I usually don’t write about things that don’t affect me, because as a reader once said to me, topics that pique the author’s own interest create the best content. I’m making an exception here because it’s important enough if by chance you happen to be able to take advantage.
I’m talking about making non-Roth after-tax contributions to your 401k or 403b plan, followed by rolling the money over to your Roth IRA. Jim Dahle at The White Coat Investor coined it as the “mega backdoor Roth.” I’m going with that. If your plan cooperates, you can put up to an additional $43,500 a year into your Roth IRA! If you are married and both of you have a cooperative plan, you can put up to an additional $87,000 a year into two Roth IRAs!
Before you get super excited, I have to warn you that not everyone can do it. Neither I nor my wife can. Sadly if your plan doesn’t cooperate, there’s nothing you can do about it. You are completely at the mercy of your employer’s 401k or 403b plan. If your plan doesn’t allow it, you are simply out of luck.
Employers that allow it tend to be large employers. Being in a large plan is still not a guarantee. For example, the federal government’s TSP is huge but it doesn’t allow it.
Between my wife and me, we worked for 8 different employers in the last 20 years. None of the 8 employers allowed non-Roth after-tax contributions. If as Vanguard said that 40% of the plan participants can do it, we would have a 98% probability of hitting at least once (1 – 0.6^8 = 0.98), but we struck out 8 out of 8.
It’s similar to having access to a 457 plan. Some people can contribute to both a 403b plan and a 457 plan, which gives them double the annual contribution limit. My wife and I never once had access to a 457 plan. I doubt we will ever. Meanwhile, some people always had one even when they move from one employer to another.
Feeling Lucky?
How do you know if you are lucky or not? Check two things:
1. whether your employer’s 401k/403b plan allows non-Roth after-tax contributions; and
2a. if it does, whether such contributions can be distributed while you are still working there (“in-service distribution”); or
2b. if the plan also offers a Roth 401k option, whether the non-Roth after-tax contributions can be rolled over to the Roth 401k part of the plan (“in-plan Roth rollover”)
#1 is the most critical piece. If you don’t have #1, you are dead out of luck. You can tell by the way you set your payroll deduction for your 401k or 403b plan. Typically you always have the choice of pre-tax. Some plans allow Roth contributions, but that’s NOT what we are looking for. You want after-tax contributions that are not Roth. Roth is after-tax, but after-tax isn’t necessarily Roth.
If you score, you then ask about the “in-service distribution” or “in-plan Roth rollover” rules of your plan. The law allows rolling over non-Roth after-tax contributions and earnings thereon while you still work at the employer. Most plans simply follow the law and they don’t place further restrictions. If you score on #1, chances are you will score on #2 as well. Make sure whomever you ask clearly understands you are talking about taking out non-Roth after-tax contributions, not taking out pre-tax contributions or Roth contributions, which is prohibited by law before you terminate or reach age 59-1/2 (or die or become disabled).
Some plans can be more restrictive. Some plans would suspend the employer match if you take money out. Some plans don’t allow taking any money out until you terminate or until you reach age 59-1/2. Some plans limit the frequency of these in-service distributions, for instance no more than once a year. Some plans charge a fee for each distribution. You will want to know whether your plan is more restrictive than the law.
Score!
Suppose you get lucky and you score on both points. Now what? You choose to make non-Roth after-tax contributions from your paycheck. Then you request a rollover of the non-Roth after-tax money and its earnings to a Roth IRA or to the Roth 401k part of the plan. Either way works. See Mega Backdoor Roth: Convert Within Plan or Out to Roth IRA? The end result is that you have more money in your Roth IRA or Roth 401k. The maximum in 2023 is $66,000 minus your $22,500 pre-tax or Roth contributions minus your employer’s match and/or profit-sharing contributions.
If you can only do it once a year, so be it. Do it once a year. If you are able to do it more frequently and you don’t mind doing it, do it more frequently.
If you can only roll it out until you terminate or until you reach 59-1/2, which you expect to be in the next few years, it still would be worth it. Just contribute now and wait it out. See the follow-up article Mega Backdoor Roth Without In-Service Distribution.
You will pay taxes on the earnings of your non-Roth after-tax contributions between the time you contribute and the time you roll it out to your Roth IRA or Roth 401k. So be it. Pay taxes on the earnings. You can get fancy and have the earnings go to a traditional IRA or even maneuver to roll the earnings back into the plan. I won’t bother unless the earnings are substantial. You already got lucky with being able to do the mega backdoor Roth, which many can’t do. You don’t have to push it further. The earnings usually won’t be much anyway.
Some say keep the non-Roth after-tax contributions in a money market fund before you take it out. I disagree. Not only is it difficult to do, because plans typically don’t allow you to designate funds by contribution type, but it’s also unnecessary. Paying taxes on earnings is better than not having earnings to begin with.
Discrimination Test
Plans that allow non-Roth after-tax contributions must go through a discrimination test to make sure they don’t disproportionately benefit highly compensated employees. If you are a highly compensated employee and your plan fails the test, the plan will have to return some of your contributions and earnings thereon to you the next year. If by that time you already took the money out, it can become a tax mess.
If you are not a highly compensated employee, you don’t have to worry about this. If you are not sure whether you are a highly compensated employee, ask your HR.
Your plan may or may not be at risk to fail the test. However, if you want to avoid this possibility altogether, wait until October 31 the next year to request your distribution for the previous year’s contributions. October 15 is the extended deadline for a plan to file its report to the IRS. By that time it should be clear whether the plan passed or failed the test for the previous year. You can also ask your HR whether the plan passed the test. Once you know it passed, you are clear to request your distribution.
Self-Employed
What if you are self-employed? No mainstream solo 401k providers such as Vanguard, Fidelity, Schwab, TD Ameritrade, or E*Trade allow non-Roth after-tax contributions in their plans. You can pay a service provider a modest fee for a custom plan that allows it. I hope the publicity on the mega backdoor Roth will prompt the mainstream solo 401k providers to add this feature, but I’m not holding my breath. I went ahead and got my own plan. See Mega Backdoor Roth In Solo 401k: Control Your Own Destiny.
Priorities
If you are able to do this, where does it stand in terms of priorities? I see it this way:
- Max out pre-tax or Roth 401k/403b, including age-50 catch-up contributions if applicable
- Max out deductible traditional IRA or Roth IRA
- Max out non-Roth after-tax 401k/403b rolled over to Roth IRA (“mega backdoor Roth”)
- Regular taxable account
If you are not maxing out the first two items yet, don’t worry about this mega backdoor Roth. If you are in a position to max out all three, take full advantage before you mess with regular taxable accounts.
Let’s just say I’m jealous of you if you are able to do the mega backdoor Roth.
For more on mega backdoor Roth, please read:
- Mega Backdoor Roth Without In-Service Distribution
- Mega Backdoor Roth Without a Big Paycheck
- Mega Backdoor Roth and Access To Your Money Before 59-1/2
- Mega Backdoor Roth In Solo 401k: Control Your Own Destiny
- Mega Backdoor Roth: Convert Within Plan or Out to Roth IRA?
Say No To Management Fees
If you are paying an advisor a percentage of your assets, you are paying 5-10x too much. Learn how to find an independent advisor, pay for advice, and only the advice.
desper-otto says
I contributed after-tax money into my 401K for years before my employer offered a Roth 401K. When I retired in 2010 I had pre-tax, after-tax and Roth contributions in the 401K. I contacted Fidelity to roll the whole shebang into my Vanguard IRA and Roth IRA. Surprise! I’d expected those after-tax contributions to show up as basis in my conventional IRA. Instead they wound up in my Roth. I’m not complaining, mind you.
John says
TSP may not allow it but if you are in CSRS (i.e. an “old timer”) you can contribute up to 10% of your lifetime earnings to the Voluntary Contribution Program. Only permits one withdrawal in your lifetime so most users contribute right before retirement and have the contributions “immediately” rolled over to a Roth IRA. Info not applicable to many but it’s good if you can use it! Search CSRS and VCP for details.
Guy says
My employer’s plan doesn’t allow after-tax contributions. My wife’s 401k allows them up to 20% of salary, but rollovers are limited to once every six months. We are putting as much into hers as we can.
Layne says
One addition to John’s comment above re: VCP. If you are CSRS and have had your VCP for some time, you have tax-deferred (pre-tax) earnings in your account. You can (should!) roll those over into your TSP and then roll your contributions (which are already-taxed money) into a Roth.
phr3dly says
I worked for a company (rhymes with doogle) for two years that allowed this. It was great, and I took full advantage. My current company does not. A handful of us tried to get the retirement committee to change the 401k plan, but they’re unable because the government has 401k guidelines that, apparently, require employers to emphasize broad participation.
So a company like ours, with a large number of very well compensated employees and a large number of lower compensated manufacturing employees can find itself in trouble if the well compensated employees suddenly start contributing $53K while 401k participation among the lower paid employees is still very low.
Matt says
I’ve been reading about the mega backdoor Roth for several months now, but just today realized I didn’t read my SPD correctly in that I missed the section discussing in service withdrawals and rollovers of after-tax contributions. I always knew I could make after-tax contributions, but I thought I didn’t have the in-service rollover option. I’m off the figure out how much I can contribute through the mega backdoor in 2015!
Marc says
Thanks for this post. It appears that my employer’s plan allows me to do this, with an unlimited right to withdraw the after-tax contributions. However, the amount of after-tax contributions may be limited in the event that the total amount of such contributions would cause the plan to lose its qualification, and there is no way to know what that amount is until after the tax year closes. Contributions in excess of that amount are returned to the employee. Apparently, fewer than 1% of the employees here take advantage of this, so I suspect that the contribution limit would be somewhat low. (In any event, I fund a traditional IRA with after-tax money each January and immediately convert it to a Roth IRA).
Harry Sit says
Before other high earners in your company catch on, there’s a window of opportunity for you to contribute and when averaged across all higher earners the percentage is still not high enough to make the plan fail the test. You snooze you lose.
Steve F says
Thanks. For some reason, this didn’t sink in when I read it on WCI. It took a second round (and I guess your explanation) to drive it home. I think we might actually be able to do this, though not all the way to the max limits. I have a few detailed questions for my plan administrator now.
Paul says
Both of my employers over the past 28 years have allowed after tax contributions which I have made. Now that the IRS has stated they are in agreement with cleanly moving only the after tax contributions to a Roth (IRS Notice 2014-54) I have moved up to a 50% contribution of my salary to my 401k. I am using a low rate (prime – .5%) HELOC to cover my expense gap while I plow a majority of my salary into after tax contribs. I will max these out for the rest of my working career which is currently planned at 1 to 3 years (but depending on circumstances may be longer).
Harry Sit says
You can also stop the clock on the after-tax contributions you made in the last 28 years by rolling them over to a Roth IRA. In your case because the earnings are more substantial, you send them go to a traditional IRA.
Brad F says
Question to the group.
I called my HR dept and cannot make in service distributions.
However, I have always maxed my 457 and 403b, and any “left over” money I put into my post tax IRA. I never considered using the post tax option in the 403b for those last few bucks.
