Mega Backdoor Roth newbie w/ "after-tax" problem.....

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Topic Author
cudds
Posts: 79
Joined: Wed Dec 03, 2014 11:33 am

Mega Backdoor Roth newbie w/ "after-tax" problem.....

Post by cudds »

The 401K for the small business I own now has the ability to use the Mega Backdoor Roth method starting this year.

My problem is that when I joined the 401K plan 6 years ago I rolled over some "after tax" money from my previous employer into my current office's 401K (I worked at the VA and your employee pension withholdings are released to you as "after tax" money if you leave before becoming pension eligible). The $15,000 I rolled over has now grown into $25,000.

When I add NEW "after tax" money this year and go to convert that over to Roth 401K money within the 401K plan I'm guessing I'll have to roll the OLD "after tax" $25,000 as well, and thus pay tax on the $10,000 gains?

Is there anything I can do now to move that $25,000 in old "after tax" money out of my 401K without paying the tax on the gains?

Can I roll it into my Thrift Savings Plan and let it sit there?

I'm guessing my 401K plan cannot keep my OLD "after tax" money and my NEW "after tax" money separate and only convert the new after tax money (which will have zero gains) into the Roth 401K moving forward?

NOTE: We also do traditional Backdoor Roth conversions every year so rolling some/all of the $25,000 in old money to a traditional IRA will run us into the pro-rata issue.

I'm guessing I'm stuck just paying the $10,000 in gains this year and not worrying about it moving forward, but wanted to check.

Thanks in advance!!
sailaway
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Re: Mega Backdoor Roth newbie w/ "after-tax" problem.....

Post by sailaway »

Can you roll the gains to a tIRA, then do a reverse rollover back into your 401k? This is how we eventually cleared up DH's after tax tIRA, but not all plans accept reverse rollovers.
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retiredjg
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Re: Mega Backdoor Roth newbie w/ "after-tax" problem.....

Post by retiredjg »

cudds wrote: Fri Jan 27, 2023 11:12 am My problem is that when I joined the 401K plan 6 years ago I rolled over some "after tax" money from my previous employer into my current office's 401K (I worked at the VA and your employee pension withholdings are released to you as "after tax" money if you leave before becoming pension eligible).
Something seems wrong, at least to me.

I would think pension money is usually pre-tax, not after-tax.

If it is after-tax, I don't see how it could have been (correctly) rolled into a 401k plan.

Designated Roth dollars (but not Roth IRA) can be rolled into Roth 401k, but I don't think "after-tax" dollars can be rolled into a 401k at all. I could certainly be wrong though.

Can you actually see a screen or a chart or something that shows this account separate from your other 401k accounts? If yes, what are the names of the accounts in the 401k?
Topic Author
cudds
Posts: 79
Joined: Wed Dec 03, 2014 11:33 am

Re: Mega Backdoor Roth newbie w/ "after-tax" problem.....

Post by cudds »

sailaway wrote: Fri Jan 27, 2023 11:21 am Can you roll the gains to a tIRA, then do a reverse rollover back into your 401k? This is how we eventually cleared up DH's after tax tIRA, but not all plans accept reverse rollovers.
Thanks for the idea!

I will contact my 401K plan and see if rolling just the $10K gains into my empty VG tIRA is possible. If so I have confirmation from TSP that they will accept a tIRA rollover into my traditional 401K account with them.
Topic Author
cudds
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Joined: Wed Dec 03, 2014 11:33 am

Re: Mega Backdoor Roth newbie w/ "after-tax" problem.....

Post by cudds »

retiredjg wrote: Fri Jan 27, 2023 11:50 am
cudds wrote: Fri Jan 27, 2023 11:12 am My problem is that when I joined the 401K plan 6 years ago I rolled over some "after tax" money from my previous employer into my current office's 401K (I worked at the VA and your employee pension withholdings are released to you as "after tax" money if you leave before becoming pension eligible).
Something seems wrong, at least to me.

I would think pension money is usually pre-tax, not after-tax.

If it is after-tax, I don't see how it could have been (correctly) rolled into a 401k plan.

Designated Roth dollars (but not Roth IRA) can be rolled into Roth 401k, but I don't think "after-tax" dollars can be rolled into a 401k at all. I could certainly be wrong though.

Can you actually see a screen or a chart or something that shows this account separate from your other 401k accounts? If yes, what are the names of the accounts in the 401k?
Thanks as always!

I re-verified and yes, it is after tax. On my 401K plans website under "Balance By Money Source" the $25K is listed as "Rollover After Tax."

And to be clear, these funds were withheld from my paycheck while at the VA (4.4% each check) and were held in a fund that would have helped fund my pension if I were to stay at least 5 years to be pension-eligible. However, since I left prior to 5 years they gave me back the 4.4% that they withheld and that's how they were rolled into my current 401K as "Rollover After Tax."
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retiredjg
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Re: Mega Backdoor Roth newbie w/ "after-tax" problem.....

Post by retiredjg »

cudds wrote: Fri Jan 27, 2023 2:46 pm
retiredjg wrote: Fri Jan 27, 2023 11:50 am
cudds wrote: Fri Jan 27, 2023 11:12 am My problem is that when I joined the 401K plan 6 years ago I rolled over some "after tax" money from my previous employer into my current office's 401K (I worked at the VA and your employee pension withholdings are released to you as "after tax" money if you leave before becoming pension eligible).
Something seems wrong, at least to me.

I would think pension money is usually pre-tax, not after-tax.

If it is after-tax, I don't see how it could have been (correctly) rolled into a 401k plan.

