Roth Contribution on top of Roth 401k and Conversion

Submitted by Greg Schmit on Fri, 2014-08-29 17:23

My employer provides a 401k that allows me to contribute a combination of pre-tax, after-tax, and Roth dollar. The maximum annual contribution limit to the plan is $51,000 which must include no more than $17,500 pre-tax and/or Roth dollar. I would like to know, if I contributed fully to this amount ($51000 with 17500 as Roth dollar), can I still contribute to a separate personal Roth IRA?

If my retirement saving has the balances below:

Traditional IRA with 80K balance of which 15K is base (this is where I rolled all my old 401k balances).
In my company 401k, I have:
20K in Pre-Tax Dollar
70K in After-Tax Dollar
50K in Roth Dollar
30K in Employer Match Dollar (this comprise of both Roth and Pre-Tax Dollar)

I am one of those who suffered a pretty significant drop during the most recent recession so the balances represented above are what I contributed (i.e. no gains). My current salary places me in the 28% FIT bracket and I reside in California, so there is a 10% SIT. I have a couple of questions:

If I am to leave my company and roll the 401k balance out, I will obviously need to setup a Roth IRA for the Roth Dollar. Would you recommend that I set up a contributory IRA for the After-Tax Dollar so that the Pre-Tax and After-Tax Dollar are kept separate (i.e. a Contributory IRA)?

I understand Roth IRA is ideally where I should keep the majority part of my retirement balance since it does not have RMD and both base and earning are tax free during withdrawal. I would like to structure a plan to convert my entire balance over to Roth over time. Is it true that when conversion is done, we cannot convert a specific dollar category to Roth? Every dollar we convert contains portions of all categories. Hence, based on the retirement saving dollar balance illustrated above, total Pre-Tax dollar comes out to 94K (20K from the Pre-Tax Dollar in my 401k + 65K from my traditional IRA + 9K from my employee match (i.e. 30*(20/(20+50)) ) and total After-Tax Dollar comes out to 85K (70K from the After-Tax Dollar in my 401k + 15K from my traditional IRA). So every dollar converted will be 53% Pre-Tax (94/(94+85)) and 47% After-Tax, correct?



Submitted by Alan - IRA critic on Fri, 2014-08-29 18:21

  1. You can still contribute to a Roth IRA if your modified AGI is not too high to allow direct Roth IRA contributions.
  2. If you roll the 401k into a traditional IRA and then do conversions from the TIRA, pro rating will be calculated on Form 8606 to determing the taxable portion of the conversion. Since all your TIRA accounts are included in this calculation, there is no benefit in opening additional TIRA accounts in order to separate the after tax basis from the pre tax.
  3. Your math is a little off. The company match all goes to the pre tax account in the 401k even if all your contributions for that year were Roth. Therefore, the 30k is entirely pre tax. If you did a rollover of the non Roth portion to an IRA, it appears that you would have a total IRA of 200k, of which 85k will be IRA basis. A conversion would be 57.5% taxable. Your IRA basis of 15k should have been documented by Form 8606 reporting each non deductible contribution. Note that in your 401k plan, all earnings other than on your Roth contributions are pre tax.
  4. There may be a more efficient way to get your after tax 401k basis into your Roth IRA. Your plan evidently has an after tax sub account in the pre tax (non Roth) portion of the account. You may be able to separately distribute only the after tax amount and the earnings generated on the after tax amount and do a direct rollover of the entire after tax sub account to your Roth IRA. Keeping these funds OUT of your TIRA will eliminate the less favorable pro rate calculation stated above. You may have very little earnings on your after tax contributions. But I am not clear whether your breakdown is correct. For example, if you contributed 70k to the after tax sub account, where are the earnings on the 70k. Are they part of the 70k or in another category?
  5. Converting to a Roth IRA may not benefit you if you have to pay taxes on the bulk of the dollars converted. On the other hand, converting when the Roth rollover is mostly tax free becomes a no brainer. So the first thing I would check into is the possibility of doing a direct rollover of ONLY the after tax sub account. Then do the rollover of the rest of the balance at a later date, preferably in the next calendar year. What I am proposing here is to use an “isolation of basis” strategy and this subject is complex because there are various ways to do this. The IRS rules are not clear, but taxpayers have been successfully isolating their basis in recent years without any IRS issues. You might do a search on isolation of basis to read up more about it.
  6. Your Roth 401k balance would be directly rolled into your Roth also. While this is a tax free transfer, you need to keep track of your Roth IRA structure so you know how the portions of the rollover are treated once in the Roth. Your contributions are treated as regular Roth IRA contributions EVEN if you had losses in the Roth 401k. If you had gains, the gain is treated as Roth IRA earnings. These totals would then be combined with the totals of the after tax sub account rollovers to your Roth. This can all be confusing, so you probably have more questions.

Submitted by Greg Schmit on Wed, 2014-09-03 17:26

Thank you for your detailed response. I do have one follow-up question.  I checked my prior year MAGI and it disqualifies me from Roth contribution.  May I contribute the amount to a non-deductable IRA instead (i.e. $5000 on top of the $51000 401k maximum annual contribution limit)?  I can alway convert it to Roth later.

Submitted by Alan - IRA critic on Wed, 2014-09-03 19:07

Yes, if you have either filed your 2013 return on time or filed an extension, you can recharacterize your Roth contribution as a TIRA contribution and file Form 8606 documenting that contribution. The amount you contributed to your 401k does not affect this. Any earnings on your Roth contribution will also be transferred to the TIRA. When you convert, the taxable portion is calculated using the balance of all your owned non Roth IRA accounts. If this is your only TIRA balance, when you convert the earnings on that contribution will be taxable.

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