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I read recently there may be an option to use something called a back door roth IRA conversion. For anyone who is capped out of ROTH, the article basically implied one could make non-deductible tIRA contributions, and then roll it over to ROTH without incurring the tax hit. But there were some complications involving pro-rata, which the story did not get sufficiently into.

We have a majority of our savings in t-IRA already, and look forward to converting to ROTH as best as possible once my earned income drops to lower tax brackets. But in the meantime if there is a way to move some more money to ROTH I would like to know how.
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But there were some complications involving pro-rata, which the story did not get sufficiently into.

Well, the pro-rata rule requires that you pay taxes on any conversions from a Traditional IRA to a Roth IRA based on the percent of pre-tax out of the total account value. So if you have a $93k balance as of 1/1/21, all pre-tax, and add a non-deductible contribution next week of $7k, you would have a total account balance of $100k with a $7k basis (after tax amount). Then you do a conversion of, say $10k, sometime during 2020 - you will have to pay taxes on $9300, and $700 of the conversion will be non-taxable. You will have a remaining basis in your Traditional IRA of $6300 That basis will be kept track of using IRS Form 8606 so that any future withdrawals or rollovers will account for the basis and won't tax that part of the withdrawal/rollover.

Please note - trying to keep a separate IRA account that only has non-deductible (after-tax) contributions, and just converting that account will not work. The IRS requires that you consider ALL Traditional IRA accounts in your name when calculating the pro-rata taxes. As an FYI, "IRA" stands for Individual Retirement Arrangement, not Individual Retirement Account, so it covers all of T-IRA accounts in your name.

We have a majority of our savings in t-IRA already, and look forward to converting to ROTH as best as possible once my earned income drops to lower tax brackets. But in the meantime if there is a way to move some more money to ROTH I would like to know how.

Well, here's a use for a 401(k). If your 401(k) (or other qualified employer plan) accepts rollovers from IRAs (most do, although they legally can't accept rollovers of after-tax basis), you can roll all of your pre-tax T-IRA money to that plan, so that you have no pre-tax money in a T-IRA in your name - only after-tax basis. Then you make your non-deductible contribution and convert the entire account balance to your Roth IRA. You will owe taxes on any earnings or gains over and above your basis.

Another method for getting more money into Roth accounts is if your employer plan allows you to make after-tax contributions to the plan, has a Roth option, and allows you to do in-plan conversions, you can make after-tax contributions to your employer's plan, and then convert the money to the Roth account. In 2021, you can make total contributions (including your salary deferral of $19,500, any employer match and your after tax contributions) of up to $58,000 For those 50 and older, catch-up contributions of an additional $6,500 can be made on top of that.

AJ
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Hi AJ,

A few years ago I learned about the backdoor After-Tax 401k -> Roth IRA approach you described. I wish I learned about it years ago.

Fortunately I am in a position to max out my 401k + catch-up contributions AND make some additional 401k after-tax contributions. Then at the end of the year I roll over my 401k after-tax contributions into the Roth-IRA.

So now in addition to my t-IRA (an prior employer 401k rollover) and my current 401K with company match, I now have a smaller but growing Roth-IRA.

I don’t know how I missed it before, but certainly wish I had started doing this backdoor Roth approach 15 years ago. Anyone with a 401k should investigate this possibility - can you afford to make the after-tax contributions (after maxing out the pre-tax), will your plan allow it, and dows it make sense for you to start a Roth-IRA. Not all 401k plans have this option, but many do.

Jeff
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I don’t know how I missed it before, but certainly wish I had started doing this backdoor Roth approach 15 years ago. Anyone with a 401k should investigate this possibility - can you afford to make the after-tax contributions (after maxing out the pre-tax), will your plan allow it, and dows it make sense for you to start a Roth-IRA. Not all 401k plans have this option, but many do.

Well, the IRS didn't actually give guidance allowing conversions of after tax employer plan contributions into Roth accounts until 2014 https://www.irs.gov/pub/irs-drop/n-14-54.pdf so if you've been doing this for 5 or 6 years, you actually got in pretty early.

AJ
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Thanks AJ,
now I don't feel like I missed out on much ;)
This is my 3rd year.

Trying to be Foolish,

Jeff
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I'm just catching up with this thread...

Assume you are currently maxing out your 401k, then investing additional money into a taxable account (Vanguard in my case).

Assume also that your employer offers a Roth option in the 401k (mine does). Assume also that your employer allows you to roll after-tax contributions to your 401k into a Roth IRA (I'm not sure yet about my employer here).

It sounds like what is being suggested is that, instead of putting that extra after-tax money into a taxable brokerage account, you can put it into your 401k and later (when, the following year at tax time?) roll it into a Roth IRA without paying any *additional* tax up front? And of course you'll pay 0 tax later (5+ years/after age 59.5) when withdrawing from the Roth, versus capital gains taxes (and dividends) in the taxable account.

Is this true? If so, is it a loophole for high earners to get into Roths? Maybe it is meant to reward people for maxing out their deductible 401k contributions?

I've read about Roth conversions many times before, here and elsewhere, but I always figured I would do them when I retire and my income drops significantly to bring me to a low tax bracket. This feels like a loophole.

Thanks for any clarifications.

-progmtl.
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It sounds like what is being suggested is that, instead of putting that extra after-tax money into a taxable brokerage account, you can put it into your 401k and later (when, the following year at tax time?) roll it into a Roth IRA without paying any *additional* tax up front?