Designated Roth dollars (but not Roth IRA) can be rolled into Roth 401k, but I don't think "after-tax" dollars can be rolled into a 401k at all. I could certainly be wrong though.

Can you actually see a screen or a chart or something that shows this account separate from your other 401k accounts? If yes, what are the names of the accounts in the 401k?
Thanks as always!

I re-verified and yes, it is after tax. On my 401K plans website under "Balance By Money Source" the $25K is listed as "Rollover After Tax."

And to be clear, these funds were withheld from my paycheck while at the VA (4.4% each check) and were held in a fund that would have helped fund my pension if I were to stay at least 5 years to be pension-eligible. However, since I left prior to 5 years they gave me back the 4.4% that they withheld and that's how they were rolled into my current 401K as "Rollover After Tax."
Ok. Thanks for the clarification.

The only way I can make sense of this is that your current plan always offered an after-tax account, but did not offer the second step necessary for for the mega-backdoor. Now, you do have the second step necessary for the mega-backdoor (or you had it all along and just didn't know it).

When money is taken out of an after-tax account in a 401k plan, they must distribute a pro-rated amount of pre-tax and post-tax dollars. It is my understanding that there is no way to take out the cream and leave the coffee in this kind of account. (It is possible to separate the cream from the coffee in an IRA which is what Sailaway mentioned.)

Having said that, there may be a workaround. It depends on your plan.

1. If the plan only offers an in-plan Roth rollover (IRR) of the after-tax account to Roth 401k, there is nothing you can do. For every after-tax dollar you rollover, there will be some pre-tax dollars tagging along that will be taxed. If you decide to roll everything at one time, there will be tax on all of the $10k earnings.

2. The workaround if you don't want to pay the tax:

If the plan allows you to roll the after-tax account out to Roth IRA, you can request a "split rollover". That means the after-tax part goes to Roth IRA (no tax) and the pre-tax part goes to tIRA (again no tax). They are required to do a split rollover but do not have to make it easy. We'll go into that if you find that is the case.

This, of course, will mean you have to roll the tIRA back into the 401k (or into your TSP) before the end of the year if you continue to use the ordinary backdoor process. Some people have done this.

So....where does your plan allow you to roll the after-tax account?
Topic Author
cudds
Posts: 79
Joined: Wed Dec 03, 2014 11:33 am

Re: Mega Backdoor Roth newbie w/ "after-tax" problem.....

Post by cudds »

retiredjg wrote: Fri Jan 27, 2023 3:06 pm
cudds wrote: Fri Jan 27, 2023 2:46 pm
retiredjg wrote: Fri Jan 27, 2023 11:50 am
cudds wrote: Fri Jan 27, 2023 11:12 am My problem is that when I joined the 401K plan 6 years ago I rolled over some "after tax" money from my previous employer into my current office's 401K (I worked at the VA and your employee pension withholdings are released to you as "after tax" money if you leave before becoming pension eligible).
Something seems wrong, at least to me.

I would think pension money is usually pre-tax, not after-tax.

If it is after-tax, I don't see how it could have been (correctly) rolled into a 401k plan.

Designated Roth dollars (but not Roth IRA) can be rolled into Roth 401k, but I don't think "after-tax" dollars can be rolled into a 401k at all. I could certainly be wrong though.

Can you actually see a screen or a chart or something that shows this account separate from your other 401k accounts? If yes, what are the names of the accounts in the 401k?
Thanks as always!

I re-verified and yes, it is after tax. On my 401K plans website under "Balance By Money Source" the $25K is listed as "Rollover After Tax."

And to be clear, these funds were withheld from my paycheck while at the VA (4.4% each check) and were held in a fund that would have helped fund my pension if I were to stay at least 5 years to be pension-eligible. However, since I left prior to 5 years they gave me back the 4.4% that they withheld and that's how they were rolled into my current 401K as "Rollover After Tax."
Ok. Thanks for the clarification.

The only way I can make sense of this is that your current plan always offered an after-tax account, but did not offer the second step necessary for for the mega-backdoor. Now, you do have the second step necessary for the mega-backdoor (or you had it all along and just didn't know it).

When money is taken out of an after-tax account in a 401k plan, they must distribute a pro-rated amount of pre-tax and post-tax dollars. It is my understanding that there is no way to take out the cream and leave the coffee in this kind of account. (It is possible to separate the cream from the coffee in an IRA which is what Sailaway mentioned.)

Having said that, there may be a workaround. It depends on your plan.

1. If the plan only offers an in-plan Roth rollover (IRR) of the after-tax account to Roth 401k, there is nothing you can do. For every after-tax dollar you rollover, there will be some pre-tax dollars tagging along that will be taxed. If you decide to roll everything at one time, there will be tax on all of the $10k earnings.

2. The workaround if you don't want to pay the tax:

If the plan allows you to roll the after-tax account out to Roth IRA, you can request a "split rollover". That means the after-tax part goes to Roth IRA (no tax) and the pre-tax part goes to tIRA (again no tax). They are required to do a split rollover but do not have to make it easy. We'll go into that if you find that is the case.

This, of course, will mean you have to roll the tIRA back into the 401k (or into your TSP) before the end of the year if you continue to use the ordinary backdoor process. Some people have done this.

So....where does your plan allow you to roll the after-tax account?
Unfortunately the plan only allows for rolling over to the Roth 401K. I tried to get the option to roll into a Roth IRA without success as that would have been my preferred final destination to begin with.

Thanks again for your help and for your time. I appreciate it!
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retiredjg
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Re: Mega Backdoor Roth newbie w/ "after-tax" problem.....

Post by retiredjg »

:happy Looks like this is a time to be grateful for what you have. It is a good thing, even if not as wonderful as what you wanted.
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