the year to take advantage of some of this.
I already have about $20k from 401k after-tax and 401k after-tax growth because I over-funded my 401k a few years back and stumbled upon 401k after-tax contributions. I’m assuming when I do this, I would be paying taxes on this. I’m 10+ years from retirement, so it sounds like it’s worth it to take that hit now in order to start shielding the growth?
Anyone have recommendations on how/where to find a good accountant that can accurately deal with all this madness?
Yes, you can do all of this for 2014 but I figured I’d just use 2015 numbers since we’re nearly there.
It sounds like a good accountant would be able to sort through your issues but I have no idea how you’d find one!
I accidentally did this back in 2012. I was attempting to front load my contributions, and by the middle of the year, my company cut off further contributions because I had hit the before-tax contribution limit. What I didn’t expect was the company match also cutting off, so to get it back I contributed 6% as after-tax. In 2013 when I changed companies and rolled the account over, Vanguard knew exactly how to handle everything. Very smooth. It wasn’t exactly Mega for me, but it works as advertised.
I used this method on accident in 2012. I was trying to front load my contributions for the year and hit the 401(k) deduction limit by mid year. My employer cut off my before-tax contributions and their match. To get the match back, I contributed 6% in after-tax dollars for the rest of the year. In 2013 when I switched companies, I rolled the 401(k) into an IRA and Roth IRA. Vanguard knew exactly how to do it without triggering any taxes. Very smooth and no accountant needed. It wasn’t a Mega backdoor for me, but it certainly could be and works as advertised.
So question…
If I continue to max out a traditional IRA for the tax benefits now and funnel excess into after tax 401K (pre-tax maxed of course) I can then, since my plan administered by Vanguard permits, complete in service withdrawals and roll directly into the Roth IRA also with them? Will not run into a contribution limit problem because of the tIRA? In what way is this strategy preferable for early FI folks to funding a taxable brokerage?
Rollovers don’t affect contribution limits.
This strategy is preferable for early FI folks the same reason it’s preferable for most folks…it’s a way to shield more of your money from tax (IRA accounts vs. taxable accounts)
I think RJ is questioning if the Mega Backdoor Roth is in fact superior to a taxable account for FI (specifically those who can utilize the 0% LTCG tax).
The Mega Backdoor Roth (MBR) shields gains from taxes, but at a cost of liquidity. With an MBR, contributions are tied up for 5 years (it’s treated as a conversion), and gains until 59.5.
Conversely, if I put that money into a taxable account, I have immediate access to the money, and a 0% tax rate on LTCG (which could be tax-gain harvested each year).
Certainly tax laws could change. The 0% capital gains tax could go away, whereas current Roth funds would likely be grandfathered if tax changes happened to Roth accounts.
The MBR is great for higher incomes who can’t take advantage of the 0% LTCG tax, but a taxable account may be better for those who can.
I would appreciate it if you could poke holes in my argument – as I have the ability to do an MBR this year, but am planning on putting that money into a taxable account instead (I can utilize the 0% LTCG).
Ahh, thanks for clearing that up, Carl.
As you mentioned, this strategy is more useful for those with higher incomes so for some fientists, it may make more sense to go directly into a taxable account.
Do I understand correctly that some of the plans mentioned in previous posts allow for in-service distributions before age 59.5? I called the customer service line this morning for our company’s plan and they told me you could not take in-service distributions until age 59.5.
My understanding is that the law does not allow in-service distributions of pre-tax or Roth balances before 59½, but pre-59½ in-service distributions of after-tax (not Roth) balances are legal. Many 401(k) plans allow you to make these distribution, but your plan’s controlling documents may not allow this.
It may be worthwhile to call again and escalate to a supervisor to make sure that these are not allowed for your plan, since after-tax balances are fairly obscure and many customer service representatives may not be aware of this exception to the “no in-service withdrawals before 59½” rule.
In-service distributions before age 59.5 must also be legal for pretax and roth 401k plans, because my company allows it. They told me the restriction is that I can only roll over employer matches that are at least 24 months old. So none of my contributions, earnings, or recent employer matches are eligible. It’s not much, but it’s better than nothing. I assume each company has different rules.
Correct. My plan does in fact permit unlimited transfers of after tax contributions from my 401K to my Roth IRA by a simple phone call to Vanguard up to the maximum combined pre/post tax 401K contribution limit each year. Any gains incurred however though must be taken with the contributions per the rules of the plan. I will call the day after each contribution is posted. I may be able to do it on line via the Vanguard app but have to wait to see if this option becomes available once after tax contributions are credited to the account. A great tip I will maximize going forward. Note however my plan and many limited after tax contributions to a certain percentage of your income, so if you are a serious saver in excess of 75-80%, you may still have to fund a taxable account in addition to this or some other investment vehicle.
This isn’t a legal thing it is dependent on the way the plan provisions are lined out in the Plan document. You can take in-service withdrawals specific to certain transactions (rollovers to an IRA etc) on some plans and with your vested account balance, but others have restricted if withdrawals are allowed while employed. They can also restrict the types of assets that can be used or rolled out or withdrawn at different times. I run large corporate plans for Fidelity and ran large tax-exempt plans for years, and this is all dictated by the provisions setup by the plan sponsor. In-service withdrawals can be anytime for Rollover assets moved into the plan (regardless of taxation) if the plan sponsor allows it. The withdrawals can be based upon pre-tax, or Roth or after-tax and again whatever the vested balance may be. These can be limited to whether it’s employee or employer dollars through match or profit sharing. And most often we see the withdraws limited by age, such as what does the ER deem Normal Retirement Age.
Bottom line, it is a permissible action across all 401(k) plans but it is entirely at the discretion of the sponsoring employer. The largest Administrator and Recordkeepers can administer any of these options and are much more flexible with operational design, but the boutique entities are more restrictive with what they can operationally administer. Hope this helps someone!
I really do learn a lot when a read a MF article. I will check into it ASAP for our company to find out if it is possible for me to utilize. This would be a big help with early retirement if the plan allows it! Keep up the good work, sir.
Thanks! Hopefully your plan allows it!
Is there any way to get around the issue of our MAGI being to to high to contribute to a Roth IRA? Could I roll all of it into a traditional IRA and then backdoor it into a Roth IRA somehow?
Yes, take a look into the normal Backdoor Roth to see how you can get around the Roth income limits.
If you can make after-tax contributions to your 401(k)/403(b), that would also be a good way to legally contribute to a Roth IRA.
If our MAGI exceeds limits for contributions to a Roth IRA is there any way to take advantage of this? Could I roll it all over into a Traditional IRA and then Backdoor it somehow?
Contribution income limits don’t apply to rollovers so your income doesn’t matter when it comes to the rollover strategies described in this post.
Thanks for the post Mad Fientist, another gem indeed! I’m rereading you post and comments every other day and I keep learning more with every reread.
A suggestion for the blog. I find that a lot of my questions and confusions were cleared up by the comments section, but I did find sorting through the comments a bit difficult. What about organizing the comments reddit style with upvote and downvotes so misinformation can be avoided? Could be a good way to crowd-source additional information generated from your post via the comments section.
Hi Jen, thanks for the kind words.
Good idea with the reddit-style comments. That’s actually something I’ve been looking into lately because I’m getting pretty overwhelmed with the amount of emails I’ve been receiving. I figured if I could answer some of these questions in public (via a reddit-style interface), more people would benefit and also others in the community could start answering some of the questions, which would help me get through the backlog. Sadly, none of the solutions I found seemed very good so I’ll keep searching for an easy way to integrate that functionality into my site.
MF – thank you so much for sharing your insights with us. I would NEVER have known any of this without having access to your blog. It seems like there are a lot of strategies to make your money work for you. I am a newbie learning more each day, but it’s all still a little bit over my head. So I have a few questions…
1. Most of us have limited incomes, how do you decide in what order to do things? For example, I’m maxing out my pre-tax 403b at work and contributing the $5,500 to a Roth IRA. With the rest of my monthly income (about $900 after tax), which strategy is next? Do I do after-tax contributions as your article suggests? Or do I put it in a taxable account? HSA? I’m about 8 years from FI which would put me in my mid-40’s. I’m sure it’s a case by case basis…but what determines your case? :-)
2. I am receiving a gift of 32,000 (probably given equally over 3 years), same question as above – what is the best thing to do to shield any gains and have it accessible for FI years?
If I was in your situation, I’d max out my HSA (see why I think it’s the Ultimate Retirement Account) and then put the rest in a taxable account so that I have some money that’s easily accessible. I actually plan on writing a post on which type of account to contribute to first so look out for that early next year.
As far as your gift is concerned, I’d check if you could make some after-tax contributions to your 403(b) and try to do that after maxing out your pre-tax 403(b), Roth IRA, HSA, and contributing whatever amount to your taxable account that makes you feel comfortable.
Thanks so much for the feedback! I will definitely look forward to reading that post.
This isn’t exactly new news – the option has been there for a while, and I’ve used it for a few years now.
For those of us who are self-employed, this is straightforward to implement. You need to set up your own custom IRA plan that allows for both after-tax contributions and in-service withdrawals. All of the financial institutions which will let you open a self-employment IRA have their plan documents set up in a way that does NOT allow that.
What you would need is something called a Third Party Administrator. I use TPA Inc (aptly named). They aren’t in my state and I’ve never met them in person but it hasn’t mattered. Love working with them. They were a little puzzled by me wanting to invest 52K then within a few months rolling the whole amount over – but once I explained it it made perfect sense to them.
The advanced topic question is – how do you invest OVER 53K per year? Afterall the 53K limit is per plan, not per person. If you have two employers (or one employer and self employment ) you could contribute 53K to each plan
What you can’t do is open a second plan for your company. You also can’t create a separate company and set up a separate plan under that. If there’s common ownership (that includes spouses) – there are detailed rules for what that means – then for the purpose of retirement plans it’s considered the same company.
You also can’t use a PEO (professional employment organization) – they will still use your EIN for setting up the retirement plan.
So I’m still looking for options. If anyone has any ideas I’d love to hear.
I talked to my 401K plan administrator. We have both a pre-Tax and post-Tax 401K available under our plan and the plan administrator says that the total contibution limit for 2013 is 17.5K for both the plans put together and not 52K as you mention. Can you please refer to the IRS document that says the combined limit is 52K and not 17.5K.
Sure here’s one link http://www.irs.gov/publications/p560/ch04.html
search for 52,000
here’s an example they list:
Greg can make a nonelective contribution of $52,000 to his solo 401(k) plan. This limit is not reduced by the elective deferrals under his employer’s plan because the limit on annual additions applies to each plan separately.
Your plan administrator doesn’t know what he she is talking about. But it doesn’t matter. If your plan allowed it then they would know about it. That means your plan doesn’t have that option. It won’t help you to rub their nose in it.
There’s a 17.5 limit for contribution per person across all plans; there’s also a 52K limit for each plan. The difference is made up with this Voluntary AFTER-TAX contribution to PRE_TAX plan. The law allows it but the plan document has to have that provision enabled. If your plan’s establishing document doesn’t have it then it’s not an option to you.
Don’t confuse sources as separate plans or what is considered a contribution versus plan deferral limit. The combined IRC limit (yes, IRS code governing the plan type) is $54,000 (2017) annually and typically adjusted for inflation. (unless you are catch-up eligible and those provisions and amounts are different depending on the type of plan. What that means is that if you are covered under two employer sponsored 401(k) plans In total you cannot defer more than an aggregate of $54000 between both plans. This is regardless of source type such as pre-tax, Roth, (combined contribution between those sources is limited to $18000 annually or reduced based upon employer compensation limitations (they say you can only defer up to 50% of your salary and if that is less than $18000 you are restricted to that number)) employer match and possibly profit share contributions (these are non-elective and will contribute to the overall deferral limit. So even if you are covered in two plans that fall under the same IRS code, you absolutely cannot through your contributions and employer matching contributions exceed the annual plan (401(k) being the plan) limit of $54,000. This is all reported on your W-2s and if you are found to have over contributed to the plans you will have to remove the excess contributions and earnings before tax filing deadline of the following year. You will be responsible for paying the taxes on the applicable money (unless it was Roth but responsible for tax on earnings) and subject to penalties if money is not out in time.
