Understanding After Tax 401k in Plan Roth Conversion

You can convert after-tax 401k contributions to a Roth IRA, but the process is a bit more complicated than a traditional conversion. The IRS considers after-tax 401k contributions as already being taxed, so you won't be able to convert them to a Roth IRA in the same way you would with a traditional 401k.

The good news is that you can still use the after-tax 401k funds to pay for a Roth IRA conversion, but you'll need to pay taxes on the converted amount. This is because the IRS considers the conversion to be a taxable event, even if the original contributions were made with after-tax dollars.

The key is to understand that after-tax 401k contributions are considered to be already taxed, which affects how you can use them in a Roth IRA conversion.

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In-plan conversions allow you to convert after-tax contributions in your 401(k) to a Roth 401(k) inside the plan.

You can do an in-plan conversion even if there isn't a clear opportunity to do so during the year. If that's the case, you can convert the contributions at the end of the year, and you'll be in the same tax position as if you had contributed to the designated Roth account all year.

In-plan conversions can result in a permanent tax savings for the employee and a permanent loss for the government. For example, if you have a $10,000 contribution and it's worth $9,000 after a 10% correction, the taxes on the conversion would be $2,160, but the difference of $240 from the paychecks would be a permanent tax savings.

The actual correction is not 10%, but rather 7.6%, because the employee now owns 100% of the $9,000. The government no longer has a claim on any future growth.

If you have after-tax contributions in your 401(k) and your employer's plan allows in-plan Roth conversions, you can convert the after-tax contributions (and associated gains) to a Roth 401(k). You'll receive a 1099-R form showing the gross distribution, and you'll need to report it in Turbo Tax Deluxe 2023.

When reporting the in-plan conversion in Turbo Tax, you'll get a prompt asking if it's a rollover or a conversion. You should answer "No", because an in-plan conversion is not the same as a rollover.

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Here are some key factors to consider when deciding whether to do an in-plan conversion:

Keep in mind that in-plan conversions can be complex, so it's essential to understand the strategy before making a decision.

In-plan Roth conversions can be a great way to optimize your after-tax 401(k) contributions. You can convert after-tax contributions to a Roth 401(k) within your plan, which can provide tax-free growth and withdrawals in retirement.

To do an in-plan Roth conversion, you'll need to check with your employer to see if it's an option. Some plans may offer automatic conversions, while others may require you to request the conversion. It's essential to understand the benefits and limitations of in-plan Roth conversions, as they may not offer the same flexibility as a Roth IRA.

In-plan Roth conversions can provide tax-free growth and withdrawals in retirement, but it's crucial to consider the potential benefits of leaving assets in your 401(k), such as institutional pricing and creditor protection.

Here are some key takeaways to consider:

In most plans, the source of the contribution is maintained even if the funds are converted from a pre-tax or after-tax contribution. This is important when considering withdrawal options before age 59½ while still employed.

Many plans allow pre-59½ withdrawals of after-tax contributions and rollover contributions. You can roll after-tax money in a workplace plan, like a 401(k), into a Roth IRA.

To roll after-tax money into a Roth IRA, earnings on the after-tax balance must, in most cases, also be rolled over. Depending on the plan, it may be necessary to roll over any other pre-tax money too.

Pre-tax contributions are deducted from your salary before income taxes are taken out, and employer contributions to the plan, such as matching funds and profit sharing, can also be pre-tax contributions made to the plan. In retirement, all withdrawals of pre-tax contributions and the attributable earnings on them would be taxed as ordinary income.

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Roth contributions are made after taxes have been taken out of your salary, and when Roth contributions, along with any attributable earnings on them, are withdrawn from a plan in retirement, no taxes or penalties would be due as long as the withdrawals are qualified.

The IRS allows employees to contribute up to $23,000 combined in pre-tax and Roth contributions to workplace plans. The IRS also allows for after-tax employee contributions to a plan. These contributions, combined with the $23,000 elective deferral limit and any profit-sharing or match offered by an employer, have a limit of $69,000 in 2024.

Those who are age 50 and above can make an additional employee contribution of $7,500. In retirement, withdrawals of after-tax contributions would be tax-free, but any earnings on the after-tax contributions would be taxed as ordinary income.

Some employers offer a Roth 401(k) option and also allow participants to convert after-tax contributions into an in-plan Roth account. In some cases, it may make sense to roll over your after-tax contributions to a Roth inside your plan rather than outside.

Flexibility is a key benefit of a Roth IRA, allowing for penalty-free withdrawals for a first-time home purchase or qualified education expenses like going to graduate school. After certain requirements are met, converted balances within Roth IRAs may be withdrawn without taxes or penalties for other purposes as well.

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A Roth IRA may provide more investment choices than are typically available in an employer's plan, although an employer's plan may also offer institutionally priced investments and/or customized plan options not available in an IRA.