Should I defer the IRA going forward and fun the 403b exclusively? 403b seems to have the advantage as tax treatment goes at retirement time.
Thanks
Brad
Harry Sit says
If by “post tax IRA” you meant a Roth IRA, keep doing it. This is for people who want to stuff more money into a Roth IRA, not to replace existing Roth IRA contributions. See comments above from Paul, who supplements income with money from a HELOC in order to max out the mega backdoor Roth.
Brad F says
Your suggesting borrow at all costs and fund 403b, 457, post tax 403b (I think I am allowed up to 10% of salary), and fully fund ROth IRA.
If I cant afford to fund it all, and I dont want to borrow, my question relates to the marginal dollars going to Roth IRA vs the post tax 403b?
Thats the crux of my inquiry.
THanks
Brad
Harry Sit says
I’m not suggesting borrowing at all costs. Paul does it with a low rate HELOC he’s comfortable with. I would probably just sell some assets in my regular taxable account if I need to supplement my smaller paycheck. It will effectively move those assets from taxable to Roth and make future gains tax free. I put this below regular Roth IRA contributions under the “Priorities” heading in the article.
Steve F says
Out of curiousity, how long has this been an allowed option?
Harry Sit says
At least since 2008, when you were allowed to rollover from 401k/403b directly to a Roth IRA instead of doing a two-step. Even before then, if you “hide” the pre-tax IRAs as you do in a regular backdoor Roth, you could achieve the same thing with a two-step. The recent IRS notice only made it easier in that you can defer paying tax on the earnings. As I wrote in the article, paying tax on the earnings isn’t a big deal.
Steve F says
Well, I’ve certainly missed a trick. Thanks for pointing that out. However, it’s only recently that we’ve been stuffing money in a regular taxable account after maxing out 2X 401K, 2X Backdoor Roth, 1X HSA maxed.
Thanks again for the post — just what I needed!
Harry Sit says
For high earners, since 2010 when the $100k income limit for converting to Roth was removed, which also enabled the regular backdoor Roth. The difference is that anyone is able to do the regular backdoor Roth by taking the right steps whereas the mega backdoor Roth requires a cooperating 401k/403b plan.
Paul says
Harry, you are correct. I do not borrow at all costs.
1. I have the means to pay off my HELOC at anytime if rates go up.
2. Until interest rates rise to a point that it is unreasonable to borrow any longer I expect my rate of return to be better than the HELOC cost offset by he associated tax deduction for the HELOC. Right now this net rate is about 1.8% for me. I expect to get a minimum of another year, probably two, before rates rise enough to push me to change direction.
From a risk point of view if I can’t do better than 1.8% in this market I’m investing very poorly (and should not be in the market at all). And I am willing/able to take any hit associated with using this strategy.
Yes, the old 401K after tax contribs are being Rothed now that the IRS has cleared that process.
D says
I can’t do this, could afford it, and am a bit jealous of those who can.
Rick says
No Joy – Vanguard Solo 401k here!
Nora Bethman says
There’s one little wrinkle to your strategy that you are mis-informed about. Marc on Dec. 8 made reference to it. That wrinkle is that a qualified plan, such as a 401(k) plan, is subject to 401(m) (sometimes referred to as Average Contribution Percentage, or ACP) testing. Harry, you are incorrect in your assumption when you said:
Harry Sit says
December 8, 2014 at 4:23 pm
“Before other high earners in your company catch on, there’s a window of opportunity for you to contribute and when averaged across all higher earners the percentage is still not high enough to make the plan fail the test. You snooze you lose.”
The testing is dependent on the lower paid earners, not the higher earners. You could have a company with thousands of employees in a 401(k) plan, and unless you can get at least one lower paid eligible employee to make voluntary after-tax contributions, then the plan WILL fail the testing, even if you are the ONLY high earner to make these voluntary after tax contributions. Lower-paid workers very rarely, if at all, will contribute voluntary after tax contributions when they already have 401(k) and Roth contributions to choose from, because they simply can’t afford to contribute the max with those choices. That’s why many plans that once allowed after tax contributions have removed that option, especially once Roth was allowed, since Roth is not included in the testing, but voluntary after tax contributions are.
What’s worse, if the plan does fail the testing, it is not usually known until March or so of the following year. If you’ve already taken a distribution of your voluntary after tax out of the plan to do your back door Roth, and/or filed your 1040 for the year before you are notified by your company that the plan failed the testing and your voluntary after tax contributions are not allowed, then your disallowed contributions are no longer eligible for rollover. You will have to not only reverse your back door Roth transaction; you will in effect pay double tax on the earnings as a penalty because now it is considered excess contributions; and you may have to revise your 1040 form to report these transactions, depending on the timing. It can be a paperwork nightmare; your accountant, if you use one, is going to charge you to redo your taxes, and you invite IRS scrutiny.
So besides these two items:
1.whether your employer’s 401k/403b plan allows non-Roth after-tax contributions; and
2.if it does, whether such contributions can be distributed while you are still working there
I would add a third:
3. Whether your employer thinks your making a non-Roth after tax contribution would pass the required testing.
Your employer’s retirement plan service provider or TPA may be able to “preview” or do modeling to estimate whether your after tax contribution will pass testing and be allowed or not before you put it into the plan. This could save a lot of pain.
Harry, I also take umbrage at your comment about Third Party Administrators (TPAs):
“What if you are self-employed? You are out of luck again. No mainstream solo 401k providers such as Vanguard, Fidelity, or Schwab allow non-Roth after-tax contributions in their plans. You can pay a third-party administrator $1,000 a year for a custom plan that allows it. I don’t think it’s worth the fee. Just stay with your typical solo 401k plan with employee contributions and pre-tax employer contributions. I can only hope the publicity on the mega backdoor Roth will prompt the mainstream solo 401k providers to add this feature. I’m not holding my breath.”
A good third party administrator (TPA,) such as myself, could explain such transactions and the tax ramifications to you, since by your comment, you were not aware of this potential pitfall. A good custom document, prepared by a TPA, for a self-employed person can allow for any type of rollovers, loans, and other features that the “off the shelf” plans provided by the mutual fund companies do not. As I mentioned in my previous post, one tax “mistake” or IRS penalty can wipe out years of investment gains. You get what you pay for.
Harry Sit says
Ms. Bethman – You are the expert. If I’m not mistaken, the 401(m) or ACP test is done together with the employer match, which becomes an equalizer between lower-paid and higher-paid employees. Therefore even if zero lower-paid employees make voluntary after-tax contributions and only some higher-paid employees do so, the plan can still pass the test when enough lower-paid employees receive the employer match for their pre-tax contributions. I believe that’s how so many plans are able to pass the test. Vanguard reported that 40% of people are in a plan that allows after-tax contributions. Those plans apparently are able to pass the test even though as you said lower-paid workers very rarely, if at all, make voluntary after tax contributions.
To avoid the possible tax hassle after the plan fails the test, I’m going to add a paragraph and suggest waiting until 10/31 of the following year to request a distribution. By that time it would be clear whether the plan failed the test or not. Thank you for that reminder.
By the way this is not unique to after-tax contributions. You can run into the same situation with pre-tax contributions. You terminate employment and you request a rollover. Then the next year you are told some of your contributions must be returned because the plan failed the test, but you already took the money out of the plan.
Last, my comment about the $1,000/year fee being not worth it was not that the TPA’s time and expertise aren’t worth $1,000 a year or whatever the fee rate. I meant wanting this feature in an individual plan isn’t worth $1,000 a year. If you don’t have this feature, you won’t have the pitfall, which removes the need to have an expert explain to you about the pitfall. If my estimate of $1,000 a year is too high, please correct me. Obviously if the cost for having a custom plan which includes this feature is only $100 a year, it changes the conclusion.
Nora Bethman says
Harry, with respect to matching contributions, many companies since 1998 have switched to a safe harbor matching design, for the very reason of avoiding the difficulty in passing the ACP test, and as such, would not be included in testing. Many more companies have instituted Automatic Contribution Arrangements, EACAs, and QACAs, all of which may have matching which is not subject to testing. Some SPDs and other materials given to participants are written in such a way that it is difficult to determine whether a match would be subject to testing or not.
Even in plans that allow after-tax contributions (which according to Vanguard is 40%), I really don’t see people actually making them often, either highly paid or non-highly paid. Ten years ago people would, once in a great while, but not lately. It could be that their HR department is discouraging after tax contributions because of testing hassles and extra cost on the company’s part, or that people are making Roth contributions instead since those have different, more desirable characteristics, or, people run up against a plan or other IRS limit that prevents additional after tax contributions.
In any case, because of the complexity of the situation, and the severity of the problems that can result if it is mishandled, I think you would be doing a disservice to not at least mention, as I did with my comments previously, a warning about potential pitfalls with after tax contributions. And yes, you are correct, it can happen with pre-tax contributions as well, with the same result to remedy the situation.
That is always a hazard in the do-it-yourself method, no matter whether it’s fixing the brakes on your car, or handling your own retirement plan. You can rely on online postings, which may be true 99.99% of the time, but unless you sit down with someone who knows about the subject, whether it is a good mechanic or a good TPA, who will know specific questions to ask to determine all of the facts and circumstances of your own particular situation, you run the risk of making mistakes. And you don’t want to find yourself in the predicament of discovering that your brakes are not working when you are getting off the freeway, or discovering that you need to pay a big IRS penalty from your retirement savings when you are age 64.
I don’t know where you live or who you’ve been talking to, but $1,000 per year sounds high to me. I think there may be an initial fee of $1,000, which is in most cases fully tax deductible for self-employed people, and an annual maintenance fee of a few hundred dollars, again usually fully tax deductible as a business expense.
In this post, it is your opinion that wanting the ability to make a back-door Roth was not worth a $1,000 fee to set up a plan which would allow it, and that’s your opinion, and you are certainly entitled to it. In your previous post, you were disappointed that the off-the-shelf plan document offered by Vanguard free of charge did not allow rollovers from IRAs. When taken in totality, it appears that you are willing to give up quite a few plan features, which might help you in the long run, to save a $1,000 deductible set up fee, which is also certainly your prerogative. But I do hope that you won’t be disappointed if you only achieve off-the-shelf results with your retirement plan when you are ready to retire, in order to save $1,000 today.
Harry Sit says
Ms. Bethman – Thank you again for your comments. Based on your previous comments, I added three new paragraphs under a separate heading to deal with the ACP test issue. Please let me know if those are inaccurate or inadequate. I don’t know how all those plans that offer after-tax contributions pass the test but apparently they have been able to pass it.
If expert help makes economical sense, I’m not shy of using it. For my own solo 401k plan, I’m using Fidelity, which accepts incoming rollovers from IRAs. It doesn’t limit the menu of available investments and it adds no surcharge. It doesn’t have the problems you previously mentioned. I only wish it has the after-tax feature. For my small contributions at the moment, I’m pretty sure I won’t be disappointed if I only achieve off-the-shelf results. If you are willing to give me a quote for a custom solution which includes the after-tax feature with in-service distributions, I’m all ears. Many readers also have solo 401k plans. They would also love to have that feature. You can reach me via the contact form.
