Mega Back Door Roth
I have a self employed client that we run a solo 401k for. I’d like her to take advantage of the mega back door roth strategy considering we have another $20,000 of available contribution dollars to reach the $58k limit.
My question is.. once the after tax funds are in the 401k what is required to move those funds into a Roth IRA? I’ve done research and it appears that IRS notice 2014-54 states that you need to rollover the entire balance of the 401k (pre tax and post tax) out of the plan to isolate just the after tax dollars going into a Roth IRA. Meaning, I’d have to roll all pretax dollars and earnings into a TIRA and only then could I roll the after tax dollars into a Roth IRA. If I move out just a portion of the 401k then it is subject to pro rata rules of pre and post tax dollars.
I’ve read online that some companies allow for their employees to roll only the after tax dollars to a Roth IRA but am unsure on what the work around is. Are they just ignoring the IRS ruling or is there a way to accomplish this without rolling out the whole 401k balance? In summary I want to make the after tax contribution then turn around and roll just those after tax dollars into a Roth IRA outside of the plan. Thank you.
Permalink Submitted by Alan - IRA critic on Tue, 2022-01-04 17:16
401k plans that allow after tax contributions typically use a sub account to hold these contributions and their earnings. This sub account is usually distributable even when the plan is receiving contributions. As such, the only pre tax amount that must be distributed are the earnings in the sub account. Those amounts are usually small enough to justify rolling the entire sub account into a Roth IRA. There is no pro rating with the pre tax portion of the plan. If the earnings in the sub account have accumulated to a meaningful amount, Notice 2014-54 could be applied to split the rollover with the after tax contributions going to a Roth IRA, and the earnings to a TIRA account. No taxes would be due. Therefore, you should verify that this plan allows after tax contributions, maintains separate accounting for them in a sub account, and allows in service distributions. If so, the distribution request should be very clear that is only applies to the after tax sub account.
Permalink Submitted by Derek Johnson on Tue, 2022-01-04 19:19
So the sub account is not subject to the aggregation rule set by the IRS?
Permalink Submitted by Alan - IRA critic on Tue, 2022-01-04 20:15
Not as long as the plan maintains separate accounting for the after tax contributions and their gains or losses per Sec 72(d)(2). It is very rare that a plan that accepts after tax contributions would not have the accounting in place to support a sub account.
Permalink Submitted by Matthew Santarsiero on Thu, 2022-05-19 04:18
I completed this exact scenario last year. I had built up an after-tax amount in a large corporate 401k at Vanguard with significant gains over the years. Vanguard did maintain separate accounting for after-tax. I processed two separate rollover checks – cost basis amount of after-tax for rollover into Roth IRA and earnings portion of after-tax for rollover into new tIRA. I had zero assets in IRA’s prior to this transaction. Can I complete this rollover assuming build up of more after-tax contributions for this year? Does the pro-rata rule come into play? Thank you so much for any insight – this is a very specific question!
Permalink Submitted by Alan - IRA critic on Thu, 2022-05-19 14:58
You can do this every year, but now you either will have very small gains in the after tax account, or if it is invested in stocks or stock funds, you probably have a loss. If you have a loss, you can postpone the rollover to your Roth IRA until there is no longer a loss, If you don’t then you need to find out how the plan accounting works with respect to carrying over the loss to the following year. For example, if you currently have a 3000 loss and do the rollover to your Roth (no split rollover needed), if that loss disappears at year end, you may as well wait to do the rollover until the loss has been made up with gains. Even if you have gains in the account, they are small enough to just roll the after tax account balance to your Roth IRA, and pay the small tax.
There are no pro rating issues from the 401k, as you will be rolling over the entire balance periodically to your Roth IRA and paying taxes on any small gains. However, the amount of gain you have already rolled into your TIRA will cause pro rating issues if you do basic back door Roth conversions from your TIRA. If you plan to do those back doors, you might look into rolling the pre tax TIRA balance back into the 401k as that will eliminate pro rating if you plan to do basic back door Roth IRAs.