What are the benefits of converting an after tax 401(k) to a Roth IRA?
I have a Fidelity 401(k) with about $1,400,000 invested. About $240,000 of it is after tax contributions. I read that upon retirement, I can convert the after tax contributions to a Roth IRA. Is this done to convert part of a 401(k) to a Roth IRA and avoid paying taxes on the gains? Can the remaining 401(k) stay or be rolled into a conventional IRA?
This is a great question. The answer is “the Mega Back Door Roth”. In September 2014, IRS Notice 2014-54 clarified the tax treatment of distributions from plan funds when the plan contains both pre-tax and after-tax amounts. According to the Notice, the pre-tax and after-tax portions of that distribution from the 401k plan can be split, allowing the pre-tax money to be rolled to a traditional IRA with no current taxable event, while the after-tax portion is converted, tax free, to a Roth IRA. You will want to confirm that this is how your distribution from the plan will work with both the plan custodian and plan administrator as well as with your tax advisor as this is not intended as tax advice. Certainly, the advantage of this is that you end up with an IRA direct rollover without generating current taxation and you also have achieved some tax diversification with the Roth IRA which is funded from the after tax contributions you made to the plan. There would be no current taxation on the Roth and it, under current rules, would grow tax free. Remember the 5 year aging rule. This is a great way to create a smart plan for diversifying your retirement assets from a tax perspective. Good luck!
Charlotte Dougherty is a registered representative of Lincoln Financial Advisors a broker/dealer (Member SIPC) and registered investment advisor. Dougherty and Associates is not an affiliate of Lincoln Financial Advisors. Lincoln Financial Advisors does not offer legal or tax advice. CRN-1935483-103017
Way to go. You've done a great job building your portfolio for your future needs. You read correclty, you can convert the after tax dollars to a Roth IRA. The advantage of the Roth is there is no required min distribution (RMD) age like there is for a traditional IRA, all gains, dividends and interest grow tax free and all distributions are tax free, under current tax law. Roth IRA assets also give you the opportunity for creative investment strategies. For example, since there is no RMD age, you could look at this "bucket" to be used in your 80's and beyond, given that, you could consider investing this portion more agressively than the IRA. You'll be able to roll over the pre-tax dollars to an IRA.
I think that you are in a good place, having a blend of taxable and tax-free money in retirement. If you do nothing, once you begin taking your RMD you will see that the entire balance is used to calculate the yearly distribution and it is pro-rated between the tax and tax-free amounts. If you placed the after-tax portion into a Roth IRA then it would not be subject to any RMD requirements. You may convert the pre-tax 401(k) into a traditional IRA. I hope that you have a happy retirement!
That's a great question.
First assumption: The only qualified investment dollars (IRA, 401k, etc) you have are the ones mentioned in this question.
Based on the information provided, when you are able to distribute your 401k (via retirement or in-service distribution) you can pull out the post-tax contributions and convert them to a Roth IRA without taxation.
In order for that to work properly, you cannot have any other IRA accounts. If you do, it becomes taxable on a pro-rata basis.
So you'd potentially want to leave the 401k as-is until the following tax year. Then you can be eligible to pull it out and put it into a traditional IRA.
*Please note: this is a complex transaction and the above should help clarify rules, not be taken directly as advice. Please consult your tax/investment advisor for additional details.
Yes, you can move the after-tax contributions to a Roth IRA upon retirement and allow that portion to grow tax-free. However, the gains while in the 401(k) on the after-tax money will be subject to taxation upon distribution. Depending on the 401(k) plan's rules, you might be able to leave the pre-tax portion in the 401(k) or you may need to roll it to an IRA if you want to move the after-tax contributions.
This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.
Josh Murray is a financial advisor located at Tupler Financial, 674 Route 202/206, Building 4, Suite 8, Bridgewater, NJ 08807. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member www.FINRA.org / www.SIPC.org, a Registered Investment Adviser. He can be reached at (908) 203-8811 or at firstname.lastname@example.org.