Nora Bethman says
I like what you added, Harry. Now I think people can make a more informed decision as to do it or not, having more information on which to base the decision.
I don’t know how plans are managing to pass testing either. It may be a situation like the one I had several years ago. I took over a nursing home 401(k) plan which was being administered by a very nice, elderly CPA in a small town who was retiring. He sent me his multi-column green ledger sheet, on which he had neatly recorded each participant’s account balance with a pencil for many years. When I asked him for a copy of the testing, he said, “What’s testing?” Particularly for plans that have been in existence for a long time, that could be the reason they “pass” testing. You can’t see it if you don’t know where to look.
Paul says
Another commentator seems to indicate that a after-tax distribution must include a proportional amount of pre-tax dollars (https://www.kitces.com/blog/irs-notice-2014-54-acquiesces-on-splitting-after-tax-401k-contributions-for-roth-conversion/). Do you agree? Why or why not? My company plan seems to specifically order distributions so after-tax dollars come out first. Any comments on this?
Harry Sit says
The IRS said that too. See IRS newsletter brought up by reader Scott. Others say the proportional calculation is limited within the after-tax subaccount, i.e. your after-tax contributions plus earnings. Anyway you let the plan administrator worry about how to do that. If the proportional pre-tax amount is too high, you do a split rollover and send the pre-tax part to a traditional IRA.
Mid TN Gardener Guy says
Paul,
Harry is correct on this, unsurprisingly. It has been possible for years, in this situation, to move after tax monies from 401k to Roth IRA. The IRS ruling referenced by Kitces simply makes it easier and less uncertain to do the split; i.e., your 401k provider sends out 2 checks (one of after tax contributions, the other untaxed earnings). Prior to this ruling, there was much angst and uncertainty (ref Fairmark.com).
I’ve done this twice with my employer’s 401k, which does permit both (a) non-Roth after-tax contributions to my [non Roth] 401k and (b) in-service withdrawals to an outside Traditional IRA or Roth IRA. The first time, I paid income tax on the un-taxed earnings which were converted to a Roth IRA; the second time, I put the after tax money into a Roth IRA and the un-taxed earnings into a new Traditional IRA.
The IRS dictates that if withdrawn (in-service withdrawal), after-tax monies contributed after 1986 must come out with the associated, yet untaxed earnings – meaning that either (a) you can put the untaxed earnings into a traditional IRA (you’ll have to pay income taxes on full amount of withdrawals in retirement later) or (b) convert the earnings to a Roth by paying income taxes now.
Also, the IRS dictates the order of any of the monies which come out of the 401k. I’m not sure if this withdrawal order continues into retirement or if it is like withdrawals from a Traditional IRA, in which the distributions are pro-rated; i.e., each individual withdrawal includes both un-taxed and after tax [if any] monies in the percentage present in the account.
$iddhartha says
Hey, Paul. I think you’re referring to a common misconception. We are only rolling over the after-tax funds and the growth resulting from those funds. The “pretax” amount is only the the growth of your after-tax contributions which haven’t been taxed yet. You only rollover the after-tax portion and its growth… Not, I repeat NOT, your normal pre-tax 401k contributions.
Jay says
Does IRA aggregation rule still apply in this case. i.e. if an individual has other active IRA’s (not Roth) besides the 401(k) account, and when the after-tax non-Roth contribution in a 401(k) account is rolled into an Roth IRA account (either through an in-service distribution or at the time of employment separation), is the entire amount that is being rolled over is considered as a tax free Roth conversion or only a percentage (depending on the aggregate amounts in other active non Roth IRA’s) is considered
Harry Sit says
It does not when you go directly from the 401(k) plan to the Roth IRA. The earnings on the after-tax contributions are still taxable when you roll the whole thing into a Roth IRA. If the earnings are substantial you can send the earnings to a traditional IRA.
mjs says
I’m not sure I’d agree with the priority language or order of priorities. I agree with #1 up to the *matching* portion the company provides then #2 (for simplicity and control).
But, outside of the minimal % level to get that match, that’s all I do in #1.
Instead, I max out #3. Here’s why:
1) My company’s 401(k) and Roth 401(k) fund offerings are only a couple plain stock/bond ones.
2) I can convert my after-tax contributions monthly to the Backdoor Roth, so earnings on contributions are minimal.
3) I can then invest after conversion in ANY fund for diversity as it’s now going to my personal Roth IRA. I do not have the option as long as the money is left with my company at time of conversion.
4) I plan on being with my company until retirement.
Given these issues, isn’t it my best case to #3 after match?
Harry Sit says
We are talking about the difference between $18k and the amount you are matched on, say $6k; that’s $12k, which is a relatively small part of your total contributions. If you would otherwise make it Roth 401(k), sure, you can make it after-tax and roll over to Roth IRA for better investment choices. However, I would prefer to keep it in the traditional 401(k) for the tax deduction. You are already getting a lot into Roth. $18k into traditional 401(k) would be good for tax diversification.
bp says
My plan allows non-Roth after-tax contributions; however, to distribute/rollover money you cannot choose only these contributions. Instead it appears they do it as a ratio of your normal contributions and your after-tax contributions. Anyone else have this problem?
Big George says
For my company’s plan, it depends on whether it is part of a final, complete distribution of the plan or not. In the former case, then you can direct that non-Roth after-tax contributions be rolled to a Roth IRA while remaining tax-deferred contributions and earnings from both after-tax and before-tax contributions are rolled to a traditional IRA (or 401k). However if it happens before retirement and distribution, then whether it is an in-plan Roth conversion or a in-service withdrawal, they will include a pro-rata portion of the earnings in the subaccount containing the after-tax contributions + accumulated earnings.
We have the added benefit (and complication) of being able to use the tax-paid funds as part of an NUA (Net Unrealized Appreciation) strategy. We are an old school company, where most employees have never worked anywhere else. So many of us have very low cost basis company stock in our savings plan. If done as part of a complete distribution following retirement, you can take company stock in-kind and only pay taxes (at that time) on the cost basis of the company stock. If you have available and elect to use tax-paid funds, you can direct that they be applied to the basis of the NUA stock, making it possible to remove a significant amount of stock from the 401k with no current tax liability and only capital gain taxes that you can take in a presumably lower tax bracket after retirement. I’m currently evaluating whether to rollover my tax paid funds to a roth or as part of an NUA strategy or both. If anyone has analyzed it, I would be interested in what you have come up with. I realize it will be very specific to the particular situation of each person (how much in tax-paid funds, the cost distribution of the potential NUA stock, etc).
bp says
For further clarification… My plan does not allow me to roll over non-Roth after-tax contributions specifically. For any rollover, they will use the taxable amount in the 401k first followed by nontaxable amount if rollover amount exceeds the available taxable funds. So for me at least, they would be doing the exact opposite of what I would want.
Harry Sit says
If you are not yet 59-1/2, they can’t distribute your pre-tax contributions and earnings when you are still working there. In effect you only have the after-tax account available for distribution. If you are already over 59-1/2, ask them if you can send pre-tax money to a traditional IRA and after-tax money to a Roth IRA. The latest IRS Notice 2014-54 allows this. Plan administrators may still need some time to update their internal procedures.
bp says
I see; I’m well under age 59.5, and I am still an employee.
Perhaps the company match is also eligible for rollover? This would explain why such a large proportion of the rollover-eligible funds are labeled as taxable.
Harry Sit says
Company match and money you previously rolled into the plan are also eligible for rollover if the plan allows.
JLT says
I understand that the annual limit for elective deferrals in 2015 is 18,000 across all plans. However, there is a $53,000 annual limit “per plan” that includes company contributions/matches as well as employee after-tax contributions. My company allows after-tax contributions and in-service distributions of the after-tax contributions and earnings.
If I plan to change employers in a few months. Can I max out my after-tax contributions (without doing any pre-tax or Roth contributions) to achieve the $53,000 annual limit for the plan including company match and, when I move to my other employer mid-year, contribute the 18,000 pre-tax to the new employer’s 401K for 2015 to also get the Traditional 401K deduction (and maybe even more after-tax contributions there since that new plan would have a $53,000 limit as well) ?
In essence, would that allow me to do a mega backdoor Roth IRA by rolling over the post-tax contributions (with low earnings) from my old 401K after termination, and then do an additional $18,000 pre-tax contributions in my new 401K to lower my taxes for the year 2015 (and maybe more after-tax contributions if the new plan allows) ?
Thanks in advance.
Harry Sit says
It’s $53k per employer, not per plan (in case the employer has more than one plan). Yes you can do what you outlined.
JLT says
Thank you for you help. One more question:
I read that it can get messy if I am an HCE and my company does not pass the test therefore having to give me next year a corrective distribution of the excess after-tax monies, after I had already rolled over all the after-tax to my personal Roth IRA.
Could you please explain how this problem would have to be corrected ?
Note that I am planning to do the mega backdoor Roth rollover as an in-service distribution before I leave my current employer so that I can only have the distribution from my after-tax subaccount without touching the pre-tax 401K, which I want to keep with my current employer due to good investment options and expense ratios. I would not want to wait until after termination since at that time I understand that the only way to separate the after-tax money would be to take the entire 401K out and direct the pre-tax to my new employer’s 401K (or Traditional IRA which I am trying to avoid for future backdoor Roths) and the post-tax to my Roth IRA.
Would a corrective distribution next year mess up things, and how would I be able to correct it?
Thanks again.
Harry Sit says
If the plan fails the test but you already did the rollover, the plan will want some money back to do the corrective distribution. You will have to convince the Roth IRA custodian to give part of the money back to the plan and make sure the IRA custodian doesn’t tag it as a premature distribution. The plan will send the check to you, maybe with a corrected 1099-R. If you filed taxes before, you amend your return.
The value of mega backdoor Roth is in doing it year after year. A one-time deal is much less appealing. Still, you decide whether you want to take a chance that the plan won’t fail the test (and deal with it if it fails), or you just wait until the picture is clear before you request the rollover.
JLT says
Thank you again. This is very helpful.
I do plan to try to do it each year but am trying to do a more sizeable contribution this time around since I just only started with my Roth IRA and don’t know how many more years I will be able to contribute to catch up in Roth savings. It seems I will have to assess the balance between risk and reward to decide if I will take a chance as you mention.
Thank you again for your help.
Greg says
We have a plan that is now eligible as of a few weeks ago. Our company did not max out pension/profit sharing in 2014. Are we eligible to contribute “make up” contributions up until April or are we only able to do so within the plan year?
Harry Sit says
The employer can contribute later but as an employee you can only contribute within the plan year.
Charlie says
I may have missed it in the article or comments but can you still do this if your income is too high to directly contribute to a Roth IRA?
