Backdoor Roth 401(k)

Person contributes $19,000/year to the company Roth 401(k). They also contribute an additional $30,000/year as an after-tax contribution to the company 401(k). At the end of each year, the convert their $30,000 after-tax account into the company Roth 401(k). They now have made a $49,000 annual contribution to their Roth 401(k).

Is this allowable?

I had a client bring this up last tax season - I was skeptical but read up on it and it seemed valid. This is being pushed by some of the bay area tech companies.

From what I've read I think there is an intervening step that was not mentioned . After you make the after-tax contribution to your 401K plan, you then request an in-service withdrawal of the funds .You then rollover the money to a traditional IRA . Finally you convert the money from a traditional IRA to a Roth IRA .

This does not seem to be a very commonplace event because many employers don't offer in-service withdrawals or having a plan allowing contributions to a Roth 401K

For 2019 the additional after tax contribution has a max of $37,000 for someone under age 50 and $43,000 for someone age 50 or more .

From what I've read I think there is an intervening step that was not mentioned

I don't agree about the "intervening step" involving IRAs, but am not 100% sure. I looked at Pub 560 and TheTaxBook desk reference, and from what I can see the original transaction as described is valid.

This does not seem to be a very commonplace event because many employers don't offer in-service withdrawals or having a plan allowing contributions to a Roth 401K

And more importantly, it would only work for the wealthy (as with most sweet tax breaks these days). After all a $49K retirement contribution after tax is more like $70K before tax, and who but the wealthy can afford to put that amount of wage earnings into long term savings each year?

The Roth 401(k) contribution limits should have been lowered to account for the after tax effect (it's not a big enough difference at the IRA level to really matter as much, but with 401ks there is clearly an imbalance).

The steps indicated by luckyo are correct. The problem is that the in-service distribution has to meet certain criteria (if even allowed) as specified in the plan document. Age and financial hardship, again if allowed, are common restrictions.

A hardship distribution cannot be made to an IRA, so that is out.

luckyo and Doug M, There is nothing going to an IRA. There is no distribution out of the 401(k). The conversion occurs entirely within the 401(k).

New to me. I scanned quickly a couple of articles about the "mega" backdoor. There is testing for HCE's, which would be a big barrier. I would assume most people who are doing this would be in the HCE category.

Could not find any articles of "authority" on this.

I do not have access to the paperwork now, but one of my tech worker clients was offered this at their company.

Perhaps something like this:

https://best401k.com/tax-401k-roth-conversion/

Is it a good move though?

Who can afford this? Likely someone in a high bracket.

The article EZTAX linked discusses the conversion of the after-tax 401(k) into a Roth IRA. As previously discussed, this has additional requirements.

This article: https://www.betterment.com/resources/ho ... after-tax/ discusses the "In-Plan Roth rollover" which is what we are talking about, here - the conversion into the Roth 401(k).

Could not find any articles of "authority" on this.

But all you really need to support your and lucyko's position is anything in the code or regs that prohibits the original transaction as described (not involving any IRA transactions).

I don't agree about the "intervening step" involving IRAs, but am not 100% sure. I looked at Pub 560 and TheTaxBook desk reference, and from what I can see the original transaction as described is valid.

You are correct that the transaction is valid assuming that the plan document allows it. Not all plan documents do.

For the mega backdoor Roth to work, you need a plan document that allows post-tax employee contributions and then you need one of two additional things:

1. A provision allowing in-service withdrawals, or
2. A provision allowing in-plan conversions to a designated Roth account within the 401(k) plan.

If you have the first one, the result is the arrangement that lucyko described. If you have the second, the result is the arrangement that the OP described.

I looked at Pub 560 and TheTaxBook desk reference, and from what I can see the original transaction as described is valid.

There is nothing in pub 560 that refers to this type of transaction. Laughable.

There is nothing in pub 560 that refers to this type of transaction.

Exactly. So why immediately assume it is prohibited?

There is material in the pub that refers to several of the steps in the transaction, if not necessarily strung together in the same order as the OP scenario. The employer must have some reason why they think it is OK, or maybe a tax professional gave them some advice?

From what I've read I think there is an intervening step that was not mentioned

I don't agree about the "intervening step" involving IRAs, but am not 100% sure. I looked at Pub 560 and TheTaxBook desk reference, and from what I can see the original transaction as described is valid.

This does not seem to be a very commonplace event because many employers don't offer in-service withdrawals or having a plan allowing contributions to a Roth 401K

And more importantly, it would only work for the wealthy (as with most sweet tax breaks these days). After all a $49K retirement contribution after tax is more like $70K before tax, and who but the wealthy can afford to put that amount of wage earnings into long term savings each year?

The Roth 401(k) contribution limits should have been lowered to account for the after tax effect (it's not a big enough difference at the IRA level to really matter as much, but with 401ks there is clearly an imbalance).

I’m definitely not considered wealthy, but I have done this two years in a row, maxing out the contribution. I converted a taxable brokerage account to tax free money.

I’m definitely not considered wealthy, but I have done this two years in a row, maxing out the contribution. I converted a taxable brokerage account to tax free money.

So, you didn't have to fund it from wage earnings, you already had a sizable investment nest egg, correct?

No, you need to fund from wage earnings. What you do is superfund your retirement account and use your taxable account to cover your current expense shortfalls.

No, you need to fund from wage earnings. What you do is superfund your retirement account and use your taxable account to cover your current expense shortfalls.

Correct.

No, you need to fund from wage earnings. What you do is superfund your retirement account and use your taxable account to cover your current expense shortfalls.

I understood that. I was referring to the overall net cash flow, which in this case depends on existing after-tax investment to fund the Roth account.

The maneuver as described, at the high dollar level, doesn't really seem to be a tax incentive for the working/middle class to save for retirement, does it? Just a tax break for those who expect to be in the same or higher tax bracket when they retire than they are now ( kind of the definition of wealthy, maybe?)

Just a tax break for those who expect to be in the same or higher tax bracket when they retire than they are now ( kind of the definition of wealthy, maybe?)

I agree that this tax maneuver likely benefits the rich disproportionately, but I disagree on some of the details, including this one. For one thing, people who are just starting out their careers are often in a low tax bracket relative to where they will be later on, and the tax bracket for them may be the same when they retire. Also, business owners frequently have fluctuating profits, and they may also dip into years where their rate will be the same or higher on retirement when income is more stable.

For another thing, having a substantial Roth component to one's retirement savings is useful beyond the mere ability to pay tax now instead of later. The money can be withdrawn, to the extent of contributions, at any time with no mandatory withholding, tax, or penalties. I've had plenty of clients raid their retirement savings and eat the 10% penalty in order to cover a major expense. They would have been better off paying tax up front and contributing to a Roth.

Yes, the $19,000 + $30,000 per year setup described in post #1 is suggestive of an above-average earner. But how about $19,000 + $10,000? Keep in mind the $19,000 doesn't have to be Roth, it can be before tax.