The sad part about this issue is the IRS deems the individual as being responsible for making sure limits are not exceeded and the sponsor is not at fault. Be very careful when contributing to two plans simultaneously to understand if you are close to exceeding your limits through EE and ER contributions. This does happen a lot in my line of work and people then have to remove excess contributions. for example: If you work for 6 mos with one employer and max out your $18000 contribution by June but then work for another employer right after, you are ineligible to participate in their 401(k) as you have already exhausted your annual contribution limit.
Suresh – the call center rep who works at your administrator is correct in their contribution information. You do not have two plans but rather a pre-tax and Roth source and the aggregate contribution annually is $17,500 ($18,000 currently) If you have an employer match and or profit sharing contribution made annually (either every pay period, monthly, quarterly, semi-annually, or even annually this amount is above and beyond what you can contribute but reduces any possible amounts you may have eligible for after-tax deferrals if that is a plan option. The administrator does know what they are talking about, and no one ever discusses the plan limit instead of the contribution limit unless your plan has specifically put that source in for additional deferrals. This is largely because the annual contributions are known and dictated by the IRS yearly, but given that many ER matches are discretionary and formulas can change or ER match not even contributed on an annual basis the call center reps do not discuss this as this is typically non-elective by you the participant. If your plan has the optional source, then they will inform you of the additional deferral option up to the plan deferral limit. Another watch out within 401(k) plans is the non-discrimination testing….so, in a really short way of explaining it you may have been able to maximize every possible avenue of contributing up to $54,000, but if you are a highly compensated individual and the ADP and ACP tests fail for the plan you may have to remove excess contributions and earnings attributable to the plan favoring highly compensated individuals. Typically this happens when HCEs want to maximize their contributions but the non-highly comps aren’t either participating or deferring enough. There cannot be a difference of more than 2% between the HCE Average Deferral Percentage and the Non-HCE deferral rate. You could have contributed 8% of your salary and the allowable ADP for HCE is 5.5%, so you will be responsible for removing the amount above the allowable deferral.
Ok, got way deep here. Bottom line is every plan is different, but understand the options available in your plan and how they work. There are always ways to save more, but sometimes we have to be creative.
OverInvestor and MadFientist – what about the ~1M limitation? Is that a hard limit on total funds (401k + Roth + Traditional?) Or is that per account? Is it per person or per family? Does it include gains or just contributions? What happens if it is exceeded?
Jaime, what is the $1m refers to?
Question; when you say the IRA you setup for your self-employed situation, are you talking about a SEP or SIMPLE as those have contribution or rather plan deferral limitations? Then when you say you invested $52,000 then quickly rolled the amount elsewhere, was that to quickly go from after-tax dollars to a Roth and limit the earnings for tax purposes? I mean, you are restricted annually to $52,000 aggregate of EE and ER funds deferred(depending on type of plan) and that is restricted to the plan and IRC it falls under. So I am curious why you’d immediately roll the money out, since you can’t continue to put more money in during that given year?
I totally get the employer sponsored plan (401(k), 403(b), or 457) and their annual limits of $54,000 (2017) aggregate of EE and ER deferrals. Again, this is only if you have the luxury of additional deferral sources above the pre-tax/Roth limit of $18,000 annually and whatever your employer match and possible profit share contributions come out to. Ex. My salary is $250,000, I contribute the maximum of $18,000 and my ER match is 100% of my deferrals up to 7% of my salary. Between those two sources, I am already at $35,500 deferral amount towards my annual limit of $54,000. Add in my 4% profit share and I am now at $45,500 of my annual limit. Therefore, if I have the additional plan provision to defer after-tax dollars, I can contribute another $8,500. But, I cannot then use an in-service withdrawal (even if my plan allows them) to move the money into other possible 401(k) options through another employer or roll them to IRAs and then restart the annual limit amount and invest again within the same year. Once I have exhausted my annual limit I am stuck for that plan and the IRC it corresponds to.
I am only allowed to continue to invest for retirement purposes and utilize the maximum deferral limits if I have access and am eligible to participate in other employer sponsored plans under a different IRC like a 403(b) or 457, or through individual IRAs with their super constraining contribution limits (possibly not having it be a tax-deductible contribution depending on income) and that’s again an aggregate of any and every IRA I have and have made a contribution to.
If I am also self-employed, I can setup an individual 401(k) and set my own parameters and sources but I am restricted to the aggregate limit of $54,000. If there is any employer money put into this it has to be pre-tax to get the corporate or self-employed tax incentive. I suppose you could setup the 401(k) as only allowing after-tax dollars if there are no matching funds or employer contributions made. But, to use a SEP IRA or Simple you are completely restricted. SEPs are entirely ER funded and are limited to 25% of salary or $54,000 whichever is less. Beyond that, the ER gets the tax deductibility of this rendering the money tax-deferred for the employees. You can usually only ever go from SEP to SEP given the nature of the taxation and most rollover/traditional IRAs have a mix of non-deductible and deductible contributions where a lot of institutions don’t want to comingle the assets. (not to say it isn’t done) I suppose you could do a rollover of a SEP then convert to a Roth permitting you pay the tax liability.
With Simple IRAs the EE is restricted to an annual contribution limit of $12,500 and the ER match is then based on the formula of up to 3% of salary annually or a fixed 2% of salary regardless of participation. An income limit is then placed on the 2% match up to $270,000. So, the annual amounts able to be contributed can be more using the 3% method if you are the EE and ER and contributed the max and made a substantial income that year (3% of whatever that is). But again my question is how can these be after-tax sources when the contribution is largely ER and made on a tax-deductible basis?
I am just super curious, because in all my research and career working with ER sponsored plans and having a fairly good plan design, legal, and tax knowledge of self-employed plans; I am wondering what portion of the self-employed plans can you make after tax assets?
Thanks for the great post! It’s very helpful.
A quick clarification, for this Mega Backdoor to work, my plan administrator(Fidelity) has to allow after-tax contribution to Traditional 401K account. All the documents I have read so far say its not allowed.
You are correct, Fidelity has to allow it, and they do not. You are out of luck. To be fair this is a very rare option in 401k plans.
Fidelity always allows after-tax sources…..but, the plan sponsor has to dictate what sources they will allow in their plans. Administratively and operationally we support anything and everything the IRS and DOL have sent our way through laws and regulations. Just because we can allow it doesn’t give us the right to mandate that a plan allow it. Hope that helps!
I work for Fidelity and while it is an acceptable source for the plan, the plan sponsor/ employer sponsoring the plan dictates what sources they will allow to be utilized in a plan. After-tax deferrals were big years ago before Roth 401(k) provisions were created. This allowed Highly Compensated individuals to defer additional money above and beyond the IRS contribution limits if there was still an amount available after the ER match is taken into account. The issue is many people cannot afford to defer that much and need the tax benefits, so they usually just use the pre-tax/traditional source for eligible deferrals. Once Roth provisions were introduced and employees were matched on the Roth dollars put into the plan, the after-tax sources started to become frozen and no longer accepted deferrals after ERs were finding this gave EEs better tax incentives as well as helped the ER to get their tax deduction through matching contributions on the Roth source. ERs also got sick and tired of failing non-discrimination tests and having to do major corrections to show their plans were not unfairly benefiting those individuals who could truly contribute above and beyond the normal limits.
The only time I ever have plans that allow the after-tax deferral source is when the average compensation for the employees is rather high and can fluctuate significantly due to bonuses. This would allow someone getting a large end of year bonus to defer all into the after-tax if they had more room to maximize their deferral up to the plan limit. More plans are now opting for a top-hat plans instead of the after-tax deferrals so as to not influence testing.
Many plans have frozen after-tax assets in their plan, but they either don’t allow in plan Roth conversion and a way to separate the earnings from the after-tax portion through their plan provisions. At Fidelity we are ahead of the game in terms of plan design and what we can operationally support, but we are restricted by what the employer wants as an acceptable provision to their plan. Many employers are always scared of potential DOL audits and therefore limit the types of sources to mitigate issues.
Hope this helps!
Does anyone know of any Individual (self-employed) 401k plans that allow one to use after tax contributions and unlimited transfers to take advantage of the Mega Backdoor Roth IRA? I called fidelity and they do not offer this option.
There aren’t plans like that by any of the investment banks. They all have a solo 401k but none of them will have that feature. I’ve called a great many of them.
What you have to do is set up your own plan. Call a Third Party Administrator company and they will walk you through it. I use a comapny called TPA Inc but there are others.
I’m self employed so I have a solo 401k with charles schwab. Unfortunately they do not allow for after-tax contributions. Nor does Vanguard. How much should I expect to pay for a ‘third party administrator company’?
To keep things simple I’m wondering if it’s possible to keep my existing accounts(solo 401k and roth ira) at schwab, and simply open up new accounts through this third party administrator to track only my after-tax contributions to a 401k + conversion to roth. Any insight would be very much appreciated!
My company offers a Sarsep account not a 401k. Only Employee contributes employer doesn’t. I maxed it ($17500) in addition to this contributed to Roth IRA ($5500). I have sold my car recently so have $8000 (not planning on buying another car). How do I contribute this towards my retirement?
If you haven’t already, you can contribute $5.5K to your Traditional IRA, then roll it over into a Roth IRA.
If you already have made that contribution for yourself and a spouse (if any) then you’re done.
You cannot contribute to a Roth and Traditional IRA in the same year if you already maxed out the annual limit for you personally in your Roth, which you have. You could use a spousal IRA even if she doesn’t have income. This can be a Roth and you don’t have to worry about the conversion process or paying the taxes with outside funds due to conversion. You can talk to the tax advisor and depending on when you contributed to the Roth and if you made contributions the year prior, you may be able to recharacterize the contribution for the preceding year as long as you didn’t contribute the year prior and contributed the amount before April 15th.
Bottom line on IRAs is they too work collectively for the overarching deferral limits, and most people don’t realize that the IRA is the same IRS code that governs both Traditional and Roth thereby limiting you to the max aggregate deferral between the two types. In other words, you could contribute $2500 to the traditional then $3000 to the Roth in the same year so long as the aggregate of the two isn’t above the annual limits.
Do you have a High-Deductible Health Plan? If so, you could max out an HSA (see this post for more info).
You could could then use the rest of the money to front load your 2015 Traditional IRA on January 1st.
Will the Optimized Guinea Pig be able to do this? After expenses, he only saves $45,600/year, well within the $53,000 limit even without the other tax-advantaged accounts.
Just to clarify: the “only” was not meant to be a judgement on the amount $45,600 as an amount of savings. It is far more than some people save, far less than others save, and will get both Guinea Pigs to FI relatively early. It is instead meant to note that $45,600 is less than $52,000, the total amount that can go into a 401(k) for 2014 (the 2014 equivalent of the $53,000 number in the article).
I will, however, judge that $45,600 has the nice property of being easy to remember because of the consecutive digits when expressed in decimal.
Update: I found a December 4 comment on the Guiniea Pig Update 6 post saying this would happen for 2015, but not 2014.
Thank you very much for the great article. When I tried to follow up with my plan administrator he just forwarded me to Principal (they administer our plan). The told me “Withdrawals options are regulated by the IRS. This plan currently offers Rollover and 59-1/2 withdrawals.” Am I missing something for the in-service withdrawal to do this? Any IRS guidance I can throw at them?
After reading the article and the comments, this seems like a great plan to super charge savings. The problem is many people cant take such a drastic pay cut per check to fund the entire amount of 18K or 52K. Unless you are a very high income earner or have a sizable savings cushion to tide you over for months. I want to take advantage of this, but my plan administrator is fidelity so I might be out of luck, but thanks for the financial knowledge MAD fientist.
Thanks for the info Mr. Mad Fientist!
Here’s what I need help on.
Had a 401K last year, with all three types of money, 401K, Roth 401K, and my non-taxable contributions (paid with post-tax money). When I went to early retirement, they moved my Roth 401K to a Roth Rollover, into my custodial, Folio Investing. Then they moved and lumped both my 401K and non-taxable contributions into one IRA Rollover.
Now I want to “undo” that, and put all the non-taxable contributions into a Roth account. But it seems Folio Investing is going to do a plain old conversion:
IRA Rollover -> Roth Rollover
Is there a way to undo? Or am I stuck, and just go ahead with conversion of IRA to Roth IRA?