Harry Sit says
Yes, but take note of the Discrimination Test section.
sita says
I have single member s-corp and I pay my-self on W-2; and planning to contribute to 401k plan. I talked to Vanguard and they said they don’t have such; who is offering and how can we fund the accounts to meet $53000 this year., 18k with pre/post tax and 25% of 100k salary and additional 10k into another 401k account with after tax dollars, what kind of account holds this 10k? Please let me know. Thanks,
Harry Sit says
See the follow-up articles toward the end of the article. That last one addresses self-employed.
sita says
Thank you for all the details,
I am an employee of my single owner s-corp and paid 50k on W-2; Are the nbrs correct -18k pre/post employee elective deferrals +12.5k (profit sharing 25% of 50k)+22.5k (non-roth after-tax contribution) = 53k towards IRS limit for 2015?
My spouse works for another employer with 50k on their w-2 and their employer only allows pre-tax contributions 18k; Can I bring her our payroll for say 5k/10k per year for the help toward my company and help her on my 401k as well?
You mentioned 3 accounts for each participant ((husband pre-tax,husband Roth,husband after-tax) ), where does profit sharing goes? is it going to have a new account?
Ascensus questionnaire document says ‘in-plan roth rollers are not permitted’ on page 7; will it be override during the plan? is it for rolling over non-roth after-tax contributions to Roth IRA?
Thanks in advance!!
I still have questions, contacted ascensus and working on questionnaire document that is downloaded.
Harry Sit says
That follow-up article has a link to a calculator for how much you can contribute. The total can’t be more than 100% of compensation. At $50k, the maximum is $18k pre-tax or Roth, $12.5k profit sharing, $19.5k non-Roth after tax. At $10k for your wife, the maximum is $0 pre-tax or Roth (because she’s already doing $18k at her other employer), $2.5k profit sharing, and $7.5k non-Roth after tax.
Profit sharing is pre-tax. You can set up a 4th account for it or just put it into the pre-tax account.
In-plan Roth rollover is for moving money from pre-tax to Roth *within* the plan. It’s not for rolling over non-Roth after-tax money out of the plan to a Roth IRA.
As I mentioned in the comments in the other article, it’s better to go with a TPA rather than DIY with Ascensus directly. The difference is only a few hundred dollars a year.
Harry Sit says
P.S. You will also have to pay 15.3% Social Security and Medicare taxes if you bring your wife onto your payroll at $10k.
sita says
Thank you Harry for your quick response!!
Earlier I missed the part – ‘The total can’t be more than 100% of compensation’ and only concentrated on 53k/year limit., it make sense now., A 54k W-2 work better in my case to reach (18+13.5+21.5) 53k limit.
Tracy says
Thanks for this post – I read it last December and found we were able to do it! The only question I have is that my company did a safe harbor true up in April of this year for 2014 employer contributions – does this count towards the 53K contribution limit for 2015? I think it must but haven’t been able to confirm this anywhere. Thanks!
Harry Sit says
That sounds like 2014 contribution to me, but double check with the employer or plan administrator.
TL says
Hi Harry. 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!
Harry Sit says
You will get a 1099-R. You put it into your tax software. It will add an entry to Form 1040. Custodian firms receive rollovers all the time. This would be no different. If you want to eliminate the possibility of mis-classification, make your current year IRA contribution first.
sita says
What if you do a matching contributions for an employee on a single member s-corp, like 6% instead of profit sharing (25% of W-2); wouldn’t it be more towards non-roth after-tax contributions?
On 50k and profit sharing – 18k, 12.5k, 19.5k (pre/post, profit sharing, non-roth)
On 50k and 6% matching – 18k, 3k, 29k (pre/post, 6% matching on 50k, non-roth)
What is advisable and what are the major diff between profit sharing & matching contributions? I am thinking % of either profit sharing/matching contributions are up to employer, is that true?
Ascensus plan being written as traditional 401k plan with pre/post, non-roth and in-service distributions., also has profit sharing and matching options as well.
Appreciate your comments!!
Harry Sit says
For a single-person plan, because the employer profit sharing contribution is discretionary, the distinction between match and profit sharing contributions is really moot. You can just make $3k profit sharing contribution or even zero for that matter. You are really looking at whether you want up to $12.5k as pre-tax or as additional mega backdoor Roth. Here the case against Roth 401k would apply.
sita says
Harry,
I understand both pre-tax/Roth contributions should be moved from business account to 401k., How about NonRothAftertax, does it needs to be moved from business as well or personal?
Is it good idea to distribute pre-tax to traditional ira and Roth&NonRothAftertax to Roth ira same time to avoid further issues if planning to do so?
Harry Sit says
sita – The plan is sponsored by the business. All contributions must come from the business.
Keep it simple. Leave pre-tax and Roth in the plan. Only distribute non-Roth after-tax and earnings thereon to a Roth IRA.
Michael says
A bit of thanks and a question.
Your blog is outstanding and has been very helpful to me. Thank you.
Question: is the mega backdoor ROTH conversion possible from a SEP? SEP – > Individual 401K – > ROTH without paying taxes (highest tax bracket) on the amount converted.
– mp
Harry Sit says
It’s not possible. You need non-Roth after-tax contributions. SEP is all pre-tax.
sita says
Harry,
Are these NonRothAftertax should be part of the payroll setup to send the money to investment account or we can directly write a check from business account to investment company to deposit money on NonRothAftertax?
Do we need to show these NonRothAftertax money on W-2 or just submitting 1099-R explains it by itself to IRS as it is NonRothAftertax money?
Harry Sit says
The contribution is part of payroll, included in the W-2 gross but I don’t think there’s an itemized box or code for it. Issue 1099-R under the trustee’s EIN only in the year of the distribution.
Steve Flanagan says
Mr Sit,
I enjoyed your Backdoor article as well as the Mega article and appreciate the time you take to help your readers by providing and responding to specific examples. While working with Fidelity to rollover a 401K to IRA I was asked if I wanted to move the “after tax” money directly into a Roth. His and my understanding is the rollover does not care about other IRA basis. So it gets past the Pro Rata issue with a Backdoor Roth. Question 1) Is this also your understanding?
Here is a link to the IRS doc with more info on this: http://www.irs.gov/pub/irs-drop/n-14-54.pdf
On a side note I believe I may have fallen into a “Rat Trap”, or maybe I should call it a “Pro RATa Trap”.
The scenario is this.
Apr 1 2015: Two contribution were made to IRA using “after tax dollars”
• 2014 Non-Deductible IRA ($5500)
• 2015 Non-Deductible IRA ($5500)
Using the Backdoor Roth, both IRAs were converted to Roth. At the time (Apr 2015) of the Rollover there were no other IRA accounts.
Now the issue – Jul 2015 – for investment reasons decided to convert 401K to IRA Rollover this year. So now I believe Pro Rata Rule will make the Roth conversions a taxable issue.
Assuming no earnings on these funds –
Question 2: Is the 2014 Roth exempt from the Pro Rata calculation – so the only concern is the 2015 funds? Or do I now have an issue with both conversions? Had i converted 2014 back in Dec of 2014 I would have not had an issue with those funds.
Question 3: Can the Roth simply be converted back to Traditional IRA, and then can that Traditional IRA also be cashed out tax free.
Question 4: When I re-characterize it back, what Tax issues should I be prepared to to look out for, e.g. 1099R’s, explaining the re-characterization, how and where to explain, other?
Thanks for your help!
Harry Sit says
1) Correct, no pro-rata with your other IRAs when you go directly from a 401k to a Roth IRA.
2) Both conversions.
3) You can recharacterize the conversions. You can withdraw the contributions afterwards but earnings will also have to be withdrawn and you will have to pay tax on the earnings. See IRS Publication 590A under “Contributions Returned Before Due Date of Return.”
4) You will get a 1099-R with the appropriate code for the recharacterization. You enter it into the tax software as instructed.
Dan says
Harry,
My company QDCP allows pre-tax and post-tax contributions to our 401(K) and allows in-service withdraws of after-tax contributions but notes that such after-tax withdraws will be taxed on a pro-rata basis of contributions and related earnings.
During 2015 I contributed $18,000 pre-tax to my 401(K), $21,132 after-tax, and my employer contributed a match of $12,924.
In November 2016, once I’m certain that the QDCP passes any required testing, I’m planning on having Fidelity, my 401(K) plan administer, “rollover” the $21,132 after-tax 2015 contributions and any associated gains to my ROTH IRA administered by Vanguard.
1. Do you foresee any issues/concerns with my plan?
2. Based on the above, would I only be responsible for paying taxes on the associated gains of the $21,132? and if so on what form would Fidelity report the taxes?
3. Is the term “rollover” correct or is this called a “transfer” or something else?
4. Lastly, I prepare/file my own tax returns using Turbo Tax. Do you have an guidance on how to properly report the mega rollover in Turbo Tax?
Thanks,
Dan
Harry Sit says
1) No issues. You are doing exactly as the chart in this article shows.
2) Yes you only pay tax on the earnings. It will be on a 1099-R.
3) Rollover is the correct term. Or you can say you are doing an “in-service distribution” in the form of a rollover to a Roth IRA. There are other forms of in-service distributions, such as taking the money as cash, or rolling over to a traditional IRA. You are not doing those.
4) Just search for 1099-R. Enter the numbers as shown on the form. It will be obvious. When I do mine next year, I will show an example.
Alex says
Harry, appreciate the immensely helpful content. Did you end up using Turbo Tax for your 2015 filing and your Mega Backdoor? If so, did you happen to document it, as you mentioned to Dan (above) you might?
Harry Sit says
Alex – I just tried it in TurboTax Online. It’s very straight forward. You just enter the 1099-R as-is and answer the questions: not an in-plan Roth rollover, was rollover to Roth IRA, contributed after-tax, no adjustment necessary, not a public safety officer, did not recharacterize.
Palm says
Harry,
Thank you very much for sharing your learning. I wish i have come across your blog many, many moons ago. I have a lot of clean up to do.
How should i sequence the regular back door IRA and Mega back door IRA? Should i do Mega door first to minimize the probability of (any) of my traditional IRA is lumped with my after tax 401k?
I have inadvertently done after tax ( non Roth) 401k contribution for many years and i have non-deductible traditional IRA for several. My employer allows in service withdrawal of the after tax 401k.They also are kind enough to track the 401k by funding sources. I am far from 59.
Also, should i backtrack and calculate the total contribution of after tax 401k to ensure only this portion is rolled over? And if they insist both earning and contribution to be rollover, then split to Roth (contribution) and traditional (earning), then i should not sweat it since i can move the tradional IRA to the 401k ?
Harry Sit says
The plan administrator is already tracking the after-tax contributions and earnings thereon. They are required by law to distribute both. As a one-time clean up, when the earnings are substantial, do the mega first. Send your accumulated contributions to Roth IRA and the earnings to Traditional IRA. Then send the Traditional IRA back to the plan. Then do your regular backdoor Roth.
Ongoing, because the earnings aren’t much on just one year worth of contributions, keep it simple by sending both after-tax contributions and earnings to the Roth IRA directly. Then your mega and regular backdoor become independent of each other.
Palm says
Thank you!
Palm says
Now I realized that my company also allows in service distribution of company match. I understand this is a pre-tax, so if I roll it over, it will be to a traditional IRA. I can not find any article mentioning pros/cons on this. I can see this is a way to get the funds out of 401K, then it can be converted to Roth IRA. Do you have any advice?
