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401k after-tax with roth conversion?

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  • Avatar LizOB 
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    Status: Physician
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    My husband’s employer has recently introduced an after-tax contribution option to their 401k plan (with Fidelity). This would be in addition to the $18,500 pre-tax 401k. There is the option for “automated roth in-plan conversion of after-tax contributions”. My understanding after reading everything is the contributions are taxed as regular income but there would be no tax on dividends or capital gains with automated roth conversions.

    Is there a catch to this? It sounds like it’s basically opening up more roth space that we should use before moving on to taxable (this is after max 401k’s x2, backdoor roths, we don’t have a health plan that qualifies for hsa).

    Also, it’s not clear from the plan documents what happens if my husband leaves his job. Can we just leave the roth money in that account and let it keep growing tax-free?

    #156107 Reply
    Avatar jacoavlu 
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    Yes this is an excellent plan feature and equivalent to the so-called mega backdoor Roth. You should definitely take advantage of it. The only thing that you’re giving up is the liquidity of your after-tax money that would alternatively end up in a taxable brokerage account.

    At separation from employer, you should either be able to leave the funds there, or the funds would be moved to a Roth IRA via rollover.

    The Finance Buff's solo 401k contribution spreadsheet: https://goo.gl/6cZKVA

    #156108 Reply
    Avatar Larry Ragman 
    Participant
    Status: Other Professional
    Posts: 522
    Joined: 08/30/2018

    Yes this is an excellent plan feature and equivalent to the so-called mega backdoor Roth. You should definitely take advantage of it. The only thing that you’re giving up is the liquidity of your after-tax money that would alternatively end up in a taxable brokerage account.

    At separation from employer, you should either be able to leave the funds there, or the funds would be moved to a Roth IRA via rollover.

    Click to expand…

    Yes. And one additional point: your husband is limited to a total of $55k per year across his pretax, this after tax, and the employer contributions to the 401k. He should also convert the after tax contributions to the Roth account as soon as possible after each contribution (pay day).

    #156157 Reply
    Liked by LizOB
    Avatar jacoavlu 
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    Joined: 03/01/2018
    He should also convert the after tax contributions to the Roth account as soon as possible after each contribution (pay day).

    Click to expand…

    Note the participant’s plan has option for “automated roth in-plan conversion of after-tax contributions” so this is already taken care of.

    The Finance Buff's solo 401k contribution spreadsheet: https://goo.gl/6cZKVA

    #156159 Reply
    Avatar Larry Ragman 
    Participant
    Status: Other Professional
    Posts: 522
    Joined: 08/30/2018
    He should also convert the after tax contributions to the Roth account as soon as possible after each contribution (pay day). 

    Click to expand…

    Note the participant’s plan has option for “automated roth in-plan conversion of after-tax contributions” so this is already taken care of.

    Click to expand…

    Ah, thanks for pointing that out. I was going too fast. That’s a great option. I have to covert every two weeks.

    #156161 Reply
    DMFA DMFA 
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    Status: Physician
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    Joined: 06/24/2016

    That is awesome. Like, really awesome. That makes it so easy for the end-user.

    That gives you the opportunity to get a tax advantage on up to the $55,000 limit (or whatever the cap is on after-tax contributions; my wife’s plan caps them at 3%); you can tax defer whatever you can/want, and put the rest in Roth.

    Employee contributions and their gains *should* be fully vested. That’s part of qualified plans. You could leave it or do a Roth IRA rollover eventually.

    "I like money." - Frito Pendejo (Idiocracy)

    [Not a financial professional (yet), lawyer, or employee of The White Coat Investor]

    #156164 Reply
    Liked by LizOB
    Avatar LizOB 
    Participant
    Status: Physician
    Posts: 315
    Joined: 06/05/2017

    Thanks everyone. It sounded like a good thing to do but wanted to make sure I wasn’t missing anything!

