Tax loss harvesting Mega Backdoor

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Topic Author
southbogle
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Joined: Wed Apr 21, 2021 9:48 am

Tax loss harvesting Mega Backdoor

Post by southbogle »

First of all, apologies if I am totally off on something. This is my first year doing a Mega Backdoor since joining a company that offers this possibility. Over this year 2022 I have contributed the maximum I can to the After tax 401K. The plan does offer in service withdrawal but only once a year. So I decided to invest the contributions instead of keeping it in cash.

Now due to the way the market has crashed this year, the After tax 401K has lost quite a bit of value. I am wondering if I can do something like TLH in this case.

Total contributions to After Tax 401K: 40K
Current value of After Tax 401k: 34K

I plan to start contributing again next year to the After Tax to max out the contributions. My question is if I do the Roth conversion now (leave say $100 in the After tax) whether I can "harvest" the 6K of losses from this year to offset growth next year (if it happens). e.g. If I invest 40K next year and it grows to 46K can I convert the whole 46K tax free?
muffins14
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Re: Tax loss harvesting Mega Backdoor

Post by muffins14 »

These funds are inside your 401k, not a taxable account, so , to the best of my knowledge, there is no notion of capital gains/losses for you to exploit to do TLH with
Last edited by muffins14 on Thu May 19, 2022 9:41 am, edited 1 time in total.
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livesoft
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Re: Tax loss harvesting Mega Backdoor

Post by livesoft »

No, you cannot. Tax-loss harvesting is not something done in tax-advantaged accounts.
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neurosphere
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Re: Tax loss harvesting Mega Backdoor

Post by neurosphere »

The short answer is no, you can't really take advantage of losses which happen in a tax-advantaged account. Similar to if those contributions had been made as pre-tax contributions.

The only possible benefit is that those "losses" can offset future "gains" (maybe, I'm not positive about this). What do I mean by gains?

Suppose you contribute $1000 to an after tax account next year but don't convert those amounts to Roth dollars until after they've increased to $1100. Normally you'd pay tax on the $100 in gains. But you may be able to avoid tax on this if you had previously converted after-tax amounts which had a "loss".

However, in general you'd want to either 1) not invest after-tax amounts until you get a chance to convert them, which prevents both decreases and increases in value prior to conversion or 2) convert as quickly as is allowed/practical which will limit changes in value.

There is really no benefit to you to intentionally try for gains in your after-tax account prior to converting, vs just converting right away. Now, I personally only wished to do one annual after-tax-->Roth conversion, just for my convenience. And in general, that cost me in the form of extra taxes on gains compared to had a I converted more often. In such a case the fact that your conversion amount is less than your "basis" (i.e. the amount of after tax dollars you originally contributed) may indeed limit future taxes. Note again, I'm not SURE about this. This is how it can work when it comes to after-tax (non-deductible) amounts in a Traditional IRA that is converted to a Roth. I'm not sure if it's the same in an employer account.
If you have to ask "Is a Target Date fund right for me?", the answer is "Yes" (even in taxable accounts).
sailaway
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Re: Tax loss harvesting Mega Backdoor

Post by sailaway »

We have always invested after tax, as well. If you still have losses when you convert, those losses can be carried over to next year. They will then offset gains whenever the market recovers. If you leave this job before the market recovers, that space will be lost. We were not aware that we would be able to carry over like this, but that is how the tax forms showed up.
Silk McCue
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Re: Tax loss harvesting Mega Backdoor

Post by Silk McCue »

sailaway wrote: Thu May 19, 2022 9:53 am We have always invested after tax, as well. If you still have losses when you convert, those losses can be carried over to next year. They will then offset gains whenever the market recovers. If you leave this job before the market recovers, that space will be lost. We were not aware that we would be able to carry over like this, but that is how the tax forms showed up.
I think you are in error. These are after tax retirement accounts in which you cannot TLH regardless of what your tax form may have led you to believe.