I did more research on this with my custodial, Folio Investing.
My inquiry:
“If I complete the Conversion Form to move the $XX,XXX from my IRA Rollover to my Roth Rollover for tax year 2014, can Folio Investing move just the portion that is declared non-taxable contribution (i.e., the entire $XX,XXX)?
Really, I just want to make sure I do not incur additional tax penalty for tax year 2014.
I don’t know if this is done at Folio Investing during the Conversion process or another IRS form needs to be filled out for tax year 2014 to declare this type of conversion.”
Folio Investing IRA Dept Response:
”
A conversion to a Roth IRA results in taxation of any untaxed amounts in the traditional IRA. The conversion is reported on Form 8606, Nondeductible IRAs.
We will move whatever amount the client requests and they will determine pre-tax or after-tax amounts when they file their taxes.”
———————
So the conclusion: that custodial will move as much as you want, and you just have to file the 8606 form to determine your pre-tax and after-tax liability.
I work with a TPA and have been in the administration business for 25 years. This after-tax rollover concept was recently presented to me. One of the issues that appears to be missing from the discussion is the requirement to test the after-tax contributions being deposited into the qualified plan. If an employee is considered highly compensated (More than 5% owner or income in excess of $115,000 in 2014), then any after-tax contributions made to the plan have to be included in the ACP test along with any company match. If the test fails then a portion, if not all, of the after-tax contributions may have to be refunded to the participant. I would think those refunded dollars would not be able to be rolled over.
I would suggest that this may cause complications for a fair amount of people trying to employ the strategy you are discussing and/or recommending. Has this issue been discussed previously and I have missed it?
Seems like if you are the only employee (self-employed) the test doesn’t apply since you won’t have non-highly compensated employees.
Also after a cursory search I found this:
“Some companies use a Safe Harbor 401(K) plans to avoid the ADP/ACP test entirely.”
Not sure what Safe Harbor entails but seems like there’s a way to get around the test.
You are confusing the ADP and ACP test. ADP test looks at the deferral rates for HCE versus NHCE to ensure that both parties are using the plan efficiently. there can only be a difference of 2% or less between the Average HCE deferral rate to the Average Deferral Rate of the NHCE. Therefore, for all those eligible and not participating NHCE this totally lowers the ADP the HCEs can use.
And Safe Harbor eliminates certain tests. I would recommend not necessarily putting this out there unless you can accurately explain how it works and what tests even a Safe Harbor plan has to go through. For instance, their top heavy test has to look at the match structure amongst employees and use the after-tax provision as this is believed to favor only those over the HCE threshold. If the plan is shown to favor the HCEs, then the plan could lose their SH status. The only Safe Harbor eliminated test is truly the ADP. Due to the match and vesting nature being 3 or 4% and immediately vested for every employee, testing for discrimination amount ADP is not necessary. However; if you fail the other required tests you are then required to test the ADP regardless of safe harbor provisions.
Bottom line, there are not ways to really get around the regs and taxation. The IRS and DOL are looking for people and plans that they and find all the loopholes and the penalties are costly and severe for individuals and sponsors.
Those would be considered excess contributions and the ER will have to determine their corrective actions. Either they do a QNEC to correct and bring the NHCE deferrals and benefits more in line with the HCEs or they will remove all excess and earnings making them taxable to the employee. Joey: I am so grateful as you are saying everything that I have been correcting on here. ER sponsored 401(k)s are different animals with certain DOL testing requirements that self-employed individuals don’t have to abide by. Bottom line is yes this gets very messy and those assets cannot be rolled over. They must be removed from the plan and earnings attributed to them. Then a person has to potentially re-file their income taxes to account for the earnings.
As for the match, people do not understand that the use of the after-tax provisions unfairly favor highly compensated individuals and that is exactly what ERISA law and DOL regs are trying to prevent. This is why they are included in the ACP test.
I agree with you if the plan is a solo plan (self employed). No testing required here.
In general, the safe harbor feature you are referring would not get you around the ACP testing requirement for most cases. Again, I think this could be a big sticking point for “highly compensated” employees of companies that also employ non-highly compensated employees.
Does this ACP test mean that for a company with HCEs and NHCEs, if the HCEs contribute after-tax money the plan might fail the test if the NHCEs do not contribute, despite having the opportunity to do so?
Regardng the ACP test, yes, that is correct. the HCEs may be restricted in what they can contribute to the plan.
I’ll be implementing this strategy in 2015, at least the contributions side. I am going to wait until March of the following year (2016 in this case) to roll over 2015 contributions+gains though to make sure they pass the HCE test. I hear it is quite a mess if you have to back out after you’ve rolled over to the Roth.
I plan to pay taxes on the gains (a little more perhaps since I have to wait) to keep the tIRA open for the regular backdoor Roth.
I just checked and it looks like my company’s 401k plan does allow both after tax contributions and in-service distributions. They do charge a fee of $15 per in-service distribution and there is a maximum of 4 such transactions per year. Thank you, I will be using this strategy in 2015!
You lucky dog. Well enjoy your mega back door.
Would you mind sharing which employer offers that option?
I work for a large multinational corporation in the Power/Energy industry. I feel very fortunate that our benefits are above average in many areas.
It was not easy to figure out that the in-service distributions are allowed, I really had to dig into the fine print of our 401k plan. Also, I’m now finding that we may have a hard 25% limit on the amount we are allowed to withhold from paychecks for the 401k. Since my salary is under 90k, this will limit the amount of after tax dollars I am able to squeeze in once I’m finished with the pre-tax contributions. First i’ll contribute 25% to the regular pre-tax 401k until it’s reached the $18,000 limit, then contribute the 25% maximum to after-tax. My after-tax will be limited to something like $5,000/year due to the 25% limit.
My employer has a slightly better % limit and a slightly worse roll-over limit. I can do 2 in-service After-Tax rollovers per year (cannot touch traditional or Roth investments). The company limits it to 40% of my paycheck before pay adders (location and COL adjustments). Because of these, I won’t be able to take advantage of the entire $53,000, but it’ll be better than nothing. With the 6 month limit on timing, there may be some growth added to the equation, but I have the option of rolling it with the rest into a RothIRA and being taxed on the growth or rolling it into a separate Trad IRA. I’m pretty excited, and will start doing this as of my next paycheck.
PowerMustache:
It has been a while and not sure if you implemented, but make sure the 25% of your salary isn’t applicable to the overall salary cap. For instance; some employers state you cannot contribute more than 25% or whatever amount of your salary annually. Unfortunately that limit is applied to all sources. So there is a possibility that you may have exceeded what you can put into the plan entirely before you get to the after-tax source. Remember, your employer’s salary cap on eligible compensation trumps the IRS limit. Usually employers says no more than x% of your salary deferred into the plan in a year and they do not care what sources this is comprised of. You just can’t exceed the annual cap imposed by your employer.
Not if Obama gets his way:
http://www.msn.com/en-us/money/retirement/president-obamas-2016-budget-targets-retirement-accounts/ar-AA90CwO
He is removing the ability to roll over after tax contributions (point #2)
Anybody here done the Form 8606 to declare how your IRA to Roth conversion gets taxed?
Seems like, with this form, you can declare how much of your conversion is taxable or non-taxable.
It makes a moot point of converting your 401K into two IRA baskets, pre-tax and after-tax contributions.
If you’re stuck, like me, with the 401K rolled into one IRA basket, just do the conversion right way. Set your conversion to your after-tax (non-taxable) contributions, and file that as non-taxable.
My question is – are the after tax contributions to the 401K “discoverable” when filling out the FAFSA? My understanding is the 401K balance is not considered an asset nor would Roth contributions but pretax contributions would get added back in as income on the FAFSA. Would the after tax contributions to the 401K be considered income?
Yes, it’s discoverable. Income is income; you have to report all of your income as such on the FAFSA, whether you deposit it into pretax 401k or aftertax or Roth.
Assets are a different story. Neither Roth nor aftertax nor pretax get reported on the FAFSA, nor on the CSS form, in contrast to the 529 plan which does not get reported on FAFSA but does count as parental assets on the CSS form. Which makes the Roth a much better vehicle for college investing.
“The total 401(k) contribution limit for 2015 is $53,000 ”
Isn’t it true that for those of us over the age of 50 who are eligible for catch-up contributions the limit for 2015 would be 53K + 6K = 59K?
Yes, the limit is $59k for those turning 50 or older by the end of the year.
Great strategy. Unfortunately, our supreme leader must read your blog, because his new budget (targeting retirement accounts) is going to close this after-tax loophole.
See point #2.
http://www.msn.com/en-us/money/retirement/president-obamas-2016-budget-targets-retirement-accounts/ar-AA90CwO
Yay for taxing the rich!
This is a fantastic article, thanks for giving us such awesome info!
I guess the next step is to read the fine print on the 401k documentation while keeping the fingers crossed. We shall see…
Thanks for the excellent article.
My employer offers in-service withdrawl but I am not sure where I can open an IRA which will be happy to receive this money. Any pointers?
Also, along with the regular 401K, I am offered Roth 401K. Is there a reason I should not deposit my money directly into the Roth 401K but do the in-service withdrawl into a Roth IRA?
Ignore the Roth 401K question, I understand that the limit remains the same irrespective of the 401K. Would appreciate if you tell me about some institutions who will be happy to take my inservice withdrawl and open an IRA
I have about 20K in after tax in my 401k and about 100K in pre tax. I am currently employed at the company with the 401k. Am I able to move just the 20K in after tax, and move no pre tax money? Does it have to go to a Roth IRA or can it go to a Roth 401k?
So I front-loaded my 401(k) this year and did the mega back door Roth. But miscalculated. I will end up exceeding the $53k 401k limit this year if I continue to contribute the minimum per paycheck to get my full company match for the remainder of the year. So I can:
1) Lower my contributions even more, in which case I would be leaving money on the table because I wouldn’t be getting the full match.
2) Keep contributing and exceed $53k.
Assuming I go with #2 and the company doesn’t stop me from contributing over $53k, what happens? Do I have to withdraw the contributions before April 15 to get back to $53k? What about the gains? Are there any penalties? Is it worth it? Any advice would be appreciated.
Hey there. If you over contributed and do not remove the excess contributions by tax filing deadline of following year, earnings applicable to those contirbutions, and the match money will be forfeited to your employer you can be in for penalties in addition to the taxes. Plus, if your money is still in when your company does their NDT testing and they fail, you could then remove your excess and they will still remove the excess contributions attributable to your portion of the failure. bottom line, get the money out ASAP.
Hello! Bad news for small business owner with employees! According to ascensus and vanguard this would not allow you to pass ACP testing. So recently I’ve been shot down for profit sharing and mega backdoor Roth. Kind of makes me wish I was an independant contractor again. Any ideas or websites for small business owners? After reading the HSA article we jumped on that last year but always looking for more ideas beyond that and the 401k.
Just want to add that you’ll really need to read the fine print on your 401k plan rules which are usually in the Summary Plan Description (SPD). I was so excited to learn my company’s plan, administered through Fidelity, allowed for after-tax contributions and in-service withdrawals. I was about ready to take the plunge until I read the SPD which stated there would be a 6 month suspension on ALL contributions (pre-tax, Roth, after-tax, etc.) after making an in-service withdrawal. That essentially would have stopped me from receiving my normal employer match on contributions for 6 months!
You may be referring to a Hardship…that is different than just an in-service withdrawal. In-service withdrawals permissible by the ER not related to the IRS hardship requirements are totally different and do not impact your continued deferrals. Hardships actually tax the assets and apply a penalty to the assets in the time taken. Granted these are extreme hardship situations that have to be substantiated for allowing the deferrals. The IRS looks at these as you have no other source to pay whatever needs to be paid. These can be extreme medical bills, foreclosure of a home, eviction from a residence, and natural disasters that have demolished your residence.
Yes be careful!!! This just happened to me. I just tried to reset my contribuiton percentages to my 401k and was surprised by a notification that my contributions are suspended until July!!! Apparently my in-service distribution of my post-tax dollars performed the 1stvweek of Jan. (which was rolled into my Roth IRA in a MEGA Backdoor conversion) triggered a 6 month suspension.
