401k automated daily conversions to Roth 401k

[azucena]

Last year, Fidelity starting servicing my company's 401k. I sat thru their Roth webinar yesterday which was mostly just a sales pitch for their advisor services. I did pick up this nugget that seems useful:



If I call them, they have a way to set up automated daily conversions from 401k deposits to Roth 401k. This minimizes taxation before earnings develop.



If it helps, I gross $200k with a bonus target of $50k. Last year our accountant had DH file separately (income $30k) and that gave him space for like $1500 Roth IRA deposit whereas I was still ineligible. It also saved us on taxes.



Both age 44 with retirement goal of 60.



I currently have almost $600k in my work retirement plan.

- 45% pre-tax 401k

- 25% company match which I think is also pre-tax

- 15% roth 401k (only became an option 5-6 yrs ago)

- 15% profit sharing which I think is also pre-tax

We have roughly $80k in other retirement accounts so my plan is the bulk of our retirement.



I currently have my elections set to

- 10% pre-tax 401k (will max at 22,500)

- 0% roth

- 7% after-tax (will max at 10,500)

I've gone back and forth on roth funding bc my current tax bracket is so darn high.



Do this automated daily conversion from 401k to Roth 401k solve that problem? Any pitfalls?

[azucena]

I found this Fidelity document (TVA is not my company, so not everything applies):

nb.fidelity.com/bin-public/070_NB_PreLogin_Pages/documents/tva_RothInPlanConversionGuide.pdf

It kinda makes it sound like the automatic conversion could/would apply to my after-tax deposits too.

[minnesotapaintlady]

I'm confused.  What's the point of contributing to a traditional 401K and converting?  Why not just contribute to the Roth 401K directly?

Unless they're talking about AFTER-TAX contributions to 401K.  Do you have the mega backdoor Roth option?  Where you can put like another 30K or more in after tax? 

eta:  Ok, read your post more carefully and realized you were doing after-tax.   Yes, it will help on taxes if you were letting it build up and converting just once a year before.  What is the problem you're trying to solve?  Having your husband file separately?

[azucena]

I've mostly been maxing trad 401k space to save on taxes now. If I continue doing that and then daily convert then my earnings will not be taxed either, right?

Trying to minimize taxes now and in retirement.

[minnesotapaintlady]

Feb 16, 2023 12:57:08 GMT -5 azucena said:

I've mostly been maxing trad 401k space to save on taxes now. If I continue doing that and then daily convert then my earnings will not be taxed either, right?

Trying to minimize taxes now and in retirement.

Yes, you should definitely max your pre-tax first at that income.  You have been converting the after-tax to Roth every year though right?  Please say yes.

The daily conversion should completely eliminate any post-tax earnings because they roll to Roth immediately.  

[teen persuasion]

Feb 16, 2023 12:57:08 GMT -5 azucena said:

I've mostly been maxing trad 401k space to save on taxes now. If I continue doing that and then daily convert then my earnings will not be taxed either, right?

Trying to minimize taxes now and in retirement.

What are you daily converting?  After-tax - yes, that sounds like mega-backdoor Roth - convert ASAP.  Pre-tax - no, don't convert that!  You will be taxed on the conversion.

[azucena]

Feb 16, 2023 13:36:36 GMT -5 teen persuasion said:

Feb 16, 2023 12:57:08 GMT -5 azucena said:

I've mostly been maxing trad 401k space to save on taxes now. If I continue doing that and then daily convert then my earnings will not be taxed either, right?

Trying to minimize taxes now and in retirement.

What are you daily converting?  After-tax - yes, that sounds like mega-backdoor Roth - convert ASAP.  Pre-tax - no, don't convert that!  You will be taxed on the conversion.

My plan only added after tax option last yr and no, I didn't convert it. I guess I can convert last year's now and pay the taxes due on one yr of earning.

I thought the way fidelity presented it, I could convert the pretax 401k daily too to completely avoid taxes.

I haven't done any backdoor because I don't follow it and haven't had time and head space to figure it out. Afraid I'll make a mess of things if I don't do it right. So I've given myself grace and just keep shoveling money in bc that's the most important part.

