After-tax 401K to Roth IRA -- pro rata taxes

Submitted by supersonic_528 t3_yhrn3v in personalfinance

I have a Solo 401K plan for my business. The plan has been in existence for 3 years. For each of these years, I have contributed pre-tax dollars to it. I have only made one after-tax 401K contribution (non-Roth) so far, and that was for the tax year 2021. Also, I never contributed anything to Roth 401K (although the Solo 401K plan I have from solo401k.com supports it). Now I'm trying to find out if I can do a Mega Backdoor Roth conversion on this after-tax 401K funds and move them to a Roth IRA account.

I have two main questions.

A. Can I convert the after-tax 401K directly to Roth IRA? Or do I have to first do after-tax 401K to Roth 401K, and then Roth 401K to Roth IRA? I'm guessing both are probably legal, but might have different tax implications.

B. Since I have money in pre-tax 401K too, do I have to pay any pro-rata tax in the process?

Full background:

The business mentioned above is just a side business, and I have a full-time job. So besides the above two 401K accounts (pre- and after-tax), which are from my business, I have the following retirement accounts.

  1. Employer 401K.
  2. A traditional IRA, which I fund every year with after-tax dollars only (I'm not eligible to contribute to pre-tax traditional IRA).
  3. Roth IRA. After I fund my traditional after-tax IRA (#2 above), I almost immediately do a backdoor conversion and convert the funds in traditional IRA to Roth IRA.
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DeluxeXL t1_iufevex wrote

> Can I convert the after-tax 401K directly to Roth IRA? Or do I have to first do after-tax 401K to Roth 401K, and then Roth 401K to Roth IRA? I'm guessing both are probably legal, but might have different tax implications.

It will be called a rollover, not a conversion. But otherwise yes, you can move from after-tax 401k to Roth IRA.

> Since I have money in pre-tax 401K too, do I have to pay any pro-rata tax in the process?

No, but you have to deal with pro rata rule in the after-tax 401k alone. Your after-tax 401k account has

  1. after-tax contributions
  2. plus or minus pretax gains/losses

When you roll over from this account, both types of balances must go. You can roll over #1 to Roth IRA or Roth 401k, and #2 to the pretax account inside your 401k. Or, you can roll over both #1 and #2 to Roth IRA or Roth 401k, and pay tax on #2 if #2 is positive.

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supersonic_528 OP t1_iufirmm wrote

Great, thank you. The after-tax contribution was made only a couple of weeks ago, and the funds are just sitting in a bank account, so there's no gain/loss yet. But I get the idea. So I guess all I need to do is just move the funds from my after-tax 401K account to my Roth IRA account. Is there any tax form I need to fill out, or any other documentation I need to keep?

On that topic of after-tax contributions vs gain/loss from it, does the same rule apply when I am trying to do a regular (not mega) backdoor Roth conversion, that is, from my traditional after-tax IRA to Roth IRA? The traditional IRA account has a small gain (about $150). However, every year when I contribute to it (for example, $6000 this year), I just immediately convert it to Roth IRA. Is that okay, or am I supposed to pay tax on a pro-rata basis due to that small pre-tax gain?

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DeluxeXL t1_iufjjb5 wrote

> So I guess all I need to do is just move the funds from my after-tax 401K account to my Roth IRA account. Is there any tax form I need to fill out, or any other documentation I need to keep?

You need to tell the 401k custodian and the Roth IRA custodian that this is a rollover so that the 1099-R and 5498 are correctly coded.

> On that topic of after-tax contributions vs gain/loss from it, does the same rule apply when I am trying to do a regular (not mega) backdoor Roth conversion, that is, from my traditional after-tax IRA to Roth IRA?

In general, yes. However, unlike 401k, the IRS treats all of your IRAs (other than Roth IRA and inherited IRA) as one big IRA account.

> am I supposed to pay tax on a pro-rata basis due to that small pre-tax gain?

Yes, because of "one big account."

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supersonic_528 OP t1_iufmdti wrote

I see. If I understood it correctly,

  1. Pre-tax and after-tax 401K accounts are considered separate pools, so for the aforementioned after-tax 401K to Roth IRA rollover, no tax will be paid on pro-rata basis based on the amount I have in pre-tax 401K.