$iddhartha says
Depending on your state’s rules and personal preference, this mega backdoor Roth method can compare favorably to a 529 plan.
Lalith Perera says
Hi.
Thanks a lot for this excellent article. My company is just about to start offering this benefit – after-tax contributions and Roth in-plan conversions to the company’s 401(k) plan.
My wife is a homemaker. We both contribute to non-deductible IRA. In terms of priority, where would you put non-deductible IRA?
1. Max out pre-tax or Roth 401k/403b, including age-50 catch-up contributions if applicable
2. Max out deductible traditional IRA or Roth IRA
3. Max out non-Roth after-tax 401k/403b rolled over to Roth IRA (“mega backdoor Roth”)
4. Regular taxable account
Thank you, and best wishes,
Lalith
Harry Sit says
Laith – If you already max out deductible traditional IRA or Roth IRA in (2), you can’t contribute to non-deductible IRA any more. You contribute to non-deductible IRA only when you can’t contribute to deductible traditional IRA or Roth IRA due to income limit, and only when you convert it to Roth. See Backdoor Roth: A Complete How-To. In such case it would sit between (3) and (4).
Andy says
My wife works for GE. I believe GE allows for non-Roth after tax contributions and in service withdrawals. However, I tried to rollover the money in her after tax account to her Roth today and was told I couldn’t roll over only the money in her after tax account. I would need to rollover her entire pre-tax portfolio, as well. I confirmed that he was not just talking about the earnings in her after tax account, but all of the money in her 401k from all sources. Does this sound right to you or was I talking with a potentially misinformed employee. Fidelity manages their 401k.
Harry Sit says
Potentially a misinformed employee. If she is under 59-1/2 the law prohibits in-service distribution of pre-tax contributions and earnings. Try a different rep or try to do it online if you can. The system knows the rules better than humans.
Andy says
Thanks for your help? Would it matter that I previously (2014) moved money from a traditional IRA (from a previous employer 401k rollover) to the GE plan to be able to to a back door Roth with no prorata issues.
Harry Sit says
It could matter. Money previously rolled in is eligible for in-service distribution. They may let you pick and choose or they may say you have to take it proportionally from all eligible sources.
Sita says
Harry, Thanks all the help!!
I successfully funded 21.5k NonRothAfterTax account couple days ago, Would it be good idea to wait until November this year to make a roll over to Roth IRA even it’s a single member s-corp? Fidelity added an additional 0.02 cents to it as of today, I i do a rollover to roth ira, i believe i should transfer all including 0.02 to personal Roth..correct and submit 1099-R during tax filing this year? Thank you for your inputs.
Harry Sit says
You can do the rollover at any time. When you do, include the earnings. The article coming up next week will outline the entire process.
DM221 says
Hi Harry,
I was asking whitecoatinvestor some questions about the “mega backdoor roth” and he wasn’t quite sure, so he referred me over to your site.
I have an employer 401k plan which allows after-tax contributions and in-service withdrawals.
I have a sizable tax-deferred accumulation in my 401k and I max this each year (18k). If possible I’d like to put additional money into the after-tax 401k then roll it over into a roth to grow tax-free.
However, my CPA has told me it’s not worth it due to the “pro-rata rule” applying (just like in the backdoor roth). It was explained to me that if I have accumulated (for example) 190k in tax-deferred 401k plan, then I contribute 10k that year for after-tax contribution, then I try to roll that over to a roth then “only 5% (10k divided by 190k+ 10k) will be tax free.”
I’m not even sure I understand what that means, but essentially I’m under the impression a taxable investment account would be a better place for that extra money.
The other thing that concerns me upon reading your article above is that I’d definitely be classified as a “high income” earner, although not sure if my plan has a “discrimination test” (seems that other high earners contribute to this after-tax 401k and use it- the plan has been in place for a long time. Not sure if they roll over to a roth)
Hope you can clear this up for me.
Thanks!
Harry Sit says
Too bad you didn’t ask about this a couple months earlier. Otherwise you could’ve tested it by making a small after-tax contribution and then requesting a rollover. By the end of January you would then receive the 1099-R and see how it works.
The “pro-rata rule” wouldn’t apply if the administrator keeps pre-tax and after-tax contributions and earnings neatly separated, which most administrators with modern recordkeeping software do. When you do the rollover from only the after-tax account, they will identify the earnings in the after-tax account and put only that on the 1099-R as the taxable portion, and not prorate with your other pre-tax money.
I would just go ahead and do it. If you are more cautious you can do a small test this year but you won’t see the results until next year.
Every plan with this feature has to go through a discrimination test. You can ask your HR whether the plan ever had problems passing the test. The test is on the after-tax contributions. Whether they rollover to Roth or not is irrelevant. As it’s mentioned in the article, if you want to be absolutely sure, just wait longer before you request the rollover.
Dm221 says
After reading the rules on the IRS website it seems illegal to rollover only the after-tax contributions (unless I’m missing something?).
https://www.irs.gov/Retirement-Plans/Rollovers-of-After-Tax-Contributions-in-Retirement-Plans
Harry Sit says
You missed that you are rolling over after-tax contributions plus earnings thereon, not only the after-tax contributions.
Dm221 says
But it clearly states I would have to rollover a “proportional” amount of my pre-tax 401k balance too. So to get out the entirety of my after-tax contribution each year I’d have to rollover my entire 401k – the pre-tax portion to a rollover IRA and the after-tax to a roth IRA.
Not sure if thats a good idea or not?
Harry Sit says
It doesn’t say that. You have to read very carefully. It only said “pretax amounts” not “pretax contributions.” The earnings in the after-tax account are the pretax amounts. The earnings have to come out proportionally with the after-tax contributions. If you are before 59-1/2, your pre-tax contributions and their earnings can’t be distributed without cause (death, disability, termination, …) anyway.
Dm221 says
Gotcha! That makes sense – very confusing upon original read.
So for example if I contribute 20k in after-tax amounts this year, and it grows to 22k over this year then I would do the rollover of the entire amount (2k “pretax amounts” and 20k “aftertax amounts). The 20k would go into a roth IRA and the 2k into a traditional IRA. My tax defered contributions would be untouched.
I assume I would then pay capital gains tax on the 2k earnings at the time of rollover? I wonder if thats what my CPA meant? But it would seem very worth it if the 20k then grows tax free and can be withdrawn upon retirement without tax consequence. Not sure why he advised a taxable account was preferable – that would seem to be a huge gain if it’s possible.
Kristin says
Are backdoor Roth conversions still allowed in 2016? (after-tax money from empty IRA transferred to Roth IRA)
Harry Sit says
They are, but that’s not what this article is about.
Gino says
Harry,
Similar to Dm221 above I have a an employer 401k plan which allows after-tax contributions and in-service conversion. My after tax account is split ~50/50 between my after-tax contributions and tax-deferred earnings. My plan also has a Roth 401k and allows one conversion from the after tax account to the Roth 401k with no min or max limit on the amount.
I’m trying to decide if it’s worth converting – what should I consider as part of making that decision? I’m in high-income tax bracket now so maybe it’s worth spreading the conversions over multiple years? I may be retiring early vs. waiting until 59.5 to get full access to these funds. Thanks and great article!
Harry Sit says
Gino – See if the plan also allows rolling over the after-tax contributions and earnings out of the plan. If so, with substantial earnings, see if the plan can do a split rollover, which is allowed by the IRS Notice 2014-54, by sending the contributions to a Roth IRA and the earnings to a traditional IRA. If you can only do in-plan Roth rollover but not in-service distribution, you can convert now, spread over multiple years (but the earnings can grow during those years), or just wait until you retire early.
Gino says
Thanks, I’ve asked the plan admin if that’s possible. I guess the downside would be that I’d no longer be able to do tax-free backdoor Roth conversions in the future years (due to prorata rule and having traditional IRA)? Any other gotchas with this strategy?
Harry Sit says
You can roll it back into the plan if you’d like, or you just contribute more after-tax money to the plan instead of contributing to the traditional IRA.
Caleb says
With the Backdoor Roth IRA, the tax implications are a bit trickier if you have money in a traditional deductible IRA, as you point out int he article on the Backdoor. With the Megabackdoor, does money in a traditional deductible IRA have any tax impact on the rollover.
It seems to me there shouldn’t be because any money in an after-tax 401(k) is not mixed with any before-tax dollars. Can you confirm?
Thanks for your thoughts.
Harry Sit says
It doesn’t as long as you rollover money from the after-tax 401k directly into a Roth IRA. Don’t make an interim stop in a traditional IRA.
Dm221 says
After reading more about this it seems like a good idea since its available to me.
What is your take on the “step doctrine” though. Should we be leaving after-tax contributions for many months before rolling-over to roth IRA?
Also from what I understand this is prefered to an “in plan roth” conversion option from a tax standpoint which seems to always run into the pro-rata rule even if your plan accounts separately for all your piles of money. Do you agree?
Harry Sit says
You naturally contribute by payroll deduction over a span of time before you do the rollover maybe once a year. I agree it’s better than in-plan Roth rollover.
$iddhartha says
Regarding the step doctrine… I completely ignore it personally.
As far as leaving the money in the account for a few months before rolling over: this can actually be beneficial if your investments go down during the period before you roll over. Your losses over such a period would be averaged with the gains of the subsequent period thus lessening the taxes you would pay overall on a rollover. Again, waiting to roll over only makes sense if your current period investments you intend to roll over have gone down in value.
John Dsouza says
Thank you for the great article Harry. My company finally started offering the after tax 401(k) contributions mid-year but it does not let me set sub limits on what is in the pre-tax, employer match and the after tax contributions.
So in theory one could end up with less pre-tax and more after-tax within the 53K limit.
I assume to avoid losing on pre-tax, I should first fill this bucket and then the after-tax contribution. Challenge is that my company does a match of $6000 and it provides a true-up next year.
If the 6K match is provided next year, does it mean I can put more than 29K after tax in my 401k or is it counted against my 2016 limit?
How do I setup the various contributions so that I have $18K pre-tax, $6K match and then $29K after-tax?
Harry Sit says
The true-up match paid next year still counts toward this year’s limit. Most plans let you specify your contributions by percentages of pay: X% pre-tax, Y% after-tax. Just make the percentage for pre-tax high enough to clear $18k. It will stop automatically at $18k. Maybe the company is also smart enough to stop the after-tax automatically at $29k. In that case you just make the Y% high enough to clear $29k.
John Dsouza says
Thanks Harry. As per the Fidelity rep; my company plan does not automatically stop at $29K so I’ll have to figure the last contribution % accurately.
Also Fidelity allows either in-plan conversion or rollover of earnings to rollover IRA and rollover of pre-tax contributions to ROTH IRA with a $20 fee. The fee is charged even if it in-plan conversion so I assume it makes sense to roll it out of the account?
Is the idea to do more frequent rollovers to ensure that the earnings grow in ROTH instead of rollover IRA? I will need to balance the frequency benefits with fees.