[minnesotapaintlady]

Feb 16, 2023 13:40:15 GMT -5 azucena said:

Feb 16, 2023 13:36:36 GMT -5 teen persuasion said:

What are you daily converting?  After-tax - yes, that sounds like mega-backdoor Roth - convert ASAP.  Pre-tax - no, don't convert that!  You will be taxed on the conversion.

My plan only added after tax option last yr and no, I didn't convert it. I guess I can convert last year's now and pay the taxes due on one yr of earning.

I thought the way fidelity presented it, I could convert the pretax 401k daily too to completely avoid taxes.

I haven't done any backdoor because I don't follow it and haven't had time and head space to figure it out. Afraid I'll make a mess of things if I don't do it right. So I've given myself grace and just keep shoveling money in bc that's the most important part.

You should definitely convert the after-tax stuff.  That's the big draw.  Otherwise, you're better off putting it in a taxable account that doesn't have all the 401K rules and taxes based on the capital gains rate and not as normal income.

You can't convert the pre-tax.  Well, you CAN, but you won't get the tax break.  The converted amount will be added back on as income, so kind of a pointless exercise when you could have just put it in the Roth 401K to begin with. 

[teen persuasion]

If you put money in pre-tax, you get a tax break now, because that money isn't included in your taxable income.  You are taxed on it when you withdraw, or convert, it and its earnings later.

If you put money in Roth, it is after-tax because it IS included in your taxable income.  When you withdraw it later contributions are always tax free, earnings are tax and penalty free after age 59.5.

If you contribute after-tax, it too is included in your taxable income NOW.  Withdrawals later will be tax free for only the amount you contributed, not the earnings - they will be taxed.  Worst of both worlds - no tax break up front, none on earnings later.  But you CAN convert them to Roth - if done immediately, no earnings to get taxed.  That's the point of daily conversions - contribute to After-tax, convert immediately and it's almost as if you'd just contributed to Roth in the first place (but it's extra, above the contribution for pre-tax and Roth buckets).  That's why it's called a mega backdoor Roth - you can get extra Roth savings, but have to sneak it in thru the backdoor via conversions.

[Annie7]

We have the "before-tax", "after-tax" and "Roth 401K" options. I started contributing all my 401K contributions to the after-tax bucket this year. 

Currently 95% of my savings is in pre-tax. My goal is to diversify and not have too much RMD later in life. For this, I was told to NOT contribute to the "Roth 401K". It apparently has the same RMD as a traditional 401K. So, I'm contributing to "after-tax" and having Fidelity convert it to my Roth IRA. Some of my colleagues have been calling every pay check to convert their after-tax contributions to Roth IRA. I think that's what you might want to do. 

[teen persuasion]

Secure Act 2.0 changed things - no RMDs on Roth 401k beginning in 2024.  Even before then, you just need to roll a Roth 401k over to a Roth IRA to avoid RMDs.

[bean29]

Ok, 

I read the link.  I max my 401K and am putting 4,850 into Roth with 22,150 going to conventional 401K.  If I could utilize the Mega Back Door Roth, I would probably max the conventional 401K and contribute additional $$ to after tax.  I would probably invest about what I am putting into the conventional Roth.  I am however 59, so I don't know if I should bother-it says if you don't have a 5 year timeline, it may not be worth it b/c the funds have to be invested for a minimum of 5 years.  I plan to retire at 65 or 66.

I fired off an email to our Plan Manager to see if we can add this or not.  I would probably be the only one here that would take advantage of this unless officers/family members can also participate.

Eta., I just realized my limits are carried over from 2022.  I can do 30,000 this year.  I adjusted the conventional to 23,267 and the Roth to 6,733 for now. My contributions were correct, just the limits were wrong.

[teen persuasion]

Feb 20, 2023 10:52:34 GMT -5 bean29 said:

Ok, 

I read the link.  I max my 401K and am putting 4,850 into Roth with 22,150 going to conventional 401K.  If I could utilize the Mega Back Door Roth, I would probably max the conventional 401K and contribute additional $$ to after tax.  I would probably invest about what I am putting into the conventional Roth.  I am however 59, so I don't know if I should bother-it says if you don't have a 5 year timeline, it may not be worth it b/c the funds have to be invested for a minimum of 5 years.  I plan to retire at 65 or 66.