Cheers
sailaway
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Re: Tax loss harvesting Mega Backdoor

Post by sailaway »

Silk McCue wrote: Thu May 19, 2022 10:02 am
sailaway wrote: Thu May 19, 2022 9:53 am We have always invested after tax, as well. If you still have losses when you convert, those losses can be carried over to next year. They will then offset gains whenever the market recovers. If you leave this job before the market recovers, that space will be lost. We were not aware that we would be able to carry over like this, but that is how the tax forms showed up.
I think you are in error. These are after tax retirement accounts in which you cannot TLH regardless of what your tax form may have led you to believe.

Cheers
Well, it was about $25, so I am not going to worry about it too much, but how would one go about correcting this if they receive tax forms showing the offset? As I recall, DH was even informed that he had the $25 of space left when he did the rollover. Not that Fidelity representatives are infallible.

If I were to leave the after tax contributions in place and do one lump sum rollover after five years, the total rollover would be compared to the total contributions to determine gains. So, it does seem logical that there would be a negative space there to fill if I do the rollover annually. If you know of why this would not be true, please point the way.

This may be a very import MBR detail for those who participate over the next few years!
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retiredjg
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Re: Tax loss harvesting Mega Backdoor

Post by retiredjg »

Silk McCue wrote: Thu May 19, 2022 10:02 am
sailaway wrote: Thu May 19, 2022 9:53 am We have always invested after tax, as well. If you still have losses when you convert, those losses can be carried over to next year. They will then offset gains whenever the market recovers. If you leave this job before the market recovers, that space will be lost. We were not aware that we would be able to carry over like this, but that is how the tax forms showed up.
I think you are in error. These are after tax retirement accounts in which you cannot TLH regardless of what your tax form may have led you to believe.

Cheers
There have been a few posters over the years who said their 401k administrators kept up with the basis (after-tax contributions) and applied unused basis to future gains in their after-tax 401k accounts.

This has NOTHING to do with tax loss harvesting. It is related to not losing your basis.

I do not know if all plans will do this, but it has been reported more than once.
Topic Author
southbogle
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Re: Tax loss harvesting Mega Backdoor

Post by southbogle »

Thanks for all the responses. I will try this and see how it works out next year and report back in 2024.
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retiredjg
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Re: Tax loss harvesting Mega Backdoor

Post by retiredjg »

southbogle wrote: Fri May 20, 2022 10:34 am Thanks for all the responses. I will try this and see how it works out next year and report back in 2024.
Good idea.

If the shares in your after-tax account lose some value, you still have the same number of shares even if you convert them at the lower value...if you turn around and buy again. You haven't actually lost anything.
an_asker
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Re: Tax loss harvesting Mega Backdoor

Post by an_asker »

livesoft wrote: Thu May 19, 2022 9:40 am No, you cannot. Tax-loss harvesting is not something done in tax-advantaged accounts.
OP's terminology might be (or rather, is definitely) flawed. However, he/she is on to something. If the Roth conversion happens when the market is at a relative trough (whether short term or long term) the converter will pay less taxes on the conversion.

But again, like someone pointed out on another thread a few weeks back, it all depends on what the money - that will be used to pay the taxes - was doing the last few months. If it had been invested per asset allocation, it would also have gone down by the same fraction as the rest of OP's assets.
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retiredjg
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Re: Tax loss harvesting Mega Backdoor

Post by retiredjg »

This poster is using an after-tax account (not Roth, this is the mega-backdoor) so there are no taxes unless the account grows. In this case, the account has shrunk.
ClassII
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Re: Tax loss harvesting Mega Backdoor

Post by ClassII »

I think calling it Tax Loss Harvesting is what’s causing a derail in this thread. It’s not selling stock at a loss we’re talking about. It’s putting money into After Tax and then converting it to Roth. If the investment increased in value from when it was put into After Tax and when it was converted you’d pay tax on that. But what if the amount goes down?

Hopefully the 401k provider keeps track of the “loss” and can use it toward other conversions that show a gain.
Morik
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Re: Tax loss harvesting Mega Backdoor

Post by Morik »

So yeah definitely is not Tax Loss Harvesting.

But yes many 401k administrators will track how much basis was in after-tax 401k when converting to Roth 401k.

Example:

year 1: You contribute $15k to after-tax 401k.
Some time later: It has fallen to $10k, you convert it to Roth 401k.
You will pay no taxes at this time.

