PurpleToolBox

Can someone explain how to fund a Roth by the "back door" approach?

FDXLAG

Backdoor Roth IRA - Bogleheads

Talk to an investment guy but my understanding is:

the easiest way to think of it is you take IRA contributions that you have already paid taxes on and convert them. The catch is if you have tax deferred IRA money you have to convert some of that too.

Pretend you do not have a traditional IRA because you make too much money to get the tax deferral. You open a traditional IRA with already taxed income and then you can convert 100% to a Roth.

If you already have 10k in an IRA that has been tax deferred and you add another 10k of taxed money to it than you can convert it but you will pay income tax on 50% of anything you convert.

busdriver12

A backdoor Roth can be very uncomplicated if you have no other IRAs (you can have 401K's with no tax consequences). It gets a little tricky, if you have other traditional IRAs, like FDXLAG says, then you will have to pay some taxes. But if you don't, really consider doing a backdoor. This deal will not last forever.

Most of us don't qualify for the Roth because we make too much money. However, you can put money into an after tax IRA, and immediately convert it to a Roth. You only pay taxes on your gain from what was in the IRA and when you converted it. So if you convert the same day, there will be no tax. Totally legal, ethical. I advise opening up an investment account with Vanguard (free). They make it easy, and in fact they will tie it into your 401K account, so you can look at it all on the same page.

PurpleToolBox

Thanks for the explanations.

Nightflyer

Are there any tax implications to this?

In other words, can you take out only the money you have already paid taxes on?

Several years ago, one guy told me you could. Another guy told me they had changed the rules, and you had to take out a mixture of after tax money (what you had put in after taxes) and earnings on that money. You would then be liable for the taxes on the earnings.

Also, is this a "borrow against your 401k" situation? Or can you just take out money and not put it back in?

I am thinking this might be a good way for some of us to save money for our kids' college.

Good idea or not?

Flyinhigh

The file and suspend with Social Security has some up side and some down side to it. The biggest negative is that it is a program run by the government and can be changed at any time. I opted to get my hands on the money as soon as I turned 65. Thanks to a fat vacation buy back check followed six months later by the non-qualified lump sum pension check, we didn't need to use the Social Security funds so they went straight in to a tax exempt bond fund at Vanguard as after tax money. The fund has accumulated a little over $50,000 in just over two years since I retired. Next year thanks to the run up in our 401(K) I have set up to start taking distributions to keep the balance below a certain level so that RMDs wont hurt us too bad when I turn 70 1/2. So the SS checks keep going to Vanguard for the next year. If this plan works out I will have enough in the Vanguard fund (which I control) that I can augment SS with after tax and tax exempt funds to cover any down turn in the market and our 401(K). If my math is correct I should be able to pay myself a larger payment than I would have under file and suspend. Also, if I pass away in the next few years, the Vanguard fund goes to my spouse to augment the SS survivor benefit.
File and suspend is complicated and you need to talk to a professional to see if it is right for you. It is never too early to start planning for this stuff.

CompetentFool

Flyinhigh - can you please explain what this item is: "followed six months later by the non-qualified lump sum pension check". I've never heard of a non-qualified lump sum pension check. I assume you retired from Fedex. Maybe not tho.

Flyinhigh

Every year the IRS set the maximum limit you could earn under a defined benefit pension plan that was considered "qualified." Last year (I think) it hit$260K so the maximum earnings under the CBA for FedEx matched the qualified limit. Several of the years that I had for my high five, the limit was $225, $230 or $240 so the amount I earned above that limit was considered "nonqualified." In 2004 (I think)the CBA was changed so the non-qualified was paid in a lump sum rather than over the life of the pension. There is a formula to figure out what the lump sum amount is but I have no idea what it is. When you get your pension statement the lump sum nonqualified calculations will be included. I started requesting pension estimates about four years before I retired so I could try to understand all of this stuff. Hope this helps.

Raptor

Talking about your After Tax Contributions to the FedEx 401(k) which is called the Federal Express Corporation Pilots' Retirement Savings Plan:

Today, you can no longer specify the type of money you take out contributions versus earnings. Your contributions are tax free, but your earnings are not. And, if you're under 59 1/2 you will suffer a 10% IRS penalty on the earnings (not the entire withdrawal).