I fired off an email to our Plan Manager to see if we can add this or not.  I would probably be the only one here that would take advantage of this unless officers/family members can also participate.

Eta., I just realized my limits are carried over from 2022.  I can do 30,000 this year.  I adjusted the conventional to 23,267 and the Roth to 6,733 for now. My contributions were correct, just the limits were wrong.

That's an odd way to say it - invested isn't the issue.  I assume they are referring to a five-year rule about Roth conversions "seasoning" or aging before withdrawal so no penalties are assessed.  There's another five-year rule: you have to have a Roth account open/funded at least 5 years before any earnings can be withdrawn penalty-free (after you are also age 59.5).  But if you are already contributing to Roth 401k (some years old), and you are already 59, and don't foresee withdrawing down into earnings and conversions immediately - what's the issue?  

Do you already have a Roth IRA?  How old is that account, <5 or 5+ years? Once you reach 59.5 and your Roth IRA is at least 5 years old, you can withdraw without tax/penalty from it.
Chart from Bogleheads' Wiki on when Roth IRA distributions are qualified.

I'm not as clear on fine distinctions with a Roth 401k, since it's an employer account; there might be differences - can you withdraw from an employer plan while employed, or not until after leaving?  When you leave, will you roll it to a Roth IRA or leave it there?  For the mega-backdoor Roth, is that in-plan conversion to Roth 401k, or in-service distribution out to a Roth IRA (different plans choose different paths)?

Your direct Roth contributions always come out before any earnings or unseasoned conversions (giving conversions more time to season, unless you are draining the account in one go).

Bogleheads' Wiki has more detailed info: Mega-backdoor Roth

[jerseygirl]

Thinking the 5 year rule applies to taking out earnings - but the money put in to fund the Roth account can be taken out before the 5 years.

[minnesotapaintlady]

Feb 20, 2023 14:44:30 GMT -5 jerseygirl said:

Thinking the 5 year rule applies to taking out earnings - but the money put in to fund the Roth account can be taken out before the 5 years.

There's a few 5 year rules.  Regular contributions to a Roth IRA can be taken out at any time.  Earnings you need to be over 59 1/2 and the account has to have been open for at least 5 years.  Conversions do not count as "regular" contributions until they've sat for 5 years.  So you can't just convert a Traditional IRA when you're 50 and then immediately take it out as a Roth contribution...but you can in 5 years.  That's why Roth conversion ladders are popular for early retirement.

[bean29]

Our income is too high for me to open a roth ira. It will be a bit before I can take it out then. My DH will have to retire first. I guess I will just switch to regular 401K.

[minnesotapaintlady]

Feb 21, 2023 5:51:47 GMT -5 bean29 said:

Our income is too high for me to open a roth ira. It will be a bit before I can take it out then. My DH will have to retire first. I guess I will just switch to regular 401K.

You can still do a backdoor Roth IRA.  But, if you prefer just using the Roth 401K instead, the 5 year rule is from the date of the first contribution, not that every dollar contributed needs to sit for 5 years.  Also, it's not like you're going to need access to ALL your retirement funds at the beginning of your retirement.  Just let the Roth grow until it can be withdrawn while using other funds.  I don't plan on tapping mine until a decade into retirement just because that's the most valuable retirement savings.

[bean29]

Feb 21, 2023 8:38:00 GMT -5 minnesotapaintlady said:

Feb 21, 2023 5:51:47 GMT -5 bean29 said:

Our income is too high for me to open a roth ira. It will be a bit before I can take it out then. My DH will have to retire first. I guess I will just switch to regular 401K.

You can still do a backdoor Roth IRA.  But, if you prefer just using the Roth 401K instead, the 5 year rule is from the date of the first contribution, not that every dollar contributed needs to sit for 5 years.  Also, it's not like you're going to need access to ALL your retirement funds at the beginning of your retirement.  Just let the Roth grow until it can be withdrawn while using other funds.  I don't plan on tapping mine until a decade into retirement just because that's the most valuable retirement savings.