Year 2: You contribute another $15k to after-tax 401k.
Some time later: It has grown to $25k. You convert to Roth 401k.
Due to the rules on taxation of after-tax 401k conversions, you would normally pay taxes on $10k of that conversion (the earnings; your original $15k is not taxed again).
However, the loss in year 1 above will offset $5k of those earnings. So now you would only pay taxes on $5k of that conversion.
Topic Author
southbogle
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Re: Tax loss harvesting Mega Backdoor

Post by southbogle »

Morik wrote: Fri May 20, 2022 12:49 pm So yeah definitely is not Tax Loss Harvesting.

But yes many 401k administrators will track how much basis was in after-tax 401k when converting to Roth 401k.

Example:

year 1: You contribute $15k to after-tax 401k.
Some time later: It has fallen to $10k, you convert it to Roth 401k.
You will pay no taxes at this time.

Year 2: You contribute another $15k to after-tax 401k.
Some time later: It has grown to $25k. You convert to Roth 401k.
Due to the rules on taxation of after-tax 401k conversions, you would normally pay taxes on $10k of that conversion (the earnings; your original $15k is not taxed again).
However, the loss in year 1 above will offset $5k of those earnings. So now you would only pay taxes on $5k of that conversion.
Yes. This is exactly what I am hoping for. Not sure what else to call it. I would prefer to contribute to the After Tax and convert right away if possible but the once per year conversion limit in the company 401k plan stops me from doing so. My options were to sit on the cash until the conversion each year or invest. I am hoping next year's (or sometime soon) investments will make a profit to offset the loss.
Newgene
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Re: Tax loss harvesting Mega Backdoor

Post by Newgene »

I am hunting down confirmation on the same question, or at least get a few data points. So, now that it has been a year, did you get any confirmation saying it worked with the leftover basis carrying over into the next year? This should look like a post-1986 after tax amount showing on a statement.
986racer
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Re: Tax loss harvesting Mega Backdoor

Post by 986racer »

Last year I did 2 after-tax conversions and one had a slight gain and one had a slight loss. I was told that I couldn't apply the slight loss against the slight gain.

I don't recall though if Turbo Tax agreed with that assessment. If so, I doubt that you can carry the slight loss across years
AnEngineer
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Re: Tax loss harvesting Mega Backdoor

Post by AnEngineer »

You cannot offset conversion gains and losses in different years, as far as I know. What you could do is wait to do the conversion until you have no loss or a small gain. This will work because the account has a basis which is used to calculate the taxable portion upon conversion.

The other possibility is that you may have a negative income reported if you do a conversion when there is less in the account than your basis. I have seen negative incomes reported in other somewhat similar situations, but I'm not sure about here.
rkhusky
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Re: Tax loss harvesting Mega Backdoor

Post by rkhusky »

Something similar happens with IRA’s, but that is documented on form 8606, where the basis is carried over to the next year. Where are Mega Backdoors documented?
Last edited by rkhusky on Sun Oct 29, 2023 7:55 am, edited 1 time in total.
PCPilot
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Re: Tax loss harvesting Mega Backdoor

Post by PCPilot »

I would expect that for all after-tax 401Ks, the provider needs to track the basis, for tax purposes.
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retiredjg
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Re: Tax loss harvesting Mega Backdoor

Post by retiredjg »

rkhusky wrote: Sun Oct 29, 2023 6:39 am Something similar happens with IRA’s, but that is documented on form 8606, where the basis is carried over to the next year. Where are Mega Backdoors documented?
This is what I have gathered from posts here....

The basis is kept up by the plan administrator.

If the MBD uses an in-plan Roth rollover, the plan administrator keeps up with that and issues a 1099 for taxes (if any) to be paid.

If the MBD instead rolls out to Roth IRA, the 1099 is still issued, but the employee becomes responsible for keeping up with the basis (which is now in Roth IRA).

Form 8606 is not used at all for the mega-backdoor.
Newgene
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Re: Tax loss harvesting Mega Backdoor

Post by Newgene »

There is one sure way to find out. If the balance is only slightly under the amount contributed, I'll likely still do the conversion at the normal time at the end of this year (plan limits to one/year). If the basis doesn't actually carry over, it will be a lesson learned. I'll just lose the future tax benefit on that amount when I convert a gain. They may be relatively close.
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