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?

401(k), IRAs, Taxes
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October 2017
33% of people found this answer helpful

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

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