I never read about this being a dangerous consequence in any article about MEGA Backdoor Roth conversions. And I read a lot of them. In fact the Fidelity employee that handled the conversion told me verbatim that the transaction would not trigger a suspension. Fidelity is researching the recorded call logs and says they will call me and let me know if it can be reversed in 5 days.
For those of us with self employed income who also have regular w2 income … I contribute 18k to my 401k. What else can I do? I know there are SIMPLE IRAs, individual 401ks, and SEP plans (for those of us in the US). Anyone have guidance on what is the best way to go? I should be able to contribute 53k-18k = 35k (since my 401k has no match).
Anyone know anything about SIMPLE IRAs, and SEP plans or any other self employed retirement plan? Wondering if one is better than another for any reason. Can any offer a match?
Thanks for the help!
Ok there are two large differences between the SIMPLE and SEP. First, simple is a combo of employee and ER deferrals up to a certain limit. The employer, presumably you, will have to determine the match formula stipulated by the IRS you want to use. If you use the match up to 3% of your salary, then you can contribute 100% of your salary up to $12,500 and match up to 3% of your salary through a tax deductible ER match. I have never seen this as after tax dollars for the match as it is a corporate tax incentive to business owners. Ex. If you make $100,000, then you can contribute a total of $15,500 in 2017. That is your $12,500 EE and the 3% of your salary. The 2% match is more restrictive. You are limited to a non-elective option of 2% of compensation up to $270,000 (within your business not including your ER plan) so it isn’t a match of sorts. Then you can also contribute the EE side up to $12,500.
However SIMPLES are super restrictive with when they have to be established and you have to hold the account for two years before you can move to another type of account. Ie. rolling over to another 401(k) or even tryin gto convert for Roth tax benefits.
SEP is entirely different. It is solely an ER contribution. You are limited to 25% of your income or $54000 whichever is less.
Steve — I decided to double check my plan docs based on your comment. My plan at least distinguishes between a “hardship” withdrawal (no contributions for 6 months) and an “in service” withdrawals (no such penalty). The devil is in the details (and you may want to confirm with your plan provider as well).
I’ve just started maxing out the after-tax this year. I plan to roll it over next March/April once I know the highly compensated employee bit has cleared. It’s a bit of a hassle but it should be worth it.
As a solo/individual 401(k) holder with Roth and traditional sub-accounts, my understanding was that only $18,000 could be contributed to the Roth sub-account in my 401(k), and the remaining $35,000 would need to go to the traditional pre-tax sub-account. Is it the other way around? (I’m self-employed so employee and employer/profit-sharing come down the same funnel.)
Thanks for the great article!
no you had it right. 18K to after-tax Roth. 35K on after-tax basis to pre-tax portion. Alternatively you can put the entire 53K on after-tax basis to the pre-tax portion. Doesn’t matter either way – after you contribute the money you roll it into a Roth IRA. You just need to have a plan that allows you to make additional after-tax contributions to pre-tax account and have in-service withdrawals, which means in your case you would most likely need to create a custom plan and terminate your solo 401k.
After you do mega backdoor Roth conversion and get Aftertax-401K funds successfully transferred into Roth IRA, do you have to complete any particular tax form at end year (similiar to Form 8606 for the normal backdoor Roth)?
Additionally, is there anything you should do to ensure ROTH IRA custodian firms (such as TDAmeritrade, Etrade or Charles Schwab) would not classify the incoming aftertax-401K funds as current year’s contribution? That situation would be a mess.
Thank you!
A couple questions (and I apologize for not reading all the comments to see if they have already been asked/answered):
1. Is there a limit to how much you can rollover to a Roth IRA in a given period?
2. What are the key distinctions between a rollover and a conversion? Any limits on how much you can convert?
3. Why do you suggest moving the pre-tax contributions from the 401(k) to a traditional IRA? Wouldn’t the pre-tax contributions and growth be treated the same way in either account?
4. You don’t explicitly state this but in the diagram right above the conclusion section, where you depict the rollover strategy, it seems misleading that the growth is part of the picture since you stated that rather than leaving everything in the 401(k) to grow we immediately rolled over the balance on Jan 2. So is your image assuming 30% growth after rollover? Just want to be clear.
Awesome article with great information. Thank you!
I know this is way later, but maybe will help someone. No, rollovers are allowed for any amount and anytime. You may have custodial requirements limiting the number of rollovers you can accomplish in a time period.
A rollover is moving the money from one type of vehicle to another but using the same tax strategy. Ie. Pre-tax 401(k) to traditional IRA, or Roth 401(k) to Roth IRA. A conversion is different in that you are actually changing the tax strategy of the existing assets. for example, to convert an existing traditional IRA to a Roth IRA you can convert the entire balance. Depending on your tax situation and whether there were non-deductible contributions in there, will determine the current tax liability of the conversion. But beware, you cannot withhold the taxes to be paid from the converted amount. Most people don’t realize that. So when you have an ER 401(k) plan that allows in-plan Roth conversions and you want to convert $40,000 of your pre-tax assets, the $40,000 is considered as ordinary income at your current tax rate but you have to have cash elsewhere to pay the IRS upon filing your taxes.
Bottom line, Uncle Sam will get his money now or later.
Most people will recommend moving the pre-tax portion from a 401(k) to a traditional IRA to have the option of converting to a Roth IRA as that is what this whole article was about. Effectively and efficiently maximizing your contributions and limiting tax liability. However nice and creative these strategies are, they are not fully explained and many employers don’t offer the necessary provisions to allow for these immediate strategies.
As for your final question, I can’t speak for the author but I believe he was stating to take the after-tax amounts and earnings and moving them directly to a Roth IRA and paying the applicable tax on the earnings instead of separating the tax-deferred earnings from the after-tax contribution. I hope that makes sense.
Basically there are a few things you absolutely need to be aware of before even attempting to employ these strategies:
A. IRS is always watching for these types of creative strategies to reduce tax liability, so you better have copious documentation to back up what are truly after-tax dollars and any applicable earnings. They don’t just take you stating these assets have already had the taxes paid. You will have 1099Rs provided and 5498 for the rollover in then you will also have to file with your taxes what were pre-versus post tax cont through a 8606. A lot to make sure is in line.
B. Understand your provisions and options within your plan. Speak to someone to see if you are truly maximizing your ER options through their plan. Don’t just count on a call-center rep.
C. Assess your current tax liability for converting assets. Does it make sense to wait until you are in a lower tax bracket? Are they earnings attributable to the after-tax contributions small enough that you want to roll them directly to Roth IRA.
D. Finally, do you have the extra liquid assets/ cash on hand to pay your tax liability to the IRS as this amount cannot come from the money being converted?
Hope this helps
Ali401(k)nerd,
Thank you; your posts are always enjoyable to read!
I have the following situation:
A. My old 401k was rolled over to a Roll Over IRA years ago; it has only pre-tax contributions plus the associated pre-tax gains.
B. My current 401K allows for pre-tax, after tax and Roth contributions; additionally, it allows for in-service withdrawal for after-tax and Roth contributions.
C. I made in-service withdrawal for all my after-tax contributions; the after-tax contributions were rolled over to a Roth IRA while the pre-tax gains were rolled over to the Roll over IRA that has my old 401k.
D. I have the following questions:
1. Is there any tax liability for the rollover that was done?
2. Do I have to file form 8606?
3. Is it possible to rollover all the pre-tax assets (includes the pre-tax gains of the after-tax assets) in the IRA to the pre-tax portion of the 401K?
Thank you!
I want to make an aftertax contribution for the company 401k for tax year 2015. In 2015, suppose I earned, w2, $52,000 as a contract employee (W2), and only $4000 as a “regular” employee (W2). Since these are after-tax contributions, I believe the deadline for making the contribution is 4/15/2016. I have some questions:
1) Since I am not asking for any employer contributions, and I also don’t intend to make any pre-tax contributions (for simplicity’s sake, in this example), would I be writing a check? After all, a one time contribution of $53000 would be much more than any particular paycheck, so they could not just do a payroll deduction.
2) My employer does not offer a 401k until I change from “contract employee” to “regular employee”. But in determining my minimum total contribution limit, would’t it be based on both types of wages for that year, since both contracts were with the same employer, same W2 EIN? Hence, I can contribute more than $4000, right?
3) If my new contract to become a “regular employee” is signed, what do you think would typically need to be the latest date, in order for me to be able to make 2015 contributions? Obviously, December 31, 2015 would be a good guess, but I want to be sure. After all, there’s probably a lot of paperwork and red tape. And I want to know if I should ask them to rush this, because being late by just a few days would therefore make an entire year’s worth of 401k contributions missed.
Thanks so much for your advice!
Bruce
No to your first question. Your contributions to a 401(k) are restricted to the plan year deadline. Typically it is a calendar year ending on 12/31. You are thinking about an IRA that can make contributions up until the tax filing date in the following year.
No to your second question. You cannot write a check as these assets have to funnel through the right channels for the plan as their accounting of money coming in and going out is scrutinized annually through Financial Audit, DOL 5500 filing, Non-discrimination testing, and must be reflective for your tax purposes on your W-2. Also, it isn’t whether you are “asking” for employer contributions or not. The plan is designed in such a fashion that all employees not excluded due to their plan status (I.e temp or seasonal or contract) receive the same benefits of the plan including matching ER contributions. Otherwise, they could be shown to not giving the declared benefit to an eligible employee and could lose their overall plan tax favored status. You also need to understand what sources within the 401(k) are available to you.
Not all 401(k) plans offer an after-tax source allowing for limits up to the $54000. You may only have the pre-tax and roth source and are limited to no more than $18,000 or 100% of your eligible compensation annually (whichever is less). I would be worried that you would only have $4000 of eligible comp as they could state that your comp as a contract employee isn’t eligible as you weren’t covered under the plan when you earned that.
Also, the plan documents are very specific as to the types of eligible compensation. Most times the employee is coded as a different type of employee such as contract and non-benefits eligible for one W-2 then as a benefits eligible employee on the other W-2, and it is only the compensation they earned while they were eligible and could receive benefits that is taken into consideration. Your HR will know. This is truly spelled out as eligible compensation and eligible employees for deferring into the 401(k).
Final answer to your questions, would be you need to understand the eligibility period for enrollment. Just because you change to a “regular” full time and benefits eligible employee, doesn’t necessarily give you immediate access to a benefit. Again, depending on the way the plan is designed there could be an eligibility requirement for time before you can enter the plan. For instance, I run a plan with a 6 month eligibility time period. This means an employee has to be with the company in a benefits covered capacity to then be eligible to enroll. And then the plan could have limitations as to when you could enter the plan like every six months, or quarterly, or first of the month. Truly depends on their design. This is usually put in place where you see high turnover. However; the eligibility period could be satisfied by the time you served doing the contract work. It really depends and there is no easy answer as these are immensely specific to the parameters of your employer plan.
If one could do Mega door Roth IRA, in what instance that person would do regular backdoor Roth IRA other than if there is some more funding left? Wouldn’t it be simpler to just do the Mega door?
They can do both
Great post! This got me stoked. I checked with both my 401k and my wife’s 401k plans and they don’t allow post-tax contributions or in-service withdrawals…disappointing.
Nonetheless, thanks for the education MF!
So here’s a question. Husband retires next week. We have a 457dc that we will be moving to Vanguard Traditional IRA then doing the roth conversion ladder thing. (about $200,000 total). If we leave it with the employer-we can take payouts before retirement age but the fees are high. Is moving it the good option?
And we could contribute an additional $35,000 from his vacation paydown to the pretax account but that ties it up for another 10 years (we are both 50). We were thinking about just putting it in a taxable account for backup money. His pension payouts will be about $10,000 pretax a month. That will cover our expenses. (we live in California).
Now I’m thinking we should put it in the pretx account, roll to an ira and roll to the roth so it can grow tax free. Then it’s only tied up for 5 instead of 10 years. Thanks for your patience. Still trying to figure it out.