    #156205 Reply
    Avatar indiedoc 
    Participant
    Status: Physician
    Posts: 5
    Joined: 01/10/2019

    I also recently found out that I can allocate after-tax money into my 401k.  I am not aware of my plan having the “automated roth in-plan conversion of after-tax contributions” feature- which leaves me a bit confused.   Is it necessary to convert these contributions in real-time over to a Roth or can I do this down the road upon separation from hospital or retirement? And is there a benefit of converting monies with each monthly contribution?  Of note, I currently have some money in a SEP IRA from a previous job- not sure if that affects my ability to do this conversion at this time.  I do plan to roll it over into my employer’s 401k plan in the near future.  Thanks in advance

    #187941 Reply
    Avatar jacoavlu 
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    Status: Physician, Small Business Owner
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    Joined: 03/01/2018

    You need to inquire with your plan about in plan Roth rollover, or in service non hardship withdrawal of vested after tax contributions which would allow you to rollover the after tax to a Roth IRA.

    You want to rollover the after tax to Roth as soon as reasonably possible because the earnings in the after tax sub account are pretax whereas once the funds rollover to Roth earnings are tax free.

    The Finance Buff's solo 401k contribution spreadsheet: https://goo.gl/6cZKVA

    #187951 Reply
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    jfoxcpacfp jfoxcpacfp 
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    your husband is limited to a total of $55k per year

    Click to expand…

    $56k bg 2019.

    Johanna Fox Turner, CPA, CFP, Fox Wealth Mgmt & Fox CPAs ~
    http://www.fox-cpas.com/for-doctors-only ~ [email protected]

    #187960 Reply
    Liked by Craigy
    Andrew Musbach Andrew Musbach 
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    Status: Financial Advisor, Small Business Owner
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    Joined: 10/19/2017

    I have not seen a plan with the feature that LizOB has, but that is great!

    @indiedoc as Jacoavlu mentioned, you will want to be careful on the rules of your plan. Typically, even if your plan allows for you to roll over the after-tax contributions to a Roth IRA while in service, any in service partial rollover will be viewed as a pro rata withdrawal (similar to the issues with making back door Roth IRA contributions if you have pre-tax money in an IRA). For example, if you had $10k pre-tax contributions and $10k after-tax contributions in your 401k, you can’t just choose to move the $10k after-tax contributions to a Roth IRA. If you did a rollover of $10k out to a Roth IRA, it would be viewed as $5k from your after-tax contributions and $5k from you pre-tax contributions with the $5k pre-tax contributions being taxable.

    However, if you do a full withdrawal, it is typically much easier and you can have one check issued out to your Roth IRA for the after-tax portion and one check out to your new employer plan or IRA for the pre-tax contributions. This would need to happen when you separate from service or if you can do an in-service rollover after age 59 ½.

    Andrew Musbach, CFP® | [email protected]
    MD Wealth Management, LLC | http://www.mdwmllc.com

    #188555 Reply
    DMFA DMFA 
    Moderator
    Status: Physician
    Posts: 2126
    Joined: 06/24/2016

    I have not seen a plan with the feature that LizOB has, but that is great!

    @indiedoc as Jacoavlu mentioned, you will want to be careful on the rules of your plan. Typically, even if your plan allows for you to roll over the after-tax contributions to a Roth IRA while in service, any in service partial rollover will be viewed as a pro rata withdrawal (similar to the issues with making back door Roth IRA contributions if you have pre-tax money in an IRA). For example, if you had $10k pre-tax contributions and $10k after-tax contributions in your 401k, you can’t just choose to move the $10k after-tax contributions to a Roth IRA. If you did a rollover of $10k out to a Roth IRA, it would be viewed as $5k from your after-tax contributions and $5k from you pre-tax contributions with the $5k pre-tax contributions being taxable.

    However, if you do a full withdrawal, it is typically much easier and you can have one check issued out to your Roth IRA for the after-tax portion and one check out to your new employer plan or IRA for the pre-tax contributions. This would need to happen when you separate from service or if you can do an in-service rollover after age 59 ½.