Harry Sit says
Double-check with payroll. They control whether to stop your contributions. If they don’t stop it now, maybe you can suggest they consider doing so. Taking it out to a Roth IRA is better, for some minor reasons which may or may not apply to you. I won’t bother with more frequent rollovers than once a year, but yes, the motivation for doing it more often is to get the money sooner to Roth and accrue earnings there.
Corey says
I’ve contributed to the AT 401(k) my employer offers and they offer an in-service withdrawal option with no suspension. The amount available for rollover from the servicing website (Your Total Rewards from Aon) does not match the value of the shares purchased through my AT contributions.
I have called the plan provider to discuss this, and apparently they also allow (force) you to rollover before tax company matching contributions that are older than 24 months old (allegedly the 24 month rule applies to those who have been in the plan less than 5 years).
I said forced above because they will not let me split the rollover to be only my after tax contributions. In fact, I believe the BT company match must be rolled over first (e.g. 10k balance available for rollover with 3k BT match, if I withdraw 4k its 3k of BT match and 1k AT contribution).
Has anyone else encountered this? I imagine it’s pretty common with Mega Corp’s – the plan provider said any company match older than 24 months is available for rollover.
Harry Sit says
The IRS allows the match to be distributed in-service. Your plan can decide (1) whether to make it available; (2) whether to “force” it to be distributed before the after-tax contributions and earnings; and (3) whether to allow a split: pre-tax money to traditional IRA and after-tax money to Roth IRA. It sounds like your plan chose ‘yes’ for (1) and (2). Now ask about (3). Mention IRS Notice 2014-54.
raj says
Harry – I see you say ‘Plans that allow non-Roth after-tax contributions must go through a discrimination test’, is this also applicable for single member s-corp that setup a 401k plan with non-Roth after-tax contributions? If so, does the company HR is responsible to send the plan documents to IRS to see if they pass the discrimination test? Thanks in advance!!
Harry Sit says
It’s not needed for a one-person plan because there are no other employees to discriminate against.
raj says
Harry – Would you like to share the names of the companies offering non-roth after tax options on their 401k plans?
Harry Sit says
I don’t have a list. As I mentioned in the article, none of the companies I worked for offered this feature. However, according to readers who answered the poll (see link in the article), 60% of them have this option in their plan.
Gaujo says
Oh boy! I have been beating my head against the wall about how I am going to get all my Roth 401k contributions out, and totally ignored the after tax 401k I have access to! While I still can’t roll out the Roth 401k, this will allow me to still buff up my Roth IRA, with a 6 month contribution penalty. I need to confirm if that penalty is just to the after tax 401k though.
Thanks!
David says
I just checked my 401k plan information and realized I can contribute after-tax dollars to the IRS limit of $53k for all combined contributions. After-tax contributions can be withdrawn from the fund 24 months after contribution…so not immediately but not horrible.
I do not have a Roth IRA. I’ve been working abroad for many years and only recently moved back to the US. My wife’s and my joint income exceeds the IRS limit so I can’t directly make Roth IRA contributions.
Will I still be able to take advantage of this mega backdoor Roth conversion? Will I be able to roll these after-tax contributions into a newly established Roth IRA even if our income would not ordinarily qualify me to have a Roth IRA?
Harry Sit says
Yes. When you do the rollover, the earnings during those 24 months will come along. You pay tax on the earnings.
Charles says
Excellent content, Harry!
Your article indicates two tests. My mega corp starts to offer ‘after-tax 401k’ recently, so that passes the first test. As for the second ‘in-service distribution’, I did not see the term mentioned anywhere in the company-issued notice, but here might be the relevant parts in its FAQ:
Can after-tax contributions be withdrawn? Yes—amounts contributed on an after-tax basis can be withdrawn at any time, and for any reason.
Are amounts contributed on an after-tax basis convertible to Roth 401(k) monies? Yes—once after-tax contributions are deposited into your Plan account, they are eligible for conversion to Roth 401(k) monies within your Plan account at any time.
So can we have an attack plan like the following? As soon as the after-tax contribution is deposited, I can immediately ‘move’ it into my Roth 401K account; this way the earnings portion is not bothering since there is just not enough time for it to grow yet.
Harry Sit says
I edited the article with an option 2a and option 2b, together with a link at the end to the article comparing the two options. Either one works.
Jim says
Are there any adverse implications of doing this twice in a year, other than considering the step transaction doctrine?
Harry Sit says
From the article: “If you can only do it once a year, so be it. Do it once a year. If you are able to do it more frequently and you don’t mind doing it, do it more frequently.”
des999 says
do you ‘have’ to max out your pre-tax 18k first, before you can begin to contribute to the non-roth after tax?
Harry Sit says
You don’t ‘have’ to. Usually you are better off doing pre-tax first though.
John says
Harry, I have a different opinion and would say do the post tax before pre tax. If you switch to a different company (voluntarily or involuntarily) during the year; the probability that the new company has a pre tax option is much higher compared to post tax. Or am I missing something?
Harry Sit says
By ‘first’ I was referring to dollars, not time. When you have a limit of $53,000 minus the employer match, by doing pre-tax ‘first’ you will put in $18,000 as pre-tax and the rest as non-Roth after-tax, versus putting in 100% of your limit as non-Roth after-tax and zero pre-tax. As long as you still contribute $18,000 pre-tax, I have no problem with doing it in the second half of the year versus first half of the year. Keep in mind there is also the risk you may not find a new employer before the end of the year or the new employer doesn’t have a 401k or it has a waiting period preventing you from maxing out pre-tax for the year.
Onkar says
Hi Harry,
Reading this (especially the examples) — https://www.irs.gov/retirement-plans/rollovers-of-after-tax-contributions-in-retirement-plans — it seems like one cannot just rollover the non-Roth after-tax contributions and associated earnings; the whole account balance (pre + post tax contributions/amounts) needs to be taken into account.
Thank you.
Harry Sit says
You read it wrong. The associated earnings are the pre-tax amounts being addressed. It just said you must rollover the earnings. See the answer to the second question.
Onkar says
Thanks. I see what you say about the “Earnings associated with after-tax contributions are pretax amounts in your account.”, but the example (1st one) that talks about considering both pre-tax and after-tax amounts, threw me off.
But then I don’t understand what are after-tax amounts, and (if amounts means earnings from contributions) how can they (i.e. after-tax amounts) ever appear in a 401k account?
THank you.
Harry Sit says
When your plan allows non-Roth after-tax contributions, those contributions become the after-tax amounts. Read the first example as you contributed $20k as non-Roth after-tax many years ago and now it grew to $100k.
Onkar says
“Read the first example as you contributed $20k as non-Roth after-tax many years ago and now it grew to $100k.” — this clears it up for me. Thanks Harry.
tanvi says
So my husband is a physician makes 500k with his full time employement
he maxes out at 18k at his day job with no match
we additionally put 5500 in the backdoor entry roth (using the non deductible after tax contribution and then conversion to roth at Vanguard).
This year he will have 40k in self employed income.-
1) is solo 401k better or can we do SEP IRA 20% (pre tax) from the self employment income on top of the backdoor entry after tax roth 5500 that we have been doing for past 2 years.
2) Also considering to have mega roth at some point- is it too late for 2016? and if so would that affect the decision of solo 401k versus sep IRA…?
3) income may change mostly increase- if it does stop in the future- how would you handle 401k versus SEP IRA investments?
Harry Sit says
I replied to your other comments under the self-employed article. Solo 401k is better. It may not be too late if you do it quickly. When self-employment ends (not just pauses temporarily), he can terminate the plan and roll over the balance to an IRA just like employees do when they leave a job.
Johnson says
Guess I’m the lucky one, who has both 403b and 457.
My question is does the 53000 limit include all pretax or just 403b?
e.g. I’m maxing out 18k 403b and 18k 457.
How much can I do the mega backdoor?
53k – 18k(403b) = 35k
or
53k – 18k(403b) – 18k(457) = 17k
Harry Sit says
457 doesn’t count.
Jim says
Hi Harry – great info, thanks!
It appears (?) my 401(k) allows this without needing a back door . My 401(k)’s web site lets me split my paycheck contributions between the pre-tax and Roth portions of the plan. So I can (apparently) contribute up to $18K into the pre-tax portion, my employer matches up to $5K, and I can contribute up to an additional $30K into the Roth portion, to a combined max of $53K. Am I missing out on something by not doing the after-tax-contribution-rollover thing?
Harry Sit says
It doesn’t cut it with only pre-tax and Roth, which share the $18k limit. If you contribute $18k to the pre-tax portion, your limit for the Roth portion becomes zero. You need the non-Roth after-tax option to use the full $54k maximum in 2017.
Anonymous says
I need to clarify a few possible misconceptions about the “mega-backdoor Roth” after reading some of the earlier posts.
1. According to the IRS, you CANNOT just rollover ONLY the after-tax 401(k) contributions to a Roth IRA. You must rollover the entire after-tax account which consists of pre-tax earnings and after-tax contributions.
2. The pre-tax earnings can be rolled into a traditional or rollover ira and the after-tax 401(k) contributions can be rolled into a Roth IRA without paying any taxes. The pro-rata rules that used to apply before the IRS clarification in notice 2014-54 no longer applies to these types of distributions.
Some of the earlier posts seem to misinform people that you can just rollover the after-tax portion to a Roth IRA. The only way to accomplish this would be a in a 2 step process. First, you roll the entire after-tax account as described in the 2 steps above, but make sure that the pre-tax amounts go to a Rollover IRA, not a traditional IRA. Second, after the required time period, roll back the pre-tax amounts into the original 401(k). There are usually frequency limits on the number of rollovers allowed in a given year and it depends on your employer so if it’s every 3 months, then you would have to wait 3 months and then roll back the pre-tax amounts into your 401(k). I wouldn’t recommend this unless you have a large pre-tax balance and intend to do regular back-door Roth conversions.
Harry Sit says
Which earlier posts misinform? This is the first post in the series on this topic. The word “earnings” appear 11 times in this post, not counting comments. It’s super clear earnings must be rolled over at the same time.
Anonymous says
When I say “earlier posts”, I’m referring to posted comments, NOT your blog post, Mr. Harry Sit. I understand that this is your first blog post in the series on this topic. Your blog post is well written, but some of the early comments by other people were not as clear about earnings.
Anonymous says
You are correct Mr. Harry Sit. In many posts, you and other people clarify that pre-tax earnings must also be rolled over. I only read a few misleading posts that were unclear and came to the wrong conclusion. One section copied from Dec. 8th, 2014 from Paul is shown below:
“Now that the IRS has stated they are in agreement with cleanly moving only the after tax contributions to a Roth (IRS Notice 2014-54) I have moved up to a 50% contribution of my salary to my 401k.”
This is misleading because it is alluding to the idea that you can cleanly move ONLY the after tax contributions to a Roth which is NOT what IRS Notice 2014-54 says.
sachagravett says
Can I have a Solo 401k and a SEP-IRA? And a SIMPLE-IRA?
sachagravett says
Considering using a provider such as https://www.401kcheckbook.com/ to get Solo 401k guidance and docs. May engage in transactions that are alternative investments and need guidance regarding “prohibited transactions.” Any suggestions?