In-plan Roth conversions, like the one I did, allow you to convert after-tax contributions to a Roth 401(k) without leaving the plan. You'll need to report this as a taxable event, but it's a great way to get tax-free growth and withdrawals in the future.

Here are some key points to consider when deciding on a rollover:

You can roll over after-tax money in a workplace plan, like a 401(k), into a Roth IRA, and the earnings on after-tax contributions are treated as pre-tax money.

To roll over after-tax money into a Roth IRA, earnings on the after-tax balance must also be rolled over in most cases, and any pre-tax money in the plan may also need to be rolled over.

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Rolling pre-tax balances into a traditional IRA or after-tax balances into a Roth IRA is not a taxable event, but it's essential to consult a tax advisor to ensure you're not losing other potential tax advantages.

You can contribute up to $23,000 in pre-tax and Roth contributions to a workplace plan in 2024, and the IRS also allows for after-tax employee contributions, which have a limit of $69,000 in 2024.

High-income taxpayers have used mega backdoor conversions to Roth 401(k)s as a tax shelter, which has come under scrutiny by the House and Senate, but this practice is still allowed under the law.

If you have after-tax money in your traditional 401(k), 403(b), or other workplace retirement savings account, you can roll over the original contribution amounts to a Roth IRA without paying taxes, as long as certain rules are met.

In the most straightforward scenario, you would roll over the entire account balance out of the workplace plan and direct the after-tax contributions to a Roth IRA and pre-tax contributions and earnings to a traditional IRA.

You can roll out only a portion of the after-tax balance, but to roll over a partial amount of after-tax contributions, a proportional amount of associated earnings must also be rolled over.

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If you've separated from service, you can do a full rollover of the plan to IRAs, and the after-tax contribution amount can roll to a Roth IRA with no tax liability.

You can execute a transfer—a conversion—of pretax contributions and untaxed account earnings to a Roth 401(k), and subsequent earnings in the account accumulate tax-free.

Distributions from Roth 401(k)s are tax-free and generally must begin when the owner reaches age 72.

Here's a summary of the types of contributions you can make to a workplace retirement plan:

Remember to consult a tax advisor before making any decisions to ensure you're not losing other potential tax advantages.

Taxes on earnings from after-tax contributions can be a bit tricky. The IRS considers earnings in a 401(k) or other workplace retirement plan to be pre-tax, so you'll owe income tax when you withdraw the earnings.

You've already paid taxes on after-tax contributions, so withdrawals from a 401(k) or workplace plan are tax-free in retirement. However, the earnings are a different story.

Earnings in a Roth IRA aren't subject to income tax as long as all withdrawals from the account are qualified withdrawals.

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If you have after-tax money in your 401k and are still working for the employer and under 59 ½, you can talk to your plan administrator about in-plan Roth conversion.

You pay tax on the earnings accumulated since contribution, which can be a significant amount. For example, if you had contributed $50,000 in after-tax funds to your 401k and it was now worth $75,000, you would convert $75,000 to Roth inside the plan.

You would receive a 1099R to include in your 2021 taxes, and $25,000 of the conversion amount would be subject to income tax this year.

If you've separated from service, you can do a full rollover of the plan to IRAs. The after-tax contribution amount can roll to a Roth IRA with no tax liability.

The pre-tax portion of the plan can roll into a traditional IRA, allowing you to continue deferring taxes on the earnings.

Your employer may permit an in-service full distribution if you're still employed and over 59 ½, which can allow you to execute the same strategy described under "separated from service."

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Please talk to your plan administrator about options.

In a designated Roth 401(k) conversion, you pay income tax on the transfer of your pretax contributions and untaxed account earnings, but this can lead to significant tax savings over the years.

The participant can execute a transfer—a conversion—of those monies to a Roth 401(k), and the subsequent earnings in the account accumulate tax-free.

Distributions from Roth 401(k)s are tax-free and generally must begin when the owner reaches age 72.

You can roll over the original contribution amounts to a Roth IRA without paying taxes, as long as certain rules are met.

The IRS allows for a few different scenarios, but not all may be allowed by your plan.

In the most straightforward scenario, you would roll over the entire account balance out of the workplace plan and direct the after-tax contributions to a Roth IRA and pre-tax contributions and earnings to a traditional IRA.

If the plan allows partial withdrawals and allows source-specific withdrawals, one could take a rollover of just the after-tax source balance, which includes both the after-tax contributions and all of the associated earnings.

A proportional amount of associated earnings must also be rolled over if you choose to roll out only a portion of the after-tax balance.

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If your employer's plan allows in-plan Roth conversions, you can convert after-tax contributions to a Roth 401(k) account, even if you're still working for the employer and under 59 ½.

You can also consider a backdoor Roth 401(k) conversion, which involves transferring both pretax and after-tax contributions from a regular 401(k) account to an employer-designated Roth 401(k) account.

If your plan has after-tax contributions, you may be able to make contributions to that account and convert them immediately to Roth, reducing any gains that would result in a taxable event on the conversion.