  2. However, for IRAs, pre-tax and after-tax IRAs are considered as part of the same pool, so for after-tax IRA to Roth IRA conversion, the pro-rata rule is in effect if I have funds in pre-tax IRA account.

Is that correct? Thank you.

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DeluxeXL t1_iufrp1x wrote

> Pre-tax and after-tax 401K accounts are considered separate pools, so for the aforementioned after-tax 401K to Roth IRA rollover, no tax will be paid on pro-rata basis based on the amount I have in pre-tax 401K.

Yes.

> However, for IRAs, pre-tax and after-tax IRAs are considered as part of the same pool, so for after-tax IRA to Roth IRA conversion, the pro-rata rule is in effect if I have funds in pre-tax IRA account.

Yes, in any of your non-Roth, non-inherited IRAs

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supersonic_528 OP t1_iuipyot wrote

As I mentioned earlier, my traditional IRA account does not have any pre-tax contributions. It, however, does have a small amount of gain (about $150), which is obviously not taxed (yet). I was wondering that in order to avoid the complications with pro-rata tax calculation associated with my regular backdoor Roth conversion (after-tax traditional IRA to Roth IRA) that I do every year, if it's better to simply not have any pre-tax money in my traditional IRA account. This will mean that I move this $150 too to the Roth IRA. However, I'm not very clear about the process. Do I just move the entire $150 now, and then pay the tax on that $150 when I file my taxes next year? Thanks!

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DeluxeXL t1_iuir0h5 wrote

It doesn't matter when you do it. You only need to do it once. Easiest is to do it at the same time when you do regular backdoor Roth.

  1. Contribute $6000
  2. Convert $6150.49
  3. Report the $150 income (Form 8606 parts 1 and 2, carried onto Form 1040)
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supersonic_528 OP t1_iujvz7g wrote

> Pre-tax and after-tax 401K accounts are considered separate pools, so for the aforementioned after-tax 401K to Roth IRA rollover, no tax will be paid on pro-rata basis based on the amount I have in pre-tax 401K.

Is this true, or am I missing something? I came across this link. It basically says that we do need to pay tax on a pro-rata basis if we are rolling over from an after-tax 401K account.

https://www.irs.gov/retirement-plans/rollovers-of-after-tax-contributions-in-retirement-plans

Can I roll over just the after-tax amounts in my retirement plan to a Roth IRA and leave the remainder in the plan?

No, you can’t take a distribution of only the after-tax amounts and leave the rest in the plan. Any partial distribution from the plan must include some of the pretax amounts. Notice 2014-54 doesn’t change the requirement that each plan distribution must include a proportional share of the pretax and after-tax amounts in the account. To roll over all of your after-tax contributions to a Roth IRA, you could take a full distribution (all pretax and after-tax amounts), and directly roll over:

  • pretax amounts to a traditional IRA or another eligible retirement plan, and
  • after-tax amounts to a Roth IRA.
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DeluxeXL t1_iuk20bq wrote

>> Pre-tax and after-tax 401K accounts are considered separate pools, so for the aforementioned after-tax 401K to Roth IRA rollover, no tax will be paid on pro-rata basis based on the amount I have in pre-tax 401K.

> Is this true

Yes, it is true. Each 401k subaccount is its own pool.

Your after-tax subaccount contains

  1. after-tax contributions
  2. pretax earnings, if any -- this only happens if you don't immediately roll out after your after-tax contribution.

When you roll out of this subaccount, you must roll out both 1 and 2 and nothing else.

The IRS agrees:

> Notice 2014-54 doesn’t change the requirement that each plan distribution must include a proportional share of the pretax and after-tax amounts in the account.

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vynm2 t1_iug58ye wrote

Does solo401k.com support in-service rollovers from the 401k to an IRA? Some solo-401k providers do, and some don't.

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supersonic_528 OP t1_iuguqnl wrote

I think it does, but I will double check. Thanks for mentioning this.

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vynm2 t1_iuijylk wrote

If it doesn't, it should allow rollover from the after-tax Trad-401k to the Roth 401k.

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