Harry Sit says
Don’t. Too easy to mess up. Keep your solo 401k clean. Use your other money that doesn’t have restrictions.
sachagravett says
Harry,
Thanks for the perspective.
It does seem that avoiding anything that “has the taint of self-dealing will keep things clean and prevent prohibited transactions, though.
sita says
Can we take home mortgage loan out of this if the plan allows it and what is the reporting does IRS expect from employer/trustee?
Harry Sit says
If you are talking about withdrawing the non-Roth after-tax contributions and the associated earnings to buy a home, the plan doesn’t limit what you do with it. It won’t be a loan. It would be an outright withdrawal. The earnings will be taxable and subject to the 10% penalty when you don’t roll it over. The plan will issue 1099-R to report the taxable portion and the non-taxable portion.
sita says
Harry – I was talking about the pre-tax money to to purchase home, what is the role of trustee/employer in this case to report to IRS about the money withdrawal from pre-tax account to purchase the home., I understand it’s our responsibility fix the terms (5/15/30 year) of loan and how much to pay back (Principle & Interest based on amortization calculator);
Does plan administrator report IRS about this withdrawal? what kind of record keeping generally to maintain??
Harry Sit says
What does it have to do with mega backdoor Roth then? It’s a regular 401k loan. A loan is not a withdrawal. No reporting to the IRS is required unless the borrower defaults on the loan.
LB says
Thanks for the informative article, but I think there is some clarity that is still needed from IRS
because over at another finance website, someone posted this link which says that you cannot just rollover the after tax amount from a 401K
https://www.irs.gov/retirement-plans/rollovers-of-after-tax-contributions-in-retirement-plans
Harry Sit says
See comments #48 and #64.
Curious says
I am no longer an employee of the large company i have a 401k program which contains a small portion that is after tax non Roth money which was my contribution. i do plan to rollover the pre tax amount which is a non issue to an already existing traditional roth ira i have with a financial institution , as well as the gains generated on the after tax non roth money ( which is pre tax). My question is since taxes were already paid on the after tax non roth money – would there be any penalties incurred if that after tax non roth money stays as cash since as i understand i was told that after tax non roth money needs to be cut in a check to me when i transfer my 401k from my previous employers custodial account
Jake says
What’s the right way to evaluate the benefit of the Mega Backdoor Roth? I realize there are lots of tax related variables involved, but how does one start? How much more would I have to make at company B with no Mega Backdoor Roth to match the benefit of having a Mega Backdoor Roth at company A?
Harry Sit says
I made this spreadsheet to calculate the advantage of doing a mega backdoor Roth versus just putting the money in a regular taxable account. Although it was made for self-employed, it works equally well for employees working at a company.
DJ says
Great discussion!
Making max. contributions to pre-tax 457(k) employer plan. Separately, making max. post-tax contributions to Fidelity Roth IRA. All good.
But, want to minimize tax liability from future 457(k) RMD’s. Doesn’t seem the ‘backdoor’ Roth conversion is a vehicle to achieve this end — sans hefty conversion tax liabilities — but I may have missed this in this (or other) threads?
Harry Sit says
A 457 plan has nothing to do with backdoor. If you’d like to minimize RMDs from a pre-tax account, there are only two ways: (a) Don’t let it grow as fast; (b) Take money out of it over a longer period of time before 70-1/2. Not letting it grow as fast is counter-productive. You’d rather make money and pay taxes than not making money in the first place. So if you think RMD is going to be a problem, take the money out sooner and convert it a Roth IRA over more years (governmental 457 plans only).
DJ says
Harry,
Thank you! That’s what I thought.
I agree it’ll be a “good problem” to potentially have excess assets in the 457 down the road, so definitely focused on maximizing contributions and investment returns everywhere I can.
Best,
DJ
Mark says
How should the after-tax 401k contributions split with earnings going into a traditional IRA and basis going into a Roth IRA be reported on Forms 5498? Should the basis amount rolled into a Roth IRA show up as both a rollover and a conversion (both box 2 and box 3)? Should the traditional IRA Form 5498 show the earnings as a rollover in box 2?
Harry Sit says
Sounds correct to me. Have you looked at 5498 instructions to the institutions?
Mark says
Where do i find “5498 instructions to the institutions”?
Harry Sit says
Together with 1099-R instructions to the institutions. https://www.irs.gov/pub/irs-pdf/i1099r.pdf
Harry Sit says
Instructions for Box 3 of 5498:
“Enter the amount converted from a traditional IRA, SEP IRA, or SIMPLE IRA to a Roth IRA during 2017. Do not include a rollover from one Roth IRA to another Roth IRA, or a qualified rollover contribution under section 408A(e) from an eligible retirement plan (other than an IRA) to a Roth IRA. These rollovers are reported in box 2.”
The money coming from a retirement plan into the Roth IRA falls under the “qualified rollover contribution …” part. It should only be in box 2.
Mark says
Thank you Harry. This is very helpful!
Mark says
You should consider making a post on how the Mega Backdoor Roth should be reported on a 1099-R, 5498 and 1040 forms. I’m sure i’m not the only one wondering if everything is being reported correctly and if i’m reporting it correctly. I wasn’t able to find any clear online resource that concisely described what this reporting should be.
In light of your response above, it looks like my IRA custodian messed up and incorrectly classified it as a conversion instead of a rollover.
Lee says
Hi Harry,
I noticed a few comments over last year about doing both the Mega Backdoor Roth and regular Backdoor Roth in the same year.
I’ve been contributing up to the federal maximum ($55000 = $18500 401K + Company Match + After-Tax Contribution) and rolling over the after-tax portion + earnings into my Roth IRA for the past four years. I’ve been curious about whether doing the additional $5500 non-deductible IRA contribution and subsequent rollover into my Roth IRA during the same year was allowed or not. I haven’t really found any definitive info on the subject other than a few comments here and there. Are there any caveats about doing both in the same year? Does timing matter (do the Mega first then the regular)? Has anyone written about the specifics of doing both during the same year?
Thanks for your feedback.
Harry Sit says
It’s allowed and the two are independent of each other. Just go directly from the plan to the Roth IRA, with earnings, no split, no interim stop at a traditional IRA. It appears you are doing that already. If there’s any possibility you will withdraw from the Roth IRA before 59-1/2, keep good records and documentation for the money going into and out of the Roth IRA: when, how, how much total, how much taxable. See Maintain A Roth IRA Contributions and Withdrawals Spreadsheet.
AW says
Harry,
Great post. One quick question (that you perhaps touched on in 20 and 51)
1.) Individual has $100,000 in a Traditional IRA (100% deductible)
2.) Individual has $300,000 in a Traditional 401(k)
3.) Individual makes a $25,000 after tax contribution to their 401(k)
4.) Individual performs an in-plan Roth conversion within the 401(k)
I want to confirm that the pro-rata rules do not apply to the after-tax dollars in the 401(k) being “converted”, and specifically, if there is any IRS documentation supporting this. (In case rules may be different if we’re talking about separation of service or rolling assets out of the 401(k) with an in-service distribution vs. in-plan conversions.)
Thanks so much for all your help on the topic!
Harry Sit says
The IRS page on In-Plan Roth Rollover:
https://www.irs.gov/retirement-plans/designated-roth-accounts-in-plan-rollovers-to-designated-roth-accounts
“The amount includible in gross income for the year of the rollover is:
* the amount rolled over, less
* any basis in the amount transferred.”
No requirement to aggregate with traditional IRA there.
Dan says
Harry,
I’ve been utilizing the mega backdoor ROTH strategy for the last three years maxing out my 401(k) to the annual maximum contribution limits with no issues until 2018. Just recently I was contacted by my HR Department stating that I over contributed for the most recent plan fiscal year (July 1, 2017 – June 30, 2018). The HR Department explained that my pre-tax & post tax contributions during the fiscal year were added to the 2018 employer match for the fiscal year (which was made in August 2018; outside the fiscal year) were in excess of the $55,000 plan contribution limit by approximately $500. I have always manually managed my pre-tax & post-tax contributions with the employer match on an annual basis to ensure that I don’t overcontribute beyond the maximum contribution limits but was caught off guard that I would need to manage the plan’s fiscal year in addition to the calendar year. Was also surprised to hear that the employer match made in August 2018 counted towards the recent fiscal year that ended June 1, 2017. I’m assuming the plan will refund the $500 overcontribution from my 2018 after-tax contributions and I will only be responsible for any gains. Luckily, I don’t rollover the previous fiscal years after-tax contributions to my ROTH IRA until I’m certain that the plan past all the NDTs (non-discriminatory tests). Once I receive the refund, I believe that I will be OK to rollover the balance of the 2017/2018 After-Tax Contributions.
Thanks,
Dan says
Correction:
Was also surprised to hear that the employer match made in August 2018 counted towards the recent fiscal year that ended June 1, 2018.
Harry Sit says
That’s correct. An employer can choose to contribute the match or profit sharing several months after the plan year ends and still have it count as the contribution for the previous plan year.
Kai says
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).
Harry Sit says
It’s different and separate from regular IRA contributions and conversions.
Jessica says
Hi Harry,
Thanks for this helpful article. My employer allows the non-Roth after-tax contributions through Fidelity, and they can be distributed while I am still working there (“in-service distribution”). Someone at work recently mentioned hesitating to enroll in this plan because of the fear or possibility that the government may in the future decide to tax the earnings of the converted contributions, thus taxing on both contributions and earnings. Is this highly unlikely and so should be of no concern at all? Wanted to hear thoughts. Thanks!
Harry Sit says
If you don’t do this, the contributions and earnings are taxed anyway. How can it be worse?
T says
Thanks for this great resource. My employer offers a defined benefit plan (to which they contribute with some mandatory employee contributions from us), 403(b), 457, and an after-tax 401(a) defined contribution plan (DCP). I’m 53. I have been at the same employer for over 15 years and have not contributed to the 403(b) previously. I have some confusion about how much I can contribute to each of the optional employee-contribution plans. What I’ve come up with so far is $19,000 + $6,000 age > 50 catch-up provision + $3,000 special provision catch-up for the 403(b) and $19,000 + $6,000 for the 457 (the 457 has a catch-up provision of its own, but more for when one is close to retirement, so I’m ignoring it). The after-tax DCP contribution limit for 2019 is $56,000. The employer, fund manager (Fidelity), and my CPA all seem to agree that I could contribute a theoretical upper maximum of $28,000 (403(b)) + $25,000 (457) + $56,000 (after-tax DCP) for a total of $109,000 (they say the after-tax DCP is treated as a separate account, esp. given that the funds being placed there are after-tax). Whether we could actually do that type of amount is unclear, but before we explore that, I wanted to make sure this upper contribution limit is correct? If it makes a difference, from examining my monthly pay statements, it seems the employer is taking out around $12,000 a year in mandatory pre-tax contributions to the defined benefit plan.
I’m also interested in the megabackdoor Roth strategy, which I’ve heard other employees here are using. If the $56,000 annual limit for the after-tax portion is in fact allowable even if the 403(b) and 457 have been maxed out, how much of that could be rolled over into a Roth IRA and would you recommend doing that on a frequent basis (i.e.., as soon as possible after the after-tax monies arrive into the after-tax account) or waiting until Oct. 31st of the following year? I don’t have any regular IRAs if that matters. Thanks again for this great blog and for tackling this topic. This is the first place I’ve seen it discussed in such depth and clarity.