Depending on your age and how soon you will need the funds, the general school of thought is NEVER put a 457 plan with no early withdrawal penalties into something that will then restrict it for 10 years. I have no idea why you say the $35,000 vacation payout would tie the money up for 10 years. This is truly simple:
You keep the money in the 457 plan. This should actually be WAY cheaper than any individual account you can get with Vanguard (I worked at VG and they are awesome, but you have the collective buying power of the 457 which I assume is a SUPER LARGE governmental plan.) That being said, look at the investments you are in with the 457 plan. find some cheaper index or balanced funds and you should never have more than at the most 1% expense ratio for the fund. If you have additional fees that is crazy!
take the $35,000 and put it into the 457 plan. It is completely liquid since he will be separated from service with only taxes to pay on it if you use it!. you say the pension will cover your expenses, so why would you even consider laddering and possibly increasing your taxable income due to converting assets so soon? If you don’t need the assets, then convert a smaller portion but still leave yourself money in case of emergency. Also as awesome as it is to grow tax free, you do realize that you will have to pay the taxes initially when you convert with outside available funds. You cannot take the taxes from the money you are converting.
Bottom line, unless you have no worries about possibly throwing yourself into another tax bracket and have outside cash to pay the taxes, do not move these assets. You will restrict yourself regardless for 10 years on the Roth and Traditional IRA!!!! They both have the 59.5 age requirement for withdrawals, the difference you aren’t understanding is that if you open a Roth when you are 55, the age 59.5 is applicable for early withdrawal penalties but you also have to hold the Roth assets for 5 years from conversion date. It’s FIFO method. First in first out. this means if you open the roth after age 55, you have to wait until after you are normal retirement age and satisfied the 5 year holding period. You are really tying up your funds and not aware of the restrictions just to get some potential tax free growth, which will not be substantial in that you are converting this so much later. Truthfully people retiring and converting assets are the ones who intend that these assets are passed down to their heirs. The true benefits of tax free growth is really only good if you have a lot of it. If you never need these assets and can pay the taxes, go for it.
I would really encourage you, although now that I am seeing the date on your request, to talk to a tax attorney or solid Financial Advisor.
Guess i am one of the lucky ones whos plan allows the after tax contributions and in-service distributions on after tax contributions (apparently i can’t do any other in service distributions though). I started doing after tax contributions last year and was just able to do an in-service roll over to my ROTH. I am upping these after tax contributions this year :-) I can only contribute a total of 30% of income to my 401k in my plan but it should get me a good chunk of extra ROTH funds at the end of the year (or at any earlier point if i want to do the conversion).
my 401k plan allows us to contribute 10,0440 maximum after tax. Doesn’t it make sense to immediately transfer this money into my roth 401k? is there a reason to not do this?
My Personal Example : 401K -> IRA -> Roth | Doing the taxes for it now
Getting around to doing my 2015 taxes now, so here’s my example. Hope this can clear things up for some people.
2014: Laid off from company, took the distribution to rollover 401K to IRA on the exit.
$400K total, $100K of that was non-taxable (non-tax because those contributions were after-tax money).
2015: I converted $130K to Roth, thinking that because $100K was non-taxable, I’d be okay with not too much of a tax hit. (I WAS WRONG). I also thought, because I live overseas, I can get the foreign income deduction (I WAS WRONG, AGAIN).
2016: Turbotax said the conversion gave me about $100K of taxable income. Because the ratio of taxable to non-taxable (in the IRA) was 4:1, 75% of the $130K converted amount was taxable. I lived overseas (330 days outside of US soil), but cannot take the $100,800 deduction, because that applied only to foreign EARNED income (a Roth Conversion is not foreign earned)
I did not want to get stuck paying tax on $100K of “income”.
So will have to recharacterize the Roth (before tax due date), to partially undo the conversion. So only $34K will be considered converted from IRA to Roth for 2015.
For my filing (married jointly) I will pay 0 federal tax on $34K of “income”. If I keep converting ~ $30K every year, then in 15-20 years, the IRA will all be converted to Roth, tax free! Since I retired early, this timeline works perfectly for me.
This is a bit late, but one thing I don’t understand is the proper order in how I invest. Me and my wife make about 100k/year and I don’t think my or her 401k is anything special. I’ve been hazy if I could do both IRA and 401k. So should I do it this way?
1st: 401k up to the match for both of us
2nd: HSA (which I don’t have – or at least my employer doesn’t think I have access to it)
3rd: IRA up to the max for both of us
4th: Finish up 401k up to the limit for pretax contributions
5th: Mega Backdoor Roth
6th: And assuming anything is left – then what? After tax brokerage account?
I’ve searched the net and still haven’t gotten a straight answer about this, for some reason it seems people have been leaning on maxing out a 401k even if it’s bad and don’t say anything about an IRA unless you don’t have a 401k.
Another thing to check is if your plan allows for roll-overs within your 401k (I have a 403b, but same basic principle). I get paid bi-weekly and contribute the max of $18,000 to my Traditional 401k and some extra into the after-tax 401k. Then, as soon as I get paid I do a roll-over and move the after-tax 401k into my Roth 401k. My plan allows for in-service withdraws, but only two a year. This way, I can get all of the after-tax contributions into a tax-advantaged account right away and not have to wait!
Is it ok to just make a yearly one time contribution to your after tax 401k and then withdraw and move the entire amount to a Roth IRA the next day and pay taxes on the gains if any?
For example:
I have $20,000 in savings that I would move to the after tax portion of my 401k let’s say Jan 1st and then move the $20,000 plus any gains Jan 2nd to a Roth IRA. Would this be ok rather than contributing money to after tax every paycheck and moving money out multiple times a year?
You can’t contribute to a 401(k) from outside savings. The money has to come out of your paycheck. If you have a big bonus check or something around the beginning of the year you might be able to put that in your 401(k) to reduce the number of contributions over the year.
Can after-tax contributions made to a 401(k) plan be in excess of a person’s income for that particular year? Let’s take a Sub-S owner who is 40 years old and has W-2 income of $40,000. Can this person contribute the maximum $18,000 in deferrals (regular or roth) plus contribute an additional after-tax amount of $35,000? The total contribution made would be in excess of his W-2 income for the year. Is this OK?
Your 401(k) contribution is usually only in the form of a deduction from your paycheck, so I do not see how you could hope to fund your 401(k) with more than your income.
Could anyone guide me what I need to do to contribute 35k to after-tax Roth 401k in addition to 18k to Traditional pre-tax 401k?
I’m currently at 8k in traditional pre-tax 401k and at 6k in Roth 401k at Vanguard contributed from my payroll.
When talking to vanguard to contribute more $$ towards Roth 401k, they said that 18k is combined limit for both type of contributions.
I verified with vanguard that 18k is IRS restriction and not from my employer.
Please shoot me any questions to make this happen.
Any help in this regards is greatly appreciated.
Mat
Your plan needs to offer you the option to make after-tax *traditional* contributions. The combined limit for pre-tax traditional and after-tax Roth contributions is $18k. Only the after-tax traditional contributions can go above that limit, and not all plans allow you to make these.
Fabulous article — one area where I’m confused:
Isn’t this “Mega Backdoor Roth” (MBR) strategy incompatible with the “Regular Backdoor Roth” (RBR) strategy? The reason I’m concerned is that in the MBR strategy, we create a Traditional IRA to hold the pre-tax portion of our in-service 401k distributions. But in the RBR strategy, we need a portfolio that avoids pre-tax dollars in Traditional IRA accounts, to avoid the pro-rata rule when rolling into a Roth IRA.
So I’m confused about how MBR could be used with RBR. Are they mutually exclusive? Am I missing something?
Thanks!
This is exactly the question I was about to ask! Oh wise Mad Fientist, help us out here!
You should read the comment thread started by 1dirtypanda. You don’t have to transfer all of the 401k, pre-tax and after-tax, at once. You can just leave the pre-tax contributions and their gains in the 401k and transfer the after-tax portion to the Roth IRA. The tricky part is if you let the after-tax portion sit there for too long, because the earnings from that portion do have to be diverted to a traditional IRA since they have to be moved along with the original contribution, so the best thing to do is move that after-tax money using MBR immediately after you contribute it to the 401k, so there’s no time for it to generate earnings. Once you make sure you have no pre-tax Traditional IRA dollars, you can proceed with the RBR strategy.
How do you know if/when you’re able to transfer the balance from 401k after tax to the Roth? You mentioned your company doesn’t slow you to?assuming my company is the same way, I can do it only after I leave my current employer?
OMG if I only read this post like 1 months ago when I rolled my older employer’s 401(k) into my new employers!! I apparently had about 5k after-tax contributions in there. Now that all the money is in my new employer’s 401(k), I don’t think I can do another withdrawal/rollover until I leave or retire! Ugh!!
Great article btw! I’ll keep this in mind if I change jobs again.
You should have a provision in your plan that allows you to take distributions on your rollover assets at any time. They are always 100% eligible to be moved out of the plan. you moved them in and you can always move them out when you want. Your plan may have a weird provision that they don’t allow this, but I have yet to see them. I run large plans for Fidelity.
That being said, you have now comingled the assets and unless your new recordkeeper knew these were after-tax assets and has kept those assets separate from the pre-tax assets, you may be up a creek.
Is there any problem with doing a Backdoor Roth and a Mega Backdoor Roth in the same year? There’s a limit on the number of conversions you do per year, right? Not sure about that.
Wish i read this 2 years ago when it was posted. One question I have is :
I hear that creditors can’t go after a 401k but can go after an IRA.
If I move my after-tax to an IRA, am I exposing myself to creditors?
Do IRAs benefit from the same protections as 401k accounts?
Thanks
Curious, does this opportunity only apply to people with 401(k) retirement accounts?
Can the same process be applied to individuals with 403b or 457 retirement accounts?
Meaning (assuming that the company would allow for after tax contributions beyond the $18k limit and for in-service withdrawals), would someone be able to utilize the Mega Back Door Roth?
Yeah. a lot of people aren’t familiar with tax-exempt entity plans. I ran them for 12 years. As long as the plans have the underlying provisions like the after-tax source and in-service withdrawals, then you are golden. And if you have access to do this in a 403(b) and 457 at the same time, you actually can use each plan for its own deferral limit. Meaning, you could effectively contribute up to $54000 for your 403(b) and another $54000 for your 457. They fall under different IRS codes and therefore have independent deferral limits and the two plans do not interfere or look at aggregate contributions across plans. I used to run these and it is so cool to be able to see people effectively able to sock away $18000 to their 403(b) while also doing $18000 to their 457 at the same time. Then depending on if there is a match and how much for each plan, will determine any additional amount towards the $54000 that would have to be reduced.
As long as you do these things in plans that fall under different IRS codes, you have so many opportunities to sock the money away!
Hope this helps!
I am retired and just turned 59.5. My 401K is at Vanguard along with a personal 100K Roth IRA funded since 1998-2014. I am currently in the 15% tax bracket with about 30K room before hitting the 25% bracket.
I am looking to fund a LTC Life Hybrid policy and avoid any taxes as I would need to pull from my 401K to do this. it has a $70K premium (pay up front to avoid additional costs).
Of the 1.2M balance I have, 263K is aftertax money in this 401K. 172K is after tax I put in and 91K is the earnings on this source. So this roughly figures to be 65% what I put in and 35% is the earnings. From what I understand from the VG Rep’ is that I can withdraw 75K (amount I want to access) from this after-tax source and that approx. 48K would come out as my after-tax money (tax free) and approx. 27K would come out as taxable income. Prorated they say. This would keep me in the 15% bracket and minimize my tax bite. So with all that said here are my 2 questions.
1) Does this sound right according to the 2014-54 Notice ? Missing anything on this?
2) Would I be better off rolling the entire 263K after-tax source from a 401K to Vanguard IRA’s instructing them to put the 91K of earnings to the regular IRA and to put the 172K after-tax money I contributed to my Roth IRA account?
If the answer is #2, since I started Roth’s 17 years ago, can I then just access 75K ALL tax free from my Roth to pay this premium? Not sure how the 5 year hiding rule would work here.
Very complicated in ways as my Tax attorney and Insurance Broker are both struggling with this funding method. They seem to be learning of this just as I am. I only stumbled upon this as I was thinking to myself that this after-tax money has to have some tax benefit accessible after 59.5. It seems that if one did not pay attention to this, depending on plan administrator, it would just be lost in the shuffle and one would run the risk of paying tax on it a second time!