Well, it doesn't have to be a Roth IRA. If your plan allows, you can move it into the Roth subaccount in your 401(k). And actually, you can move the money from the 401(k) to the Roth account the next day, or possibly even the same day, if your plan allows it. (Some plans allow you to set up automatic conversions from after-tax contributions into a Roth 401(k) account.) If you wait to roll the contribution until later, you will have to pay taxes on any gains that are moved into the Roth account, so you will have to pay *additional* taxes up front. To avoid those up front taxes, you could roll the gains into a Traditional account, instead of a Roth account. Then you would just pay the taxes later, instead of up front.

And of course you'll pay 0 tax later (5+ years/after age 59.5) when withdrawing from the Roth, versus capital gains taxes (and dividends) in the taxable account.

There are potentially multiple 5 year rules involved here, because you are converting from a 401(k):
- If the conversion stays in the 401(k), your Roth account in your 401(k) must have been established for at least 5 years, in addition to you being 59 1/2 (ore meet another exception) for the distribution to be qualified.
- If the conversions have been moved to a Roth IRA, then the Roth IRA must have been established for at least 5 years, in addition to you being 59 1/2 (or meet another exception) for the distribution to be qualified.
- If you do not meet the rules for qualified distributions, each conversion must be at least 5 years old in order for the distribution to be tax and penalty free.
- If you convert within the 401(k) and later move the conversion(s) to a Roth IRA, the age of each conversion follows the conversion into the IRA.

Is this true? If so, is it a loophole for high earners to get into Roths?

Yes, it's called a 'Mega Back Door Roth'. But your employer plan has to allow after-tax contributions to be able to take advantage of this. Many plans do not offer after-tax contributions.

Maybe it is meant to reward people for maxing out their deductible 401k contributions?

I don't think so. It was more of a loophole in the way the law allowing designated Roth accounts was written. Originally, it wasn't sanctioned by the IRS, but eventually they did issue a revenue ruling (IRS Notice 2014-54) that allowed the splitting of after-tax and pre-tax, which facilitated the Mega back door process.

This feels like a loophole.

It is, for those whose plans allow it.

AJ
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I think I should be moving some of my 401(k) funds to one of my Roth accounts. (I have two such accounts, both established many years ago; plus, I'm over 59.5) But what are the mechanics of doing this? Do I contact the brokerage and have them make the starting move? Do I designate a dollar amount that should be converted -- or can I designate some specific investments that are to be converted?

culcha
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I think I should be moving some of my 401(k) funds to one of my Roth accounts. (I have two such accounts, both established many years ago; plus, I'm over 59.5)

But what are the mechanics of doing this?
Do I contact the brokerage and have them make the starting move?
Do I designate a dollar amount that should be converted -- or can I designate some specific investments that are to be converted?

------------------------------------
You indicate that you are over 59.5; but are you retired, or still working?
You can do any of those things, from a tax law viewpoint. But your 401(k) plan has to permit in-service distributions, if you're still working. And if you're still working, you probably have to contact your plan administrator, as well as the brokerage, because the administrator has to initiate the transaction for a distribution from the plan.
And, if your retirement is imminent, will you be better off waiting until you retire? Will you be in a lower bracket at that point? If so, waiting could make sense.
And when you retire, you may well prefer to roll over the entire balance to a traditional IRA tax free, and from there do Roth conversions as circumstances indicate. You might have lower annual expenses, and it's just easier to do conversions from a traditional IRA to a Roth IRA with the same custodian.

Bill
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But what are the mechanics of doing this? Do I contact the brokerage and have them make the starting move?

Are your Traditional accounts IRAs? And are your Roth accounts IRAs? As Wradical indicated, moving your money into IRAs from employer plans will probably make conversions a little easier.

And then answer to the mechanics is - it depends on your administrator/custodian. Many of them make it pretty easy to do on their website, especially if you are converting between accounts at the same brokerage, without having to contact the brokerage at all. If you want to do a conversion between brokerages, you may have better luck starting with the brokerage that has the Roth, and asking them to pull from the brokerage that has the Traditional.

Do I designate a dollar amount that should be converted -- or can I designate some specific investments that are to be converted?

You can do either. The mechanics of doing each depend on your administrator/custodian, but it is possible to convert either a dollar amount or a specific investment.
AJ
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Thanks AJ, this is super helpful!!

One more clarification.. In order to use the mega backdoor Roth "loophole", my employer's 401k plan must:
1. Allow after tax contributions to the 401k plan
2. Support a Roth 401k option in the plan
3. Allow in-plan conversions to Roth

Are all 3 above required?

-progmtl.
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1. Allow after tax contributions to the 401k plan

This is the minimum requirement.

2. Support a Roth 401k option in the plan
3. Allow in-plan conversions to Roth


Neither is truly necessary, but implementing the 'Mega Backdoor Roth' is more effective if these are available. Assuming your plan allows number 1, you can just make after-tax contributions and let them stay in the after-tax account in your 401(k). Earnings will be considered pre-tax, so it's not truly getting your money into a Roth account, as you would have to pay taxes to convert the earnings. But if you're planning on your time in that 401(k) to be short, it still might be okay. Or if your plan allows in-service withdrawals of the after-tax account, then you can roll the after-tax portion to an IRA on a monthly, quarterly or annual basis, depending on your plan's rules.

AJ
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