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Is this a Mega Back Door Roth?

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  • Avatar billy 
    Participant
    Status: Physician
    Posts: 149
    Joined: 04/07/2016

    My company’s 401k offers after tax voluntary contributions (in addition to my 401k, so after the 19,000 limit), up to 1% of my salary.  While its not a lot, its still a little more Roth space that’s opened up for me but I was very confused by the withdrawal options while in service so I am not sure if this will truly allow me to use it as a Mega Back Door Roth.   If I can’t then all earnings will be taxed so its no better than a taxable account.  I email Schwalb’s representatives asking if I can do withdrawals before age 59 and pasted their response below.  I was asking if I can do yearly withdrawals of this after tax contributions solely for the MBD Roth reason, but I don’t think they’ve encountered this before.  My company’s Summary Plan Description pdf does not really address withdrawing prior to 59 unless for medical reasons or if terminated, so I don’t think they’ve thought of this either.

    “After-Tax contributions are taken from your paycheck after taxes are deducted. After-tax contributions do not reduce your taxable income since they are made with after-tax money. When you withdraw after-tax contributions, you will pay taxes only on the after-tax earnings. Also, your plan has a provision which allows you additional flexibility to withdraw after-tax money before age 59 1/2. Please keep in mind that there is a10% early withdrawal penalty on the after-tax earnings.   When you withdraw money from the After-Tax source, your contributions are not taxed or penalized. However, if a portion of your distribution contains investment earnings, 20% will automatically be withheld from this portion of your distribution for Federal taxes. You may also be subject to mandatory State tax withholding or have the option to elect State taxes depending on the regulations for your State. 

    Since you are under the age of 59 1/2, the 10% early withdrawal penalty may apply. 

    Below are your distribution options:

    Cash out all or part of your available balance (Federal/State taxes and a possible 10% early withdraw penalty may apply).

    Rollover to an IRA.* You can make separate elections for the contributions vs the earnings.

    Rollover to a 401(k) or qualified plan.

    Defer and leave your assets in your account at Schwab.  

    So, can I use this as a Mega Back Door roth? My plan was to put the money in a core settlement fund (so no/minimal earnings to be taxed at 10%) until the max is reached each year then do a 1 time distribution into my Roth IRA, or into their Roth option in the 401k (may be easier since then its all within Schwalb’s umbrella).  If allowed is there any benefit to withdrawing it into my own Roth vs the 401k Roth? Am I missing something? Also, I live in NJ if it matters.

     

    Thanks

    #189284 Reply
    Avatar JBME 
    Participant
    Status: Spouse
    Posts: 461
    Joined: 03/26/2018

    Rollover to an IRA.* You can make separate elections for the contributions vs the earnings.”

    We’ve already established you can make after-tax contributions. What I quoted above suggests to me you also have the second component to call this the MBD Roth. You pay 10% penalties on a withdrawal, but you’re not doing a withdrawal; you’re rolling over. You need to specifically ask if you can roll over the after-tax contribution while you are “in-service” with your employer. From what you wrote, I think you can. Does your 401k offer a Roth 401k option? If so, then you have the ideal which is after the money is put into the after-tax bucket of your 401k, you do an in-service rollover within your 401k to the Roth 401k portion of the account. If no Roth 401k exists for you or you can’t do an in-plan rollover, what I gather from the response above is you can ask for the after-tax contributions to be taken out for the purposes of a rollover to your own Roth IRA. If they can separate out the earnings on the after-tax contributions, then roll the earnings over to an IRA and then roll it back into your pre-tax 401k. If they cannot separate out the earnings, you’ll pay tax on the earning portion only. In order to minimize this, you should roll it over ASAP to minimize earnings (this is what I do). You’d need to ask how often you can roll the money out of your account. For some companies it might be 1x/yr, others it might be 1x/quarter. My plan is unlimited so every time I’m paid, I call the next day to get the after-tax portion out to rollover to my Roth IRA

    #189302 Reply
    Avatar billy 
    Participant
    Status: Physician
    Posts: 149
    Joined: 04/07/2016

    It does have a roth 401k option in it.  I will ask the specific questions you identified.  Thank you

    #189309 Reply
    Avatar billy 
    Participant
    Status: Physician
    Posts: 149
    Joined: 04/07/2016

    Got my answer back- its not a simple process.  The plan  does not allow me to do an inservice rollover into my 401k Roth.  It will allow a rollover of the contributions into an (outside the 401k) roth, but requires that I rollover the earnings into a traditional IRA at the same time.  This would require a paper (not online) process so it would likely take days to do for every contribution, or I would have to wait and remember to do it by the end of the year for each year’s contributions and earnings. I would also have to time it right to be able to convert the traditional portion of the IRA to the Roth (and pay the taxes on it) to not mess up my pro rata for my backdoor roths . It also does not allow me to roll the Roth IRA amount back into the 401k.  For just 3000-3500 in extra roth space/year (the max I can put in each year based on percentage allowed), I don’t think its worth it. I’ll just keep investing in my taxable once I max out my retirement account space.

    #190028 Reply
    Liked by JBME

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