I actually probably won't need to hit my retirement savings until DH retires, and I fully expect him to work until 68 or so.  By the time I retire most of our Debt will be paid off. He is a year younger than me, so I probably won't need to touch my savings until 5 years after I retire.  At that point both of us could tap our SS, I don't know if we will wait any longer at that point or not.

[teen persuasion]

Feb 21, 2023 5:51:47 GMT -5 bean29 said:

Our income is too high for me to open a roth ira. It will be a bit before I can take it out then. My DH will have to retire first. I guess I will just switch to regular 401K.

If I understand correctly that you are already contributing at least some to your Roth 401k, that Roth is open and the clock is already ticking.  What year did you first make contributions to it?  They just count tax years, not 365-days-in-a-year open - so if you open it on Dec 31 it counts as open that whole year.

Still wondering how your plan does mega-backdoor Roth: in-plan conversions to Roth 401k (so stays in the plan), or in-service distributions (which you roll into a Roth IRA).  Income doesn't prevent you from opening a Roth IRA, it just prevents you from contributing directly to a Roth IRA. That's why this is called mega-backdoor Roth - contributions are thru the backdoor. Some people will convert a tiny bit of tIRA to Roth, just to create and fund a Roth IRA to get the clock ticking.

The backdoor Roth IRA that mpl was mentioning is similar, yet different.  You make a contribution to a (non-deductible) traditional IRA and immediately convert it to Roth.  However, if you have ANY existing traditional IRA funds, they mess it up due to pro-rata rules.  If no prior tIRA funds, then all of your new contribution was after-tax, so no tax to convert.  If prior tIRA funds, they are ALL treated as one big IRA and your conversion of the new contribution is pro-rated over the total, so you are taxed on that pro-rated portion.  Simple example: you have $94k in previous tIRA, make new $6k non-deductible contribution for backdoor Roth.  When you convert that $6k, 6% is non-taxable & 94% is taxable because of your previous tIRA balance.  Not worth doing, unless you can somehow eliminate the tIRA balance beforehand - roll it into an employer's plan.  If you have zero existing tIRA balances, backdoor Roth is straightforward.

Another thing to remember is that IRA accounts are Individual - your accounts are separate from your spouse's accounts. So perhaps only one of you has a tIRA blocking a backdoor Roth - the other can do their own backdoor Roth IRA.

The biggest draw of a mega-backdoor thru your employer plan is that you can contribute much more than the $6500/7500 Roth IRA limits, even after maxing your traditional 401k to capture all the tax deduction.  Hence the mega- qualifier.  It's always going to be after-tax $$, but instead of going into taxable and having tax drag it can go into Roth and be tax-free forever!

[teen persuasion]

A discussion of this issue on Bogleheads, with links to appropriate IRS page: link

[bean29]

Feb 21, 2023 10:11:43 GMT -5 teen persuasion said:

Feb 21, 2023 5:51:47 GMT -5 bean29 said:

Our income is too high for me to open a roth ira. It will be a bit before I can take it out then. My DH will have to retire first. I guess I will just switch to regular 401K.

If I understand correctly that you are already contributing at least some to your Roth 401k, that Roth is open and the clock is already ticking.  What year did you first make contributions to it?  They just count tax years, not 365-days-in-a-year open - so if you open it on Dec 31 it counts as open that whole year.

Still wondering how your plan does mega-backdoor Roth: in-plan conversions to Roth 401k (so stays in the plan), or in-service distributions (which you roll into a Roth IRA).  Income doesn't prevent you from opening a Roth IRA, it just prevents you from contributing directly to a Roth IRA. That's why this is called mega-backdoor Roth - contributions are thru the backdoor. Some people will convert a tiny bit of tIRA to Roth, just to create and fund a Roth IRA to get the clock ticking.