Hey MF,
Another great post man, I’m just moving along on all your articles haha!
Are there any other strategies I can look into if I’m already maxing out my 401K, Roth IRA but cannot participate in the MBR strategy? My employer does not allow additional after-tax contributions. I’ve already opened up a personal taxable account as well.
So my questions would be:
1) Is the next step for me now to contribute more and more to my personal taxable account and look into other investment opportunities? or;
2) Are there other strategies are out there that are similar to this that I should be looking into? If so, what are they?
Thank you for your time and consideration!
Eddie
Keep in mind that traditional investments are not your only source of retirement income . You can also own businesses, rent homes, get royalties, etc to provides streams of income in retirement. Too many people put blinders on and think that stock/bond investments are the only option for retirement income.
I agree, traditional investments are very sound sources of retirement income that everybody needs to do but in the meantime there are other money making options to pursue. Adding an additional stream of income where possible is a smart thing to consider.
What is the deadline for a mega backdoor Roth IRA conversion? I deposited the after-tax money in my solo 401k in December 2016, but I switched from Ameritas to Fidelity so I’m just doing the conversion now (June 2017). Is it too late to do the mega backdoor Roth IRA conversion for 2016? If so, was the deadline 4/15?
(In case it’s relevant, I have an extension on my taxes.)
Regarding in service distributions, I found the below rule on the IRS website (https://www.irs.gov/retirement-plans/rollovers-of-after-tax-contributions-in-retirement-plans). The way I read it is if I try to take an in service distribution of my after tax contributions I need to roll over everything. What am I missing?
From the IRS website:
Can I roll over just the after-tax amounts in my retirement plan to a Roth IRA and leave the remainder in the plan?
No, you can’t take a distribution of only the after-tax amounts and leave the rest in the plan. Any partial distribution from the plan must include some of the pretax amounts. Notice 2014-54 doesn’t change the requirement that each plan distribution must include a proportional share of the pretax and after-tax amounts in the account. To roll over all of your after-tax contributions to a Roth IRA, you could take a full distribution (all pretax and after-tax amounts), and directly roll over:
•pretax amounts to a traditional IRA or another eligible retirement plan, and
•after-tax amounts to a Roth IRA.
I have the same question as Tom above… I have been doing this rollover with my aftertax since last year, and moving them to a Roth and I was telling a friend about it and they sent me the link above, which says that you can’t rollover ONLY the aftertax to a Roth, you have to rollover both…. now I am a little worried the IRS is going to come a calling.
I have just been looking into this and If I am reading everything right. Please anyone confirm or correct this for my sake also!
What you have to do is this:
These numbers are for argument sake getting you to the 53 or 54K limit for the year.
1. 20,000 in after tax amount invested in the plan (on top of 18k limit and along with employer match)
– This sits there for lets say 6 months and you quit at the end of the year.
2. When you quit in January that 20k worth of the pie turned into 22K.
3. When you roll over, the 20k principal you already paid taxes on and invested through company payroll gets backdoor’d into a Roth IRA, BUT
4. You need to then rollover the 2K in profit to a Traditional IRA since in theory its extra money of which Uncle Sam never got to get his share.
Knowing the value of after-tax contribution, And I’m changing my job soon, I was wondering if its possible to have a 401k summary plan description for future employer so that I can find in advance if an employer allows to contribute after-tax on top of maximum of 18,000 combine limit for Roth & Traditional contributions.
This is a question for this group or the MF – I get paid via an agency – I am a contractor. They are just setting up a 401K, and it seems that no one who administers the plans is recommending that they have a Mega Backdoor Roth because it will fail all the testing. Can anyone here connect me to a company or benefits admin who actually has an uses a MegaBackdoor Roth? If you are using it, then I am hoping that someone here is a W2, and not a 1099. Thanks!
PS – here are the comments from my agency’s finance person, for color:
Over the past few months, I have been working with our current plan manager as well as a number of potential new plan managers to explore options for EM’s future 401(k) that would provide the most flexibility and value to our employees. One particular option that a couple consultants have requested we explore, is the option to allow “Mega Backdoor Roth” after tax contributions. So far, none of the plan managers I have spoken to have indicated that such an option would be possible for EM. The feedback I have received is that such an option would only be feasible for a company with a single, self-employed individual and no other employees. In the opinion of the plan administrators I have spoken to, companies with multiple employees will fail to pass the rigorous testing requirements required for such after tax contributions.
I don’t recall if you were one of our consultants who had participated in a 401(k) plan which allowed Mega Backdoor Roth contributions, but I am open to exploring this further if you can provide contact information or an intro to a specific company or plan administrator which offers such a plan. All of the plan administrators we have spoken to do not recommend that EM include the Mega Backdoor Roth option in its 401(k) plan as such contributions will fail testing requirements every year and the funds will have to be returned to the contributors.
You should think about going 1099, and opening a solo 401k with the Mega Backdoor Roth option.
I haven’t read through all the comments so this may have been discussed. So I think this would work, I need to research it but think about this. You make the $18,000 limit contribution to your Roth 401k, then you make non-elective contributions to your t401k. Then you roll both over into a Roth IRA. That way you are able to get extra money that is equilivent to your marginal tax rate into a Roth IRA. I need to do a little more research but I don’t see why this wouldn’t work.
I see some people discussing this that aren’t aware of the Pro Rata rule. Just FYI
https://www.irs.gov/retirement-plans/rollovers-of-after-tax-contributions-in-retirement-plans
Thanks for this info – I had not heard of this before and we are going to use it since we can’t contribute to a Roth currently due to income limits.
I have a question.
If I contribute after tax to 401(k), when I withdraw it eventually, do they differentiate it from the rest that was contributed before tax? I hope so, because I will have to pay tax on that amount twice otherwise. What if I convert to a roth IRA immediately?
We don’t have Roth IRAs since we are not eligible- paid too much. We contribute the max amount to 401(k), and employers pay 8000 dollars each into the 401k for my husband and me. We save the rest in regular vanguard account. We plan to retire in about five years at age 42. Is there something else I need to look into? Don’t want to give you a lot of work, just assuming that you already know the answer.
Ok, I saw the link on the comment above, so that part is solved!
Just to be clear, when should the after tax 401(k) contributions be taken from the 401(k) plan and rolled into the ROTH IRA? In the calendar year they are initially contributed after tax into the 401(k)? Or in a subsequent calendar year?
401(k) admin allows in-service distributions, so just want to be clear on timing of when, this year or next?
You can do the conversion at any time (within the limitations of your plan, sometimes for example only allowed every six months); Brandon’s point is that the sooner you can do it, the sooner the growth moves under the Roth umbrella and hence will not be taxed when withdrawn.
This is a great strategy if it works, but the additional after-tax contributions are subject to discrimination testing. For small plans this creates a problem.
Does anyone know if the new tax bill closed this loophole? I am trying to set up my strategy for the year.
You can still use this method under the new law, assuming your 401k plan allows after-tax contributions and in-service distributions. We might also consider not using terminology like “loophole” and “backdoor” as it implies we’re up to no good. This is the way the law is written, so let’s take advantage of it.
I’m being told by my administrator that I can contribute $18500 for all types of contributions. Can this be correct? My MBR strategy seems to be in jeopardy. see below for their response to my question on the MBR.
Regarding contribution limits, your employer determines the limitations as well as the sources (Pre-tax, After-tax, and Roth) they allow participants in the Plan to contribute to. Please be advised, the maximum amount you are able to contribute between all sources of money for 2018 is $18,500. This amount can be all Pre-tax dollars, After-tax dollars, Roth dollars, or a combination of the different sources., however, your total contributions for the year can not exceed the 402(g) limit of $18,500. This is an IRS regulation.
Same story here.
Your particular plan has to allow the after tax contributions. Not all of them do. That being said, I would get your summary plan description for your 401k and go through it. This will tell you “real” answer.
If your plan allows it, don’t expect your typical customer service rep at your 401k administrator to know anything about it. You’ll have to keep asking until you find the right group that deals with this.
Does anyone know if the total yearly contributions (54,000 – traditional/Roth – Match) are based on when you contribute to the 401k or when you roll the money over into a Roth IRA? In my case I rolled out my After-Tax contributions in 2017 but didn’t get the check and deposit into my Roth IRA until 2018. Does that amount I rolled over count towards 2017 because it was a contribution in 2017 or does it count towards my 2018 limit when it was deposited into my Roth IRA? Any help appreciated. Thanks!
The contribution limits are based on the calendar year of the contribution – when it was deducted from your paycheck and put into your 401k account. The conversion into your Roth is a completely separate event and has no impact on any contribution limits for any year – 401k, Roth, or otherwise.
Hi Brandon, thanks for updating this post. I had been making after-tax contributions in the past, but only started doing the Roth conversion recently. The point about making the Roth conversion asap makes perfect sense in terms of the growth moving under the Roth umbrella. Thanks for pointing out that subtle but powerful detail.
I have a question about the tax consequence of in-service rollover to Roth IRA of the after-tax and associated pre-tax dollars. I contributed after tax dollars to my retirement account in 2017 for the first time. My employer allows in-service rollovers. So at the end of 2017 I requested the after-tax contributions ($9852) and the associated pre-tax earnings ($407) to be rolled over to my Vanguard Roth IRA account. I didn’t want to split it into TIRA and Roth IRA to not reduce my $5,500 annual IRA contribution limits for regular backdoor TIRA to Roth IRA conversion (I can’t contribute pre-tax to TIRA or Roth IRA due to income limits). The The 401k administrator cut a single check payable to my Roth account administrator (Vanguard) and I promptly deposited the check into my Vanguard Roth IRA account. This month I received my 1099R from my retirement account administrator and it doesn’t seem to have any amount as taxable income. Here is the relevant information:
Box 1 (Gross Distribution): $10,259
Box 2a (Taxable amount): $0
Box 2b (Taxable amount not determined) Not checked
Box 2b (Total distribution) Not checked
Box 3 (Capital gain) $0
Box 4 (Federal income tax withheld) $0
Box 5 (Employee contributions) $9852
Box 7 (Distribution code) G
Box 7 (IRA/SEP/SIMPLE) Not checked
When I enter this form in my tax program, it tells me that there is no tax consequence. Shouldn’t it be taxing me on the $407 in pre-tax earnings from my post-tax contributions?
Thanks!
I plan on doing this same thing next year and was wondering about this exact case. Can anyone shed light on whether there should be taxes on the $407?
Glad there’s a 2018 update to my favorite finance article ever! I stumbled across it the middle of last year and took advantage. The one suggestion I’d have on this is to check to see if your 401k plan will allow “In Plan Roth Conversions” Not all of them do, but if yours does, you can get the exact same benefits of the article and avoid the added complexity of in service distributions.
I just started my AT contributions for 2018. I wasn’t able to plan it out for last year, so I had big chunks of my pay check coming out. This year, I’ve been able to optimize it between not taking too much out of the paycheck and minimizing my calls to Fidelity to perform the conversion. I make these calls after each paycheck to minimize taxable earnings. It’s a real pain at first, but I’ve gotten it down to a few minutes each paycheck now.
I share this article with my peers that are into investing, all the time! Keep up the great work!
LB,
By “In Plan Roth Conversions”, do you mean moving aftertax 401k monies to Roth 401k?
Basically, yes. However, our plan actually differentiates pre-tax, Roth and Roth in Plan Conversion. So I keep it all in my 401k account. A colleague at my company pulls the money out and puts it into an IRA. It costs him $20 each time he removes money. So you can do it either way. I’t just up to you as to how you want to do it.
Just to add: Here’s an excerpt from my 401k Summary Description that covers Roth In-Plan Conversions:
Roth In-Plan Conversion: If you qualify, you may elect to convert some or all of your vested non-Roth accounts under the Plan (that is, your Pre-tax, After-tax, Catch-up, Matching, and Rollover Contributions accounts, but excluding any outstanding loan balance) into designated Roth Contributions. In order to convert your vested nonRoth amounts, you must be actively employed and the amount you wish to convert must be distributable to you.
I’m in a position to make a MB Roth contribution, but I was wondering why?
