After Tax 401k/403b Back door Roth Conversion
I understand that a nondeductible IRA back door roth conversion works well unless there are traditional IRA balances that create an aggregation issue.
However, if a client has after tax contributions to their employer retirement plan-401k/403b -can they convert that over to an employer Roth 401k without exposing themselves to the aggregation rules if they also have funds in a traditional IRA? And then roll those funds over to a Roth IRA?
I have a 67 year old client in that situation that has separated service and has after tax contributions, Roth 403b and pretax 403b all in the same employer plan. They contributed to their Roth 403b directly, got matched with pretax and then contributed additional to the after tax account. They also have substantial traditional IRA funds.
Thank you,
Scott Foster
Permalink Submitted by Alan - IRA critic on Fri, 2021-11-05 03:00
If the 403b has an after tax non Roth balance, the client could request a split direct rollover of the plan in which the Roth 403b and the after tax contribution amounts are rolled to client’s Roth IRA and the remaining pre tax balance is rolled to a TIRA. No taxes would be due, and there would be no pro rating. The current TIRA balance is not a factor here. There is no need to do an in plan Roth rollover and since such a rollover would have to include any earnings in the after tax account which would be taxed, that would not be beneficial.
The split rollovers to an IRA must be requested at the same time per Notice 2014-54. Client’s Roth IRA would be fully qualified and tax free due to being over 59.5, but would also have to be held 5 years from the year of the first Roth IRA contribution.
Permalink Submitted by Mark Dudycha on Fri, 2021-11-05 19:57
I assume that this same strategy would work in a 401k as well, yes? Also, is this going away if the Bill prohibiting mega’s is passed as is?
Permalink Submitted by John Foster on Sat, 2021-11-06 00:58
Confirming-are you saying in essence that the rolling over the after tax non roth contributions in the plan avoids the tax on the earnings that would otherwise happen if they did an inplan Roth rollover? Looks like a advantageous loophole?
Permalink Submitted by Alan - IRA critic on Sat, 2021-11-06 02:33
Yes, because the earnings on the AT contributions can be rolled to a TIRA tax free. Conversely, within a 401k or 403b the earnings can only go to the designated Roth and would be taxed. Those earnings cannot be rolled into the pre tax portion of the plan. This is true for both in service distributions (when allowed), and after separation.
Permalink Submitted by William Tuttle on Sat, 2021-11-06 03:46
A split rollover interferes with a Backdoor Roth unless you can roll the pre-tax IRA rollover back into the plan.
Otherwise, it will be subject to prorata taxation if doing a Roth conversion of just the non-deductible contribution amount or the same tax liability as an IRR if doing a Roth conversion of the entire balance.
If your plan will not accept an IRA rollover, you are better off doing an IRR if available or a single direct rollover to a Roth IRA. In both cases the earnings will be taxable.
Permalink Submitted by John Foster on Tue, 2021-12-14 20:14
I’m confused with spiritrider’s comment. It seems at odds with-Alan-iracritic. Also I don’t know the IRR acroynmAre both in agreement though that the client could do an in retirement plan conversion to a Roth 403b or Roth 401k with the only issue a tax on the earnings? Then roll it out to a Roth IRA if desired?ThanksScott
Permalink Submitted by Alan - IRA critic on Tue, 2021-12-14 23:12
IRR = in plan Roth rollover. Yes, an IRR of after tax contributions and their earnings will result in tax on the gains in the after tax sub account just like a Roth IRA conversion will result in taxes on the pre tax portion as calculated on Form 8606. If the pre tax amount is small enough it is simpler and less error prone to move the entire balance to the Roth and pay taxes on the small pre tax balance.
But if the taxpayer wants to avoid all current taxes, a split rollover is possible. For a 401k plan, the pre tax amount could go to a TIRA and the after tax to a Roth IRA. spiritrider noted that if the person is also doing back door Roth conversions, the added pre tax balance going to the TIRA will impair the back door Roth conversion. But it is still possible to avoid these taxes by rolling any pre tax IRA amount into an accepting employer plan if that plan accepts IRA rollovers, then converting the IRA basis tax free. Or with many 401k plans, the pre tax portion could be rolled to a TIRA and the after tax portion to the Roth 401k as an IRR. The one transfer that is NOT permitted is a transfer of pre tax earnings in the after tax 401k account to the pre tax 401k account. With all this portability, and with some plans not offering all the IRS options, the decision is a mix and match situation using the available options, while factoring in both taxes and convenience.