Convert After-Tax Contribs to Desig. Roth Account, then roll to Roth?

Submitted by Steve Benjamin on Thu, 2018-01-18 20:05

A 401(k) participant knows that he can roll any after-tax contributions to a Roth IRA but now has asked me another question.

Consider:

He is under age 50 and will contribute $18,500 into his Designated Roth account in 2018.
The 401(k) plan allows for in-plan Roth conversions.
The 401(k) plan also allows for after-tax contributions.
Assume the participant contributes $3,000 in after-tax contributions.

Can he convert the $3,000 after-tax contribution to a Roth account inside the plan so that the earnings can start growing tax-free and then all be rolled to a Roth IRA later?

Participant is trying to avoid the “pro-rata” rule in his IRAs outside the plan.

Thank you very much.

Steve



Submitted by Alan - IRA critic on Thu, 2018-01-18 23:05

In most cases the plan allows after tax contributions to the separate sub account to be either converted to a Roth IRA or as an in plan Roth rollover (IRR) to the Roth 401k. In either case, earnings accrued in the after tax account must also be distributed along with the AT contributions. The allowed frequency of these conversions varies. Participant will have to check with the plan for the specifics. Of course, the sooner a conversion can be done after contributing, the less earnings there will be to be converted. 

Submitted by William Tuttle on Fri, 2018-01-19 03:27

  • You are losing losing the sight of the forest for the trees. While Alan’s answer to your question is 100% correct, the extra step is unnecessary.
  • While the distribution of the after-tax account must be pro-rata. The direct rollover of 401k employee after-tax contributions to a Roth IRA are not subject to pro-rata taxation of pre-tax IRA accounts. The assets are never in a pre-tax IRA account and are never included in a Form 8606 to be subject to a pro-rata conversion.
  • Your diversion to the Roth designnated account is an unnecessary step. The IRR will result in only the employee after-tax earnings to be taxable and the rollover to the Roth IRA will be non-taxable. However, a direct rollover of the employee after-tax contributions and earnings to a Roth IRA will also result in only the earnings to be taxable, but in a single step.
  • Or if you were to rollover the employee after-tax contributions to a Roth IRA and the earnings to a traditional IRA there would be no tax liability. Although you would now have a pre-tax IRA balance that would interfere with future Backdoor Roths unless your 401k or other qualfied non-IRA plan accepts rollover contributions. and you do so.
  • Believe it or not many people do just that. They rollover their employee after-tax contributions and earnings to  a Roth/traditional IRA  pair and roll the traditional IRA back into the 401k. Note: It is allowed.

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