The backdoor Roth IRA that mpl was mentioning is similar, yet different.  You make a contribution to a (non-deductible) traditional IRA and immediately convert it to Roth.  However, if you have ANY existing traditional IRA funds, they mess it up due to pro-rata rules.  If no prior tIRA funds, then all of your new contribution was after-tax, so no tax to convert.  If prior tIRA funds, they are ALL treated as one big IRA and your conversion of the new contribution is pro-rated over the total, so you are taxed on that pro-rated portion.  Simple example: you have $94k in previous tIRA, make new $6k non-deductible contribution for backdoor Roth.  When you convert that $6k, 6% is non-taxable & 94% is taxable because of your previous tIRA balance.  Not worth doing, unless you can somehow eliminate the tIRA balance beforehand - roll it into an employer's plan.  If you have zero existing tIRA balances, backdoor Roth is straightforward.

Another thing to remember is that IRA accounts are Individual - your accounts are separate from your spouse's accounts. So perhaps only one of you has a tIRA blocking a backdoor Roth - the other can do their own backdoor Roth IRA.

The biggest draw of a mega-backdoor thru your employer plan is that you can contribute much more than the $6500/7500 Roth IRA limits, even after maxing your traditional 401k to capture all the tax deduction.  Hence the mega- qualifier.  It's always going to be after-tax $$, but instead of going into taxable and having tax drag it can go into Roth and be tax-free forever!

Thank you for the clarifications.

So, I Rolled over a previous 401K plan to an IRA, and then a few years later rolled my pension from an employer over to same IRA.  So I have $157,142.78 in an IRA at Vanguard.  This will prevent me from effectively utilizing a mega back door Roth from what you are saying, but I should use the fact that my husband does not have any IRA savings to save via Mega Backdoor Roth in his name.  

For Clarification, my Roth401K started in 2014 and I only have $11,684.45 in that account.

My 401K investments with current employer are $295,630 (including the Roth401K balance of $11,684.45).
and Former employer $175,054 (I was able to leave it with them b/c of the size of the account).
I worry that we don't have enough saved, DH has no worries at all.  Says we have plenty of $$.  He says he will get more than 2M payout from current employer, but that will be taxable, so I don't look at it the same way he does.
We will have the house and 2 rental properties paid off (all debt) at retirement.
I am right now panicking at the idea of a market crash similar to 2008? and a long recovery period.  Last year I lost more that I contributed.  

So, the best thing to do, is when I start making withdrawals, use the Vanguard IRA funds first, but it may not work at all for us, as like I said, mu DH will likely continue to work for a bit.  I will do some Roth in his name in the meantime.

[teen persuasion]

Feb 24, 2023 11:31:57 GMT -5 bean29 said:

Feb 21, 2023 10:11:43 GMT -5 teen persuasion said:

If I understand correctly that you are already contributing at least some to your Roth 401k, that Roth is open and the clock is already ticking.  What year did you first make contributions to it?  They just count tax years, not 365-days-in-a-year open - so if you open it on Dec 31 it counts as open that whole year.

Still wondering how your plan does mega-backdoor Roth: in-plan conversions to Roth 401k (so stays in the plan), or in-service distributions (which you roll into a Roth IRA).  Income doesn't prevent you from opening a Roth IRA, it just prevents you from contributing directly to a Roth IRA. That's why this is called mega-backdoor Roth - contributions are thru the backdoor. Some people will convert a tiny bit of tIRA to Roth, just to create and fund a Roth IRA to get the clock ticking.

The backdoor Roth IRA that mpl was mentioning is similar, yet different.  You make a contribution to a (non-deductible) traditional IRA and immediately convert it to Roth.  However, if you have ANY existing traditional IRA funds, they mess it up due to pro-rata rules.  If no prior tIRA funds, then all of your new contribution was after-tax, so no tax to convert.  If prior tIRA funds, they are ALL treated as one big IRA and your conversion of the new contribution is pro-rated over the total, so you are taxed on that pro-rated portion.  Simple example: you have $94k in previous tIRA, make new $6k non-deductible contribution for backdoor Roth.  When you convert that $6k, 6% is non-taxable & 94% is taxable because of your previous tIRA balance.  Not worth doing, unless you can somehow eliminate the tIRA balance beforehand - roll it into an employer's plan.  If you have zero existing tIRA balances, backdoor Roth is straightforward.

Another thing to remember is that IRA accounts are Individual - your accounts are separate from your spouse's accounts. So perhaps only one of you has a tIRA blocking a backdoor Roth - the other can do their own backdoor Roth IRA.

