Mega Backdoor Roth IRA
I have a client who works for a major Tech company in Silicon Valley. The company provides very good information/education for there employees how to take advantage of other savings techniques after they max their 401k plans. My client is 45 and will max his 401k by summer, his company does offer true up contributions in regards to the company match.
The plan allows After-tax contributions up to IRS limit of $54,000 for 2017. The plan also allows Roth In-Plan conversions. My client will max his Roth 401k at $18,000 then plans on adding another $25,000 in After-Tax contributions then convert this to his Roth 401k annually. I realize if the 25k grows to 26k he will owe taxes on the $1,000 when he converts. My client does have a Trad IRA valued at 200k.
My question is … When he converts the After-Tax contributions and any earnings will his Trad IRA have to be considered for the pro rata rules? He seems to believe the Trad IRA has no bearing, I disagree. Maybe if he processes the Roth In-Plan conversion of the After-Tax contributions and earnings before Dec 31, 2017 the Trad IRA value doesn’t have to be considered??? But if after Dec 31, 2017 the Trad IRA values has to be considered??
Permalink Submitted by Ben Meyer on Sat, 2017-03-25 16:36
The recordkeeper or trustee for the 401(k) plan would have no knowledge of any traditional IRA accounts that the employee also holds. When performing an In-Plan Roth Rollover or conversion the plan will consider only the percentage of basis in the 401(k) sub-account containing the funds to be converted. Many plans allow the funds to be converted to be taken from the after-tax sub-account or the pre-tax sub account(s), as the employee may choose. But the after-tax sub-account will also contain earnings on the after-tax contributions, so there will probably be some taxable amount included in the conversion. The after-tax and pre-tax amounts are determined using the percentage of each in the sub-account. Some other 401(k) plans may require the percentage or after-tax and pre-tax money to be determined over the complete non-Roth 401(k) including all sub-accounts. But the traditional IRA will not matter in any case.
Permalink Submitted by Alan - IRA critic on Sat, 2017-03-25 17:35
Does this plan have any employer match? The 54k 415(c) limit includes ALL contributions for the year including any match or forfeitures to the participant’s account. Because of some uncertainty in the total contributions, many plans impose a limit on the after tax contributions to avoid a violation of the 54k limit and having to process a corrective distribution after the after tax contributions have either been rolled to the Roth 401k or to a Roth IRA. If the participant has a choice for the rollover destination, the Roth IRA is usually the better choice.
Permalink Submitted by William Tuttle on Sat, 2017-03-25 20:26
Maybe it is just semantics, but what you are describing is an In-plan Roth Rollover (IRR). This is an in plan Roth conversion of either pre-tax account(s) and/or after-tax accounts into a designated Roth account. As alluded to by Alan in his last sentence a Mega Backdoor Roth is if the plan allows in-service rollovers, then your client can make after-tax contributions and rollover the contributions to a Roth IRA and either do a Roth conversion of those earnings to that Roth IRA or rollover the earnings to a traditional IRA. In all of the above circumstances these are qulaified plan tranactions and do not require a Form 8606 and pro-rata consideration with any prior traditional IRA balances. P.S. As pointed out the after-tax contributions are first limited to the annual addition limit (2017=$54K) – employee deferrals – employer contributions (match, non-elective and forfeitures if any). They may also be limited by the employer plan to a fixed amount or percentage and/or if the client is an HCE, subject to ACP testing failure.