A taxable account with investments that do not generate dividends or only qualified dividends such as VTSAX will generate minimal or no tax drag, but the gains will be taxable at the time of sale. This tax may be avoided by withdrawing slowly keeping income below the 12% 2018 tax bracket income level (previously the 15% tax bracket 2017 and before).
By using the MB Roth conversion I can contribute up-to $36.5k to a Roth IRA which allows for investments that DO generate dividends, yield or have high turnover, without generating taxable gains. These will grow tax-free and withdrawals will be tax-free but can only be withdrawn after age 59.5, unless a strategy such as a Roth IRA conversion ladder or 72(t) SEPP is used.
I would love to see a graph comparing the performance of these two approaches with equivalent funds invested. I think it would be a great addition to the article and clarify for people why they might want to do this.
Thanks for a great article!
My line of thinking exactly. Not sure what is best given that I plan to be in the 12% bracket or lower in retirement.
I guess the California state taxes should be another consideration and mean I should favor the mega backdoor.
My plan administrator is saying I will incur a 10% penalty for taking an inservice withdrawal since I am not of retirement age and I’m still employed by the company. How can I explain to my administrator that I’d like to just rollover to my RIRA while I am still employed?
We own a small business and have 12 employees with a Safe Harbor 401k. My husband I would like to contribute after tax dollars to hit the max of $55k. Our current 401k does not allow this. 2 questions: if we find one that does allow it, I’ve heard differing opinions on whether or not we have to compensate our employees in order for us to contribute after tax dollars. Do we have to offer more than the 5% match in order for us to do this? Next question…how can we find a 401k for small businesses that will allow this? I’ve googled this numerous different ways, but no luck.
Awesome article as always MF! This article + the roth conversion ladder opened my eyes to the FI world and I have not been able to stop listening to podcasts and reading articles since then. Thanks a lot! I started on a 15y plan, and it is now down to under 10y, in just a few weeks by understanding some of these tax hacks.
I have a question that can affect the conversion. For the regular backdoor IRA conversion, you could end up paying taxes on a conversion if you have additional IRA funds (I included an example below, as a reference). Is this case for the mega backdoor conversion as well? I have a traditional IRA which I rolled over to Vanguard from a 401k with a previous employer. I don’t contribute to it. I am planning to utilize the mega backdoor IRA this year, but I want to make sure that I don’t pay extra taxes.
Example referenced above: in order for the Backdoor Roth IRA to work, you CAN’T have ANY other Traditional IRA, SEP IRA, or SIMPLE IRA with money in it.
Here’s why:
When you convert to a Roth IRA, the IRS counts ALL of your IRAs as part of the conversion, even if you’re only doing it from one account.And if you made deductible contributions to those other IRAs, then at least part of your conversion will be taxed.
As an example, let’s say you make a non-deductible $5,500 contribution. But let’s say you also have $25,000 in a different Traditional IRA, and that money was contributed tax-free in years past.
If you convert the $5,500 from your new account, the $25,000 will also be counted as part of the conversion. Which means that most of that conversion will be counted as money that has never been taxed, and therefore needs to be taxed now.
The calculation works like this:
$30,500 total IRA money
The $5,500 non-deductible portion is 18% of that
The $25,000 deductible portion is 82% of that
So 18%, or $992, of the conversion will NOT be taxed
And 82%, or $4,508, of the conversion WILL be taxed
I had a similar question to the above comment. I currently have ~10K in my employer 401K (all pre-tax) and ~50K (all pre-tax) in a IRRA (rollover retirement account; this is like a traditonal IRA but has money from previous employer 401Ks in it). Now say I start contributing to my current 401K and by the end of the year I have ~25K in it (10K current pretax + 10K future pretax + 5k aftertax); in short 80% pretax and 20% after-tax money in the 401K and 93.33% pre-tax and 6.67% after-tax money if I include my IRRA aswell.
Now If I decide to do a 25K rollover on 01/01/2019 from my 401K:
1. can I transfer 80% of it to my existing IRRA and 20% to a new Roth IRA without tax consequences (assume no gains)? or do I have to transfer the money from the 401K and the current IRRA into a new IRRA and a new Roth IRA in the same proportion?
2. If the latter, would I violate the one-rollover-per-year rule?
We are currently:
1. Maxing out backdoor Roths for my husband and me
2. Maxing out my husband’s pre-tax 401K
3. Contributing after-tax dollars to his 401K. After every pay period, my husband calls to convert the after-tax portion of our contribution to a Roth 401K, since this can’t be done online.
Is this a good strategy? At the end of the year, can I rollover the Roth 401K dollars to a Roth IRA? If so, after five years is that money accessible without penalty?
Thank you for the great information! This is so helpful.
Great example and question Alyssa. I am very much interested in seeing the response from the wealth of intelligence on this forum!
Me employer allows for the post tax contributions and will roll them into a Roth 401k. However, they do not allow for in-service withdrawals, with the exception of the standard hardships. Is there any document that you know of, that I can take to the plan administrator explaining that an in-service-withdrawal (especially one that rolls a Roth 401k to a Roth IRA) is allowed?
Hi Brandon,
Firstly, thank you! After reading this article I contacted Vanguard (my employers custodians) and found out we have a little known account that vanguard says is like a 401a which I can put after tax money in up to 17,700 per year. I’m only allowed in service withdrawals to my ROTH 2 times in a calendar year. Because I can only put in a certain amount per paycheck ending the year with a maximum accumulated of ~17,700, any advice for when I should do the rollovers to the roth? I was just thinking mid year and end of year moving it all over. If it grows in the 401a until the twice yearly withdrawals I’ll just have to pay taxes on the growth right? I figure growth is still growth though even if I pay taxes on it I have more money, right, so no sense in using anything other than my usual low fee stock indexes while the money waits to move to the roth?
PS Thank you so much for everything, I devoured your podcasts then moved on to Afford Anything, Choose FI, Fire Drill, BP Money. Love them all, you’ve done great service to this community!
In the example, the pretax 401k money along with the employer contributions are converted to a traditional IRA while the after-tax is converted to a Roth where the gains will be tax-free. That makes sense to me but I have a few questions.
1) Do I have to move the pretax 401k money or can I leave it alone and only convert the After-tax money? My 401k is with Vanguard invested in VIIIX which has an ER of .02, I’d like to leave it there if possible.
2) I contribute 15% of my pay per week to the after-tax 401k and can perform unlimited amounts of conversions per year at no cost, I understand it is best to do the conversions immediately so most gains will be tax free in the Roth but there is some paperwork involved and it takes time to get it mailed to me and for me to mail it back to vanguard so the reality is I’m looking to do the conversions once a month possibly twice a month if all goes smoothly and I can get a good system down. So what is the deal with any after-tax gains I earn between conversions, am I allowed to separate the after-tax contributions from the after-tax gains? Are the gains combined with the pretax gains and get taxed when I pull that money out sometime later? Do the after-tax gains have to stay paired with the after-tax contributions meaning they are taxed when making the conversion from the after-tax 401k to my Roth? Should I separate the After-tax gains and move those to a tIRA at the same time I convert the contributions to my Roth?
I may be making this more complicated than it needs to be but thanks in advance to anyone that can help me get this right. I understand the After-tax gains will be minimal at the time of the conversions but I just want to get a full understanding and make sure I get it right.
ACP testing will make mega backdoor roths for most people. Safe harbor does not eliminate ACP testing.
Referring to the final image of this article… Do you NEED to withdraw the pre-tax contributions to a traditional IRA, or can you just withdraw the after-tax portion into the Roth IRA? It seems like that would create problems for the regular backdoor Roth because you now have deductible traditional IRA funds, which would trigger the pro-rata rule.
Alternatively, let’s say you have a solo 401(k) instead of an employer-sponsored 401(k). The solo 401(k) has all after-tax contributions. In this case, you can just withdraw the whole amount into a Roth IRA, correct?
First Question: no. Any time you roll money out of a 401k the IRA makes you take it proportionally out of every contributions and tax type within your 401k. So you can choose to take all of it, half or it, or 1%. but you will get a bit from each category.
Second Question. I don’t know. I would think yes. Since a solo 401k is technically a different plan (not just a different account).
disclaimer: not a tax professional
So what’s the benefit of moving pre-tax 401k money into a traditional IRA? I’ve maxed the individual and employee 401k contributions. I’m making after-tax contributions now (let’s say there’s a max of $30K to invest in this pot, like your example). Can I take just that money and move it to a Roth IRA? Do they make you move equal proportions of the 401k, based on the % make-up among after-tax (non-Roth), Roth, and traditional? So, each rollover would move both Roth 401k and after-tax (non-Roth) 401k monies to your Roth IRA, and traditional 401k funds to the traditional IRA?
To get all the after-tax (non-Roth) money out of the 401k to take advantage of tax-free growth, would I then need to essentially move the entire 401k into IRAs (assuming I would have to pay tax on any pre-existing growth on the after-tax (non-Roth) amount)?
Example:
I maxed traditional 401k: $18,500
Employer matches 50%: $9,250
I maxed after-tax (non-Roth): $27,250
The $27,250 is gonna grow tax-free so I want to convert it all. Can I convert just that or do I need to essentially move the entire year’s contributions, so $27,750 into a Traditional IRA and $27,250 into a Roth IRA?
Hi Brandon,
What I’m currently contributing:
401K + Company Match + After-tax Mega Backdoor Roth IRA = $55000
Backdoor Roth IRA = $5500
Total = $60000
Question: If my MAGI drops below $189000 this year, in addition to the above contributions, can I also make a direct ROTH IRA contribution of $5500?
Thanks again for all the great resources!
Hi,
Should i use Mega backdoor Roth or 529 for my kids education.
I can directly contribute (6,000$) to my Roth IRA due to my income limits.
So, I will have 3 accounts.
A). Direct Roth IRA (myself)
B). After-tax 401k rollover to Roth IRA
C). 401k -> Traditional IRA -> Roth IRA
Which of these operations should i do first? Possibly, ideal time/month of the year to put the funds?
I’m new to the USA. My son is 8 years old.
The objective is the avoid the pro rata rules (of taking earnings also) during withdrawal or paying penalty to withdraw earnings because i did rollover of traditional ira first and then contributed to Roth directly.
From comments below, i see the order is the deciding factor.
Also, I’m planning for Series-I bonds (as the earnings is also tax-free) for education.
Given my low income (60,000$) per annum, whats the optimal order of investment.
Hi,
Should i use Mega backdoor Roth or 529 for my kids education.
I can directly contribute (6,000$) to my Roth IRA due to my income limits.
So, I will have 3 accounts.
A). Direct Roth IRA (myself)
B). After-tax 401k rollover to Roth IRA
C). 401k -> Traditional IRA -> Roth IRA
Which of these operations should i do first? Possibly, ideal time/month of the year to put the funds?
I’m new to the USA. My son is 8 years old.
The objective is the avoid the pro rata rules (of taking earnings also) during withdrawal or paying penalty to withdraw earnings because i did rollover of traditional ira first and then contributed to Roth directly.
From comments below, i see the order is the deciding factor.
Also, I am planning for Series-I bonds (as the earnings can be withdrawn tax-free for education).
Given my low income (60,000$) per annum in california, whats optimal items to invest in?
Does this Mega backdoor roth contribution include the (IRA backdoor to Roth IRA)? Or It’s different? In other words, Besides $56k, I still can do IRA contribution and backdoor conversion (another $6000).
So glad I found this article! I currently have Pre-Tax 401(k) contributions maxed at $19k along with Pre-Tax Employer contribution of $5500. I will turn 50 this year, so if I’m doing the math correctly, I can contribute After Tax of $31,500 in my 401K ($56k – $19k – 5.5k = $31.5K), in addition to $6k in catch-up contributions. As I understand the message of this article, I should IMMEDIATELY transfer the $31,500 after tax to a Roth IRA so that the growth will be tax-free.
My question for the group is this: Is there a compelling reason to move the pre-tax amounts to a Traditional IRA? why not just leave it in the 401(k)?
Thanks in advance!
If you are happy with your investment options in the 401(k), leave the pre-tax amount there. That’s what I do.