You are free to make up to two withdrawals a year of After Tax Contributions. (You can take loans out against your 401(k) itself, but this money must be repaid. You will suffer tax consequences if you don't repay a loan and you can suffer early withdrawal penalties if the loan wasn't done for a hardship.) But, in our case, we're talking about a withdrawal of money from your After Tax Savings--this money doesn't have to be repaid. You can log into Vanguard and go to the Employer Plans--Manage My Money--Manage My Loans and Withdrawals area. There you can see the amount of the After Tax Contributions you've made that are withdrawable.

Let's say you have made $20,000 of contributions over the years to After Tax Savings. And, during these years, you've made a $5000 gain. Your account would show you have $25,000 available to withdraw. Let's say you decided to take $12,500 out and send it to your bank account. There is no way to specify contributions versus earnings to be withdrawn, so Vanguard will assume (this is simplified, but the numbers are close) $10,000 is non taxable and $2,500 is taxable. You will receive a 1099 at the end of the year for your tax return. The catch here is that while the contributions are not subject to tax or penalty, the EARNINGS are. You will pay tax at any age and a 10% penalty on the earnings if you take them out prior to 59 1/2. As part of this process you must choose how much withholding to take on your distribution with an IRS required federal minimum of 20% on the earnings. You aren't required to make a minimum withholding on state. Therefore, taking out $12,500 of $25,000 After Tax Savings will result in $2,500 of taxable income and a 10% penalty on the $2,500 = $250 if you're under 59 1/2. You must take a minimum 20% withholding on the earnings which is $500. Therefore, your amount deposited in your bank account is $12,500 - $500 = $12,000. At tax filing time, you'll have to pay/account for the penalty of $250 if you're under 59 1/2. You could also avoid a penalty by rolling over your After Tax Savings withdrawal within 60 days into an IRA, or doing it directly on the Vanguard site.

If you're over 59 1/2 then After Tax Savings acts like a savings account in some ways. If you're under 59 1/2 when you make withdrawals, be aware of tax penalties on the EARNINGS.

Standard disclaimer: I am not a tax professional or attorney, if you have questions talk to one, or Vanguard.

Raptor

I did some more research and found this on how to avoid the 10% penalty on 401(k) After Tax Savings Earnings that are distributed directly to you. Have to rollover the money within 60 days:

60-Day Rollover

Step 1
Set up a traditional IRA. If you have an existing traditional IRA and you wish to use it for your 60-day rollover, you can. Inform your custodian or trustee that you have received a distribution from a qualified plan and wish to roll the funds over into your traditional IRA.
60-Day Rollover

Step 2 Deposit the proceeds from your qualified plan distribution with your IRA custodian or trustee within 60 days of receiving the distribution. Your old plan administrator is required to withhold 20 percent from your qualified plan distribution and send it to the IRS for taxes. To avoid paying taxes and an early withdrawal penalty on the 20 percent withholding, you will have to contribute an amount equal to the amount withheld to your new IRA from another source along with the remaining distribution proceeds.

There is also a provision I've read on some websites that 401(k) After Tax Savings withdrawals may avoid the 10% penalty on Earnings when the proceeds are used "for certain college expenses", but I also read on Forbes that this exception only applies to IRA early withdrawals and not 401(k) early withdrawals, so I would certainly do further research on the college expense exception.

See IRS Topic 413 - Rollovers from Retirement Plans
and IRS Topic 558 - Additional Tax on Early Distributions from Retirement Plans, Other Than IRAs Tax Topics - Topic 558 Additional Tax on Early Distributions from Retirement Plans, Other Than IRAs

More information on rollovers: Publication 575 (2013), Pension and Annuity Income

And this is the form 5329 information you'll have to file to recapture any early withdrawal penalties: http://www.irs.gov/pub/irs-pdf/i5329.pdf

Your financial planner would be familiar with this, or even Turbo Tax. I've used Turbo Tax for years and while complicated, you can use it to account for all kinds of retirement distribution options.