In some cases, it may make sense to roll over your after-tax contributions to a Roth inside your plan rather than outside, especially if you have greater flexibility in terms of withdrawals before retirement.

If you've separated from service, you can do a full rollover of the plan to IRAs, allowing you to roll the after-tax contribution amount to a Roth IRA with no tax liability.

Here are some key differences between rollovers and conversions to consider:

Keep in mind that some plans may have restrictions on in-plan Roth conversions, so it's essential to check with your plan administrator before making any decisions.

Criticisms of after-tax 401(k) in plan Roth conversions have been growing, with some calling it an unfair advantage for senior corporate executives. Many large corporations, including AT&T, Inc., Aon PLC, and Facebook, Inc. (now Meta), are offering this conversion opportunity.

High-income taxpayers have been using mega backdoor conversions to amass enormous, permanently tax-sheltered investments in Roth vehicles. The benefits of Roth 401(k)s favor higher-income taxpayers over those with lower incomes.

The maximum Roth IRA contribution for 2024 is $7,000, plus $1,000 for employees ages 50 and above, which is far less than the contribution limits for 401(k) accounts. Annual income limits restrict eligibility for Roth IRAs, with $240,000 for married couples filing jointly and $161,000 for single individuals in 2024.

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High-income taxpayers have used mega backdoor conversions to amass enormous, permanently tax-sheltered investments in Roth vehicles. This has attracted criticism from financial writers and policymakers.

The benefits of Roth 401(k)s favor higher-income taxpayers over those with lower incomes. The contributions allowed to regular 401(k) accounts are far higher than the ceiling amounts for Roth IRAs. The maximum Roth IRA contribution for 2024 is $7,000, plus $1,000 for employees ages 50 and above.

Annual income limits restrict eligibility for Roth IRAs, with a limit of $240,000 for married couples filing jointly and $161,000 for single individuals in 2024. There are no income limits that apply for participation in a 401(k), though plans will have rules about when employees qualify to participate.

The transfer of regular 401(k) balances to designated Roth 401(k)s in backdoor conversions vastly increases the already significant tax benefit differential.

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The Proposed Legislation aimed to limit Roth conversions by prohibiting the rollover of after-tax 401(k) contributions to a designated Roth 401(k) account or Roth IRA, except for rollovers of after-tax contributions and untaxed earnings that would be taxed on transfer.

This limitation was part of a larger plan to use the tax money generated to fund some of the spending required by the Build Back Better Act.

The Proposed Legislation also included changes to required minimum distributions and tax-reporting obligations for plan administrators.

The Build Back Better Act failed to pass, but parts of it were incorporated into the Inflation Reduction Act, which did pass, but did not address backdoor conversions.

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A 401k in-plan Roth conversion is a great way to reduce taxes in retirement, and it's especially beneficial for those who expect to be in a higher tax bracket in the future. This means you'll pay taxes now, but at a lower rate.

By converting a portion of your 401k to a Roth IRA, you'll be able to withdraw the converted amount tax-free in retirement. In fact, one example shows a 25-year-old converting $100,000 to a Roth IRA, which would be worth $1.2 million by age 65.

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You can convert up to $100,000 per year, and the conversion is not subject to the 20% penalty for early withdrawals. However, you'll still need to pay taxes on the converted amount in the year of conversion.

The tax implications of an in-plan Roth conversion can be complex, but it's worth considering if you're in a lower tax bracket now and expect to be in a higher bracket later.

After tax 401k in plan Roth conversion can be a complex process, but it's worth exploring the benefits. The 2020 tax law changes allow you to convert after-tax 401k dollars to a Roth IRA, which can provide tax-free growth and withdrawals in retirement.

This move can be especially beneficial for those who expect to be in a higher tax bracket in retirement, as it can help you avoid paying taxes on your withdrawals. The key is to consider your individual circumstances and whether this strategy aligns with your overall financial goals.

Fidelity Viewpoints is a resource that provides educational information, not tailored investment advice for specific investors. This means you can use it to learn about investing, but you shouldn't rely solely on it to make investment decisions.

The information in Fidelity Viewpoints is designed to be educational, so it's not a substitute for personalized advice. It's like reading a book on investing, but you still need to talk to a financial advisor to get advice that's right for you.

Fidelity Viewpoints is a valuable resource for learning about investing, but it's essential to keep in mind that it's not a substitute for professional advice.

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Legislative proposals to limit or eliminate mega backdoor Roth and 401(k) conversions have been supported by important members of the House and Senate tax-writing committees.

No legislation has been passed to address these conversions, despite efforts to do so.

The Build Back Better Act, introduced by President Biden, aimed to tackle these conversions, but it stalled in Congress.

The Inflation Reduction Act, which incorporated parts of the Build Back Better Act, was passed, but it did not address the backdoor conversions, which remain allowed.

Mega backdoor Roth and 401(k) conversions are still allowed, despite ongoing discussions and proposals to limit or eliminate them.

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