The biggest draw of a mega-backdoor thru your employer plan is that you can contribute much more than the $6500/7500 Roth IRA limits, even after maxing your traditional 401k to capture all the tax deduction.  Hence the mega- qualifier.  It's always going to be after-tax $$, but instead of going into taxable and having tax drag it can go into Roth and be tax-free forever!

Thank you for the clarifications.

So, I Rolled over a previous 401K plan to an IRA, and then a few years later rolled my pension from an employer over to same IRA.  So I have $157,142.78 in an IRA at Vanguard.  This will prevent me from effectively utilizing a mega back door Roth from what you are saying, but I should use the fact that my husband does not have any IRA savings to save via Mega Backdoor Roth in his name.  

For Clarification, my Roth401K started in 2014 and I only have $11,684.45 in that account.

My 401K investments with current employer are $295,630 (including the Roth401K balance of $11,684.45).
and Former employer $175,054 (I was able to leave it with them b/c of the size of the account).
I worry that we don't have enough saved, DH has no worries at all.  Says we have plenty of $$.  He says he will get more than 2M payout from current employer, but that will be taxable, so I don't look at it the same way he does.
We will have the house and 2 rental properties paid off (all debt) at retirement.
I am right now panicking at the idea of a market crash similar to 2008? and a long recovery period.  Last year I lost more that I contributed.  

So, the best thing to do, is when I start making withdrawals, use the Vanguard IRA funds first, but it may not work at all for us, as like I said, mu DH will likely continue to work for a bit.  I will do some Roth in his name in the meantime.

How does your employer do mega-backdoor Roth - in-plan conversions? You can still do mega-backdoor Roth, it stays in your 401k and is converted to Roth 401k.  If you HAVE to do in-service distributions out to a Roth IRA, your existing tIRA might get in the way, I'm not sure if it rolls directly to Roth or not.

Your existing tIRA definitely gets in the way of *you* making backdoor Roth IRA contributions ($6500/7500). If your DH has no tIRA, he could contribute to a Roth IRA via the backdoor (not mega).

The names are too similar, but mega-bd Roth is for employer 401k plans - but might end up in either Roth 401k or Roth IRA depending on rules; *just* bd Roth (not mega) is for IRA contributions.

If your Roth 401k started in 2014 it is over 5 years old, that 5 year rule is already met.


So, if I have it straight, you have roughly:
157k tIRA
175k 401k
284k 401k

11k Roth 401k

DH has, sometime in the future:
2000k ? taxable? Do you mean a lump sum taxable payout? Or something that can be rolled into a 401k/tIRA and is treated as all pre-tax, so withdrawals are all taxable as OI, no Roth at all?

If I assume DH's part gets rolled to a tIRA, you'd have a combined $2.6m; at a 4%SWR that's $104k/yr inflation adjusted.  Which is really close to what the RMD would be at age 75 (divisor 24.6) on that total.  You'd have future SS, too - likely taxed at fully 85% with those withdrawals/RMDs.  If that's enough, now, do you need to save more?  How much will things grow in the meantime?  When will you claim SS?  If there is a gap until SS, it can give you time/room to do Roth conversions before RMDs kick in. 

_____________________________________

Just went back to reread your first post.  I think you want to contribute the max $22500 to pre-tax (traditional) 401k for the tax deferral now.  Then also contribute the max you can to after-tax in your 401k, and use the automated daily conversions on the after-tax $$ ONLY to convert it to Roth 401k.  You can contribute much more to retirement each year this way (assuming that is your goal), and get a bigger chunk of it in Roth (vs taxable if you are limited to $22500 contributions).

Why is your after-tax max only $10500?  It looks like the combined limit for 2023 is $66k, so your after-tax limit should be $66k - $22.5k - matching - profit sharing, whatever that comes out to.  
May be a plan limit, I guess.

Something else struck me - DH filing MFS to be able to do $1500 Roth IRA.  Usually filing MFS makes it impossible for spouse to contribute to a Roth IRA unless their income is below $10k, and then it's still reduced. 


Realized the first post is not yours. No wonder I feel confused.