MT says
So about the priority… do I have to max out $19K first, then I’ll be eligible to contribute after-tax non-Roth?
Harry Sit says
In some employer plans, you can make both types of contributions at the same time. Some employer plans make the non-Roth after-tax contributions a spillover — contributions become non-Roth after-tax only after you max out the regular contributions ($19k in 2019).
Dan says
I work for a major aerospace corporation that allows both after tax contributions and in service withdrawals and I’ve been contributing the annual plan limit and doing the mega back door roth for several years. It’s a nice perk that allows one to grow their Roth IRA balance much more quickly than with the backdoor approach.
Thank you for pointing out that it’s wise to wait until October 31st to withdraw the after tax money to avoid the possible problem of failing anti discrimination testing. What would happen if this happened and the employer failed the testing and one had already withdrawn the after tax funds and rolled them over to a Roth IRA at a brokerage? Could these multiple transactions all be unwound?
$iddhartha says
I’m contemplating some high level jujitsu Harry. Ideally, our family would do both backdoor Roth and megabackdoor, but we would be stretching financially to do so… three kids. 🤣
Anyway, I was contemplating forgoing the backdoor Roth and merely doing megabackdoor instead. Hear me out. This would allow me to rollover some before tax 401k funds to a traditional Vanguard IRA (for more flexibility with investment choices) and not have to worry about the regular backdoor rollover complications with such before tax funds (my current traditional IRA balance is zero because I’ve continually done backdoor Roth for a decade). i.e. It’s more complicated to do backdoor Roth when you have funds in a traditional IRA.
Instead, I would do megabackdoor after-tax 401k straight to Vanguard Roth IRA. Is there a flaw in this plan? It seems like a good option to me.
Harry Sit says
If you don’t have enough money to do both, doing only the mega backdoor Roth is fine. If you have investments outside the 401k and IRAs, you can liquidate some of those to supplement your cash flow. I addressed it in Mega Backdoor Roth Without a Big Paycheck. It applies to regular backdoor Roth as well.
Jess says
Hi Harry,
After contributing the maximum allowed for 401k and IRA, which plan is better to put extra savings into: Mega Backdoor Roth IRA (with Fidelity in-plan conversion) or the ESPP plan (10% discount without lookback option)? Was thinking of putting as much as possible into Mega Backdoor Roth IRA, since the money will continue to grow tax-free over the years; whereas if I opt for ESPP and sell asap quarterly, it would yield ~10% profit but the money would no longer grow in a tax-sheltered investment vehicle. What are your thoughts? Would be glad to hear. Thanks.
Harry Sit says
ESPP, because you only need money for one round of ESPP. After you sell the shares from the first round, the cash can be used to supplement the reduced paychecks for the subsequent rounds. You will only delay or reduce mega backdoor Roth for a few months. After that you will be doing both.
Jess says
Thanks, Harry – appreciate your replying. I realized I can do both and use the money from the sold shares into the Mega Backdoor Roth. I guess I was asking since I’m living off savings while on reduced paycheck (putting paycheck money as much as possible into Mega Backdoor Roth), so the money from the sold ESPP shares is sitting in savings account.
Harry Sit says
Suppose your employer’s plan allows additional $20k/year for backdoor Roth and you need another $5k for a round of ESPP every six months. If you can spare $25k/year from your paychecks obviously you will do both. But what if you don’t? Suppose you can only save another $15k/year. If you use the $15k/year for mega backdoor Roth, you will never have money for ESPP. If you do $10k/year for mega backdoor Roth and $5k for ESPP, after you sell the ESPP shares from the first round you can raise the contribution for mega backdoor Roth back to $15k/year. Now you will have $15k/year for backdoor Roth and $5k for ESPP continuously. All you need is one-time $5k to get ESPP started. Yes it will sit outside a Roth account, but it’s only $5k, and it earns a good return over and over.
$iddhartha says
In continuation, I think the question I was getting at is this: can you do a mega backdoor Roth if you have pre-existing money in a traditional IRA? i.e. The mega backdoor method bypasses your traditional before-tax IRAs therefore avoiding taxes on those funds.
In contrast, regular backdoor Roth is not ideal for people with pre-existing amounts in a traditional before-tax IRA because the IRS would require you to convert some of those funds.
As I understand it, the answer is yes, and would mean that the mega backdoor Roth has the additional advantage of letting individuals leave their existing traditional before-tax IRA balances in place.
Harry Sit says
Yes, when you send the money directly to a Roth IRA or do the in-plan Roth rollover. Just don’t make an interim stop in a Traditional IRA.
Caleb says
Hi Harry,
A follow up to this part of the post: “You can get fancy and have the earnings go to a traditional IRA or even maneuver to roll the earnings back into the plan.”
I am hoping to move my earnings back into my BT 401k plan with my employer. As they don’t allow me to move the earnings-on-after-tax contributions directly to the BT 401k account, but would allow it via depositing those earnings in a tIRA, and subsequently rolled into the BT 401k, should I be concerned with the step transaction doctrine? Curious if you or others have done this and the approach you took.
Thanks!
AnonymousMoe says
Hi
I have struggled to figure if I am capable of doing a mega back door Roth IRA . Lets say I have a W2 job where I put in my personal 401k contribution of $19,500 and my job matches the profit sharing at $36,500. I also have 1099 income, of which is $100,000. If my 20% profit sharing contribution is $15,000 (pre-tax) after business deduction. Would I be eligible to put in an after tax Roth 401k contribution? If so, how do I calculate that amount?
Harry Sit says
See the paragraph under the Self-Employed heading and the link to the follow-up post.
Hao says
Hi Harry,
Thank you for the helpful article. Would you please tell what I could do with Roth in-plan conversions at Fidelity.
Background info:
Retirement contributions: $19,5oo to Roth 401k; $15,885 to non-Roth after-tax contribution; employer’s matching of $21,615 to traditional 401k –> Totalling $57K. The non-Roth after-tax contributions are automatically converted to “ROTH IN-PLAN CONVERSION” after each pay.
All the above plans and Roth IRA are at Fidelity.
Question:
1. Can I roll over my Roth in-plan conversions to my Roth IRA at Fidelity? during employment? after employment?
2. Can I roll over my Roth in-plan conversions to my Roth 401k?
3. Can I leave my Roth in-plan conversions as it is forever?
4. Will RMDs start for Roth in-plan conversions at age 72?
Thank you for your time.
Harry Sit says
1. The IRS allows during employment. The plan may or may not allow. You can certainly roll it over after employment.
2. For practical purpose, it’s already in your Roth 401k. It’s labeled differently only for tracking. For example, the plan may allow this part to be rolled over to a Roth IRA during employment but it doesn’t allow it for regular Roth 401k.
3. Yes, you can leave it as-is forever.
4. RMD is required at 72, but you can roll it over to a Roth IRA, just like regular Roth 401k.
Hao says
Thank you so much Harry. You are SOOOOO knowledgeable and helpful.
Joe says
Hi Harry,
I am under 59 1/2. I have a decent chunk of traditional 401-k funds (pre-tax) and plan to make an after-tax contribution this year for the first time.
My question is, if I leave my employer after I make the after-tax contribution and prior to converting it to Roth 401-k:
(1) For the traditional 401-k account, can I leave it as-is in the former employer 401-k plan or roll it over into an new employer 401-k plan?
(2) For the after-tax account, after leaving the employer, can I independently roll-over the after-tax account (after-tax contributions plus any earnings associated with such after-tax contributions) into my Roth IRA account that I have been using to do my backdoor Roth IRA without it impacting my traditional 401-k funds?
(I’m trying to ask a question about rollovers and the IRS 2014-54 notice as it pertains to my after-tax 401-k account.)
Thank you !
Harry Sit says
(1) The pre-tax account can be left in the former employer’s plan. A new employer’s plan usually accepts rollovers from another plan.
(2) After separate from service, some plans allow partial rollovers, and some plans treat it like all-or-nothing — leave everything in the plan or rollover everything out of the plan. You have to ask your plan administrator.
Patrick Aw-Young says
Hi Harry,
When you said “457b doesn’t count” in response to 67. Johnson’s example, then what is included in the $58,000 contribution limit for 2021? I was under the impression that all sources of Defined Contribution Plan are included in this contribution limit. Thanks for the clarification.
Harry Sit says
A 457 plan isn’t a Defined Contribution plan. It’s a deferred compensation plan.
https://www.irs.gov/retirement-plans/irc-457b-deferred-compensation-plans
That’s why it doesn’t count. 401(k) and 401(a) plans count toward the employer’s limit. 403(b), solo 401(k), and SEP count toward the self-employed’s limit.
John McDonnell says
Great stuff here. Question, My company plan is managed by Vanguard and seems to make Mega Backdoor easy. I can contribute After Tax dollars and have it rollover automatically to Roth with every paycheck. So easy. I am considering doing this first as opposed to a regular Backdoor Roth. In my case the Backdoor seems more complicated. I have to go through the steps of “hiding” my wife’s IRA and a fairly large Rollover IRA from a previous employer’s 401k. Then setting up Traditional IRAs and managing the contributions to those and the conversions to Roth. I already max out Traditional 401k and Catchup, so can’t afford that much more but with kids out of college looking to add another approx. $10,000. Am I missing something, with the Mega Backdoor being so easy in my situation, I think I should just do that first. Before the Backdoor. Maybe the only downside is access to the money from my company plan. Still need to research that part of it.
Ravin says
Hi Harry,
I didn’t find any reference to SECURE ACT 2.0 signed into law on Dec 29th, 2022 by the President. So posting it here… Pls let me know if there is another topic I should post it to.
As far as I can tell based on SECURE ACT 2.0 signed by the President on Dec 29th, 2022, it seems we can continue to do backdoor Roth and mega backdoor Roth funding if we don’t qualify for direct Roth contribution in 2023 per new income limits. The Secure Act goes until fiscal year end 9/30/23.
1. Should we go ahead and fund Roth IRA for 2023 thru backdoor and mega backdoor now in Jan ’23?
2. What are the chances they will revert after Oct 1, 2023 for 2023 contributions and conversions for the year 2023?
Thanks
Ravin
Harry Sit says
SECURE Act 2.0 doesn’t affect backdoor Roth or mega backdoor Roth in any way. It doesn’t end on 9/30/2023 either. A new law can always be enacted at any time. You deal with it if and when that happens.
Patrick Aw-Young says
Hi Harry,
Where should I put my non-Roth aftertax contribution before I take the balance out and roll it over to a Roth IRA? I usually do my rollover once a month. We’ve had a volatile stock market last year (with 10 months being down and only two months being up) and you’ve mentioned in your article that there’s no need to put our contribution in a money market fund.
Thanks,
Patrick
Harry Sit says
I just invest it as I normally would. Trying to prevent the value from going down only in that one month doesn’t help because it will still go up or down afterward.