I’ve read several articles about the Mega Backdoor Roth IRA, and they all say the same thing. Max out your pre-tax first to 19,000 then make after tax contributions and roll those to a Roth… why not just make all after-tax contributions and roll everything to Roth?
well if you dont do any “deferral” contributions (that first $19K), which could be Pre Tax or Roth, you will likely miss out on your employers match program.
you do have the choice or Pre tax or Roth for those, so if you are going to pass on the pre tax deduction , then you can effectively have what you are describing. its just split between 401k roth and 401k after tax.
you have to look at your specific plan rules on in service distributions. my plan, and many that i know of, only allow in service distributions on the after tax, so you wouldnt be able to get the $19k or the match contributions out.
I work in a hospital so we have a post tax 403a. I put in 6% after tax money and the hospital matches 4%.
I also contribute the max to a 403b which is pretax.
Does this stategy apply to 403a and 403b?
I don’t qualify for traditional roth ira contributions, but am considering the backdoor Roth IRA. Do you recommend any else?
Great explanation. Here’s a potential twist that I can’t quite think through. Right now, my employer contributes (not matches) 16% of my pay. So for 2019, I can contribute $19k and my employer will contribute until I hit the 415(c) of $56k. After that, the company contribution comes as taxable income. Yes, it’s a very good benefit. If I wish to do a mega-backdoor Roth, I could theoretically front load the $37k with 401(a) money and (again theoretically) hit the 415(c) limit early in the year. Then all the company contribution would come to me as taxable income. So in my case, I’m not really able to save any more since in either case I will hit the 415(c) limit. It appears to me that it then becomes a decision about diversifying into a larger Roth balance or keeping it all in a traditional 401(k) plan. That then requires an analysis of what I think will happen to tax rates in the future. Am I missing anything?
My job let me do an in-plan roth conversion of after-tax contributions last year, which I did in late December. Now the funds have grown in the recent rally but are still in my 401k account. The website shows the portion allocated as in-plan roth. If I wait until I leave my company to rollover into IRA accounts, will the growth on the after-tax roth conversion really all be able to go into a Roth IRA? I’m nervous and don’t understand what it means to be in-plan Roth in the same 401k account as pre-tax money.
My employer allows us to roll over after-tax and/or pretax 401k fund into a Roth 401k once per calendar year. I am maxing out my pretax 401k and after-tax 401k to reach the IRS contribution limit of 56,000. My question is would you recommend rolling over the after-tax portion ever year to the roth 401k every year so that the earnings grow tax deferred. I do not see a down side to this other than to pay the taxes now on the earnings. I am only allowed to contribute approximately 15K since my employer contributes
Timeless post! (Until, of course, tax rules change). Best post on the web on this topic, which is rarely known even by best “financial experts”. Great source of truth here. Thanks again!
Hello,
I have typical 401K, which i’m maxing out. My employer offers a Roth as well but no after-tax contribution option. Should invest in 401k and Roth at the same time? Or should I just keep 401K plan or try to move the money from 401K to Roth, if in-service is offered by my employer?
Thank you for your help
Amazing post!
Question for taxes and more importantly, ACA subsidies:
If I contribute all my income to a mega backdoor roth, does that reduce my MAGI?
I know contributing to a 401k will reduce my MAGI (as the money doesn’t even show up on a w-2), but I imagine my MAGI is not lowered by any mega backdoor contributions. Can anyone confirm?
I’m not sure it this article is applicable to a solo plan or an employer sponsored plan. If you are a Highly Compensated Employee (HCE), by IRS definition, a retirement plan needs to perform ACP testing on the after-tax contribution. If there are no Non-highly Compensated Employees (NHEC) contributing, the plan fails testing. A Safe Harbor plan also needs to test after-tax contributions. Generally, individuals who can afford to save this much would probably be HCE’s so it is not as easy as the article states. In addition, your employer’s plan needs to allow for after-tax contributions, which most plans no longer do.
People come across these unintended tax loopholes and try to gather your assets without telling the entire story.
One of the best, if not the best article on the web regarding the Mega backdoor Roth. Thank you for keeping it updated and easy to understand!
So I recently found out that Fidelity can automate the conversion when the after tax contribution is made if you roll it into a Roth managed by them. This prevents any taxable gains and makes the process a whole lot easier.
Mikey,
I too am doing this Fidelity, was wondering if this mega backdoor roth will create complexity come tax time? Although with fidelity’s automatic in plan conversion there is no taxable gains so I am hoping we don’t have to do anything extra for the 2019 taxes next year. This is my first year of doing the After tax 401K and in plan roth conversion.
I recently contacted Fidelity about this (the administrator for my company sponsored plan). They said that while Fidelity has the ability to do this, my company’s plan was not set up for it…yet. So unfortunately no automation at this time for me. Sounds like even though allowed your plan administrator and your plan have to be set up for it.
I will be asking each time I call to do the conversion. Before I found this article my former financial advisor tipped me off to this, and this article explains it so well. Thanks!
I’m with Fidelity also for my 401k, and I have a question about this. When you say “Fidelity can automate the conversion when the after tax contribution is made”, does that happen with every contribution? I thought you could only do the conversion once per year?
Hi Don,
I’m not aware of any limits on how many conversions you can make, though your specific plan’s Summary Plan Document (SPD) might have restrictions. The only legal limit I’m aware of is on 60 day rollovers between IRAs (those that aren’t direct trustee-to-trustee transfers), but that doesn’t apply since the money is staying in the 401(k) plan.
I haven’t seen any articles of late regarding which free plan administrators are able to perform all of the elements to utilize the mega back door for solo 401k participants. I have accounts through TD Ameritrade but am not clear if their solo 401k option will work. They say you can contribute to the account but you are responsible for all tax elements and nothing is specifically deemed an after-tax contributions. Does anyone know if this will work or if they use others like the fidelity post above references (not sure if that is an employer plan or solo they are referencing.
Seeking the same results as self employed:
– Max out annual ira contributions
– Max out personal 401k contribution
– Contribute as employer
(contribution amount is a % of revenue,
as a result, this is not maxed out)
– is that true, employer limited to contribution amount based on revenue? Any related strategies if revenue is not high enough to max out employer contribution amount?)
– now the question- as a self employed person (software consulting) can i contribute to after tex 401k?
– as a self employed person, are there options to use the in-service withdrawal to convert the after-tax 401k contribution roth ira?
This could be a game changer…
Update – this is addressed in the comments – answered in 2014! Late to the game…
Excellent Article summarizing the options to super size retirement accounts. I’ve recently been exposed to the Backdoor and the Mega backdoor options and wanted to see if you can help clarify a couple of things
Can I combine Megaback door + Backdoor to maximize my contributions? Here’s my situation - My employer allows atfer-tax 401k contributions and my plan admin allows for in-plan conversions to a Roth IRA as soon as the funds hits my 401k account allowing me to leverage the Megaback door option efficiently. However, I can contribute a certain % of my paycheck via the after-tax 401k contribution which will still leave me with more than 6k of room before I hit the 57k ceiling for all retirement contributions. I was hoping to then use the backdoor option by contributing 6k to a separate traditional IRA and then converting those funds to a Roth IRA immediately. Can I do that
I have a traditional IRA account with funds/securities from a 401k rollover from a pervious employer. If per #1 above I utilize the backdoor option by opening another traditional IRA (say with another brokerage than the one I have my older IRA with, for a clean break), contributing fresh funds to it and immediately converting to Roth IRA will I still be hit by the pro-rata rule on that conversion?
Thanks in advance for your input!
You might open multiple traditional IRA accounts with different institutes, but for IRS they all are considered one traditional account. You cannot do backdoor ROTH without tax consequences if you have funds in other traditional account.
Is there a difference or pro/con of doing a in plan after tax to Roth 401k conversation vs a in service withdraw from after tax to Roth IRA?
Hey MF, great write up.
Given that you can claim 40k every year or so of capital gains and dividends tax free, is this really so necessary? Sure you gain tax free growth of your dividends until retirement, but that’s about it. Am I missing something?
I want to move abroad and lots of countries don’t necessarily treat Roth as favourably as the US. Your thoughts?
I hope the experts here can shed some light on a question I have related to After-Tax Contributions. I have an LCC taxed as a sCorp. I set up payroll to and I am the only employee. I also set up a solo401k and it includes 3 sub accounts (solo 401k, Roth 401k, after-tax 401k). Right now I contribute the max to the Solo 401k via payroll. I find now at the end of the year that I can put some after tax money into the After-tax 401k sub account. I cannot do this via payroll so it will not be reported in box 14 of the W2. Instead would deposit the contribution directly into the after-tax 401k. I have read differing accounts of the reporting for this contribution. Some say it needs to be in box 14 of the w2, others says no need to report and one source said send the IRS a letter. Anyone know what is the right approach?
would love to know this as well
Can I use excess employer income to contribute to an after-tax solo 401k plan?
I have an employer 401k that I max out and a Vanguard solo 401k I just setup.
In my solo 401k I can contribute after-tax dollars. I only make $2k in my solo 401k business. Can I use my excess employer income to contribute after-tax dollars in my solo 401k?
Example:
1. employer pays me $100k and I max their 401k.
2. I make $2k which I put in my solo 401k.
3. Can I take $10k from my “employer pay” and contribute it as after-tax to my solo 401k?
Thanks a lot for any guidance.
I have confirmed my employer allows after-tax contributions and in-service conversions to our Roth 401k 4 times per year, which is great. We’ve already maxed out our traditional 401k, employer match, and backdoor Roth IRA, so I plan to go mega based on the great advice here!
My question is, when I go to my employer’s in-service conversion web page, I only see one big bucket of non-Roth money that is available to convert — this may be because I haven’t yet contributed after-tax dollars. Say I start putting $30k a year in the after-tax bucket and want to convert that over using the in-service option, is there any specificity required around which “bucket” of eligible money I convert it from?
My question is, can this work for someone that isn’t making six figures a year – do your after tax contributions to your 401k have to come out of your paycheck?
What is annual contribution limit for mega back-door Roth IRA for 2021 per IRS? The 401(k) employee contribution limit is $19500 (+$6500 for people of 50+). So is the limit for mega back-door IRA calculation also $58000 (+$6500 for person of 50+, thus $64500 total), or is there no age difference, i.e. $64500 for everyone no matter if 50+? Thanks.
Thank you so much for what is still the best explanation of a mega backdoor Roth on the entire internet! Years ago when I first came across this article I knew I’d want to come back to this because my employer allows in-service withdrawals and after tax to Roth conversions within the plan. But I wasn’t maxing my other buckets at that point (except the HSA of course!), so I knew I’d need to wait. Well we’re finally at the point where my wife and I are both working and maxing all of our accounts so I’ve just put in the change to my contributions to add an additional 5% to the after tax bucket to start out.
Thanks so much for sharing what you’ve learned along your journey and I hope you and yours are doing well and staying safe.
Is this scenario, is a 457 equivalent to a 401k?
Can anyone tell me if this method will still be valid in 2022, considering what congress is looking to do?
My financial advisor just told me the Build Back Better bill will eliminate this. I hope he’s wrong, but…
Looking into if I can do this, and it seems likely! My 401k provider allows after-tax contributions and in-service withdrawals. But the big question I have, is how soon can I withdraw the Mega Backdoor Roth IRA contributions? Do I have to wait 5 years to withdraw them? Or is that only if I also want to withdraw the earnings?
Can this be paired with the simple backdoor Roth IRA? I’m assuming no, because you can’t have funds in your traditional IRA account and execute the Backdoor Roth?
Hey The Mad Fientist- this article is fire! Thanks so much for dropping this knowledge. Sucks how much $ many of us spend on taxes because we’re not optimizing our finances with savvy strategies such as this.
Any chance you’d be able to edit this post with a 2022 update on what’s changed since this article was originally written (which appears to have been in 2014 based on the age of the comments) and where things stand heading into 2023?
You should check out what Ankur is sharing on Twitter https://twitter.com/ankurnagpal/status/1597630258551095296?s=20&t=kiL1Yu69mG5p7GLVVMfMog. I think you’d enjoy what he’s posting about strategies like this Mega Back Door Roth.
Hi, thanks for your great blogs and podcasts. I’m not sure if this question has been addressed before but I’m wondering if you’re 60 years old and withdrawing from your roth IRA, can you still do a Roth conversion on your traditional IRA account?