    Click to expand…

    IDK if that varies plan-by-plan, but I had zero problem with taking a non-hardship in-service withdrawal of only the after-tax portion with no prorated withdrawal of the pretax portion.  My plan does not allow for non-hardship in-service withdrawals of pretax or Roth deferrals, anyway.

    "I like money." - Frito Pendejo (Idiocracy)

    [Not a financial professional (yet), lawyer, or employee of The White Coat Investor]

    #188676 Reply
    Kon Litovsky Kon Litovsky 
    Participant
    Status: Financial Advisor
    Posts: 888
    Joined: 01/09/2016
    medical school scholarship sponsor

    My husband’s employer has recently introduced an after-tax contribution option to their 401k plan (with Fidelity). This would be in addition to the $18,500 pre-tax 401k. There is the option for “automated roth in-plan conversion of after-tax contributions”. My understanding after reading everything is the contributions are taxed as regular income but there would be no tax on dividends or capital gains with automated roth conversions.

    Is there a catch to this? It sounds like it’s basically opening up more roth space that we should use before moving on to taxable (this is after max 401k’s x2, backdoor roths, we don’t have a health plan that qualifies for hsa).

    Also, it’s not clear from the plan documents what happens if my husband leaves his job. Can we just leave the roth money in that account and let it keep growing tax-free?

    Click to expand…

    I’d be curious to find out whether there is a limit on the amount he can contribute after-tax, whether it is a fixed amount or whether he can go up to $56k.  This should be spelled out somewhere.  If not, you should find out just in case.

    Kon Litovsky, Principal, Litovsky Asset Management | [email protected]
    -401k and Cash Balance plans for solo and group practices, fixed/flat fee, no AUM fees

    #189003 Reply
    Avatar LizOB 
    Participant
    Status: Physician
    Posts: 315
    Joined: 06/05/2017

    My husband’s employer has recently introduced an after-tax contribution option to their 401k plan (with Fidelity). This would be in addition to the $18,500 pre-tax 401k. There is the option for “automated roth in-plan conversion of after-tax contributions”. My understanding after reading everything is the contributions are taxed as regular income but there would be no tax on dividends or capital gains with automated roth conversions.

    Is there a catch to this? It sounds like it’s basically opening up more roth space that we should use before moving on to taxable (this is after max 401k’s x2, backdoor roths, we don’t have a health plan that qualifies for hsa).

    Also, it’s not clear from the plan documents what happens if my husband leaves his job. Can we just leave the roth money in that account and let it keep growing tax-free?

    Click to expand…

    I’d be curious to find out whether there is a limit on the amount he can contribute after-tax, whether it is a fixed amount or whether he can go up to $56k.  This should be spelled out somewhere.  If not, you should find out just in case.

    Click to expand…

    I believe the limit is a percentage of his income (I’d have to double check). I don’t think we could get up to $56k- this is my husband’s employer’s plan, he is an engineer making about $100k. So far $19k goes into pre-tax 401k, he gets a 5% match so about $5k. He also puts 10% into the employee stock program (10% withheld from paychecks and every 6 months he cashes out the company’s stock that he gets at a 15% discount from the lower of the start or end of the 6 months, which is a guaranteed minimum 15% gain), does $5k into the childcare FSA, oh and pays for our son (and soon, baby #2) to be on his health insurance because everything pediatric is out-of-network on mine. I’m pretty sure there’s not enough left for after-tax contributions to get up to 56k total. A physician income could probably do it but like I said this is all through his employer not mine.

    #189387 Reply
    Hank Hank 
    Moderator
    Status: Attorney
    Posts: 1284
    Joined: 03/27/2017

    LizOB,

    If you guys are putting money into taxable investments, you should reduce your husband’s tax withholding and put as much after tax income into his 401(k) as possible. Roth dollars are way better than taxable dollars.

    You could increase your own withholding or even make estimated tax payments to get to the 100% / 110% prior tax year liability safe harbor. Even if your husband’s net paycheck is almost zero, the total tax treatment for the two of you would be more favorable.

    #189497 Reply
    Liked by jfoxcpacfp

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