Maxing Annual Additions Plus Funding Backdoor Roth

[AJC]

I have a client under age 50 who makes $500K annually and has been contributing the annual additions limit under his 401(k) plan and also contributing to a backdoor Roth (via traditional IRA) for the past half-dozen years or so. I just learned about the client funding the backdoor Roth. The client's investment broker says, all is well. I admit that I have not been this close to a backdoor Roth before. Is it possible to contribute the annual additions limit in the 401(k) plan (all pre-tax) and fund a backdoor Roth? How is it possible without exceeding the annual additions limits? And if it is wrong, how is it corrected?

[Lou S.]

Has he been contributing the 415(c) annual addition limit, or the 402(g) annual 401(k) limit, or maybe both through combo of ER and ER contributions?

Typically when you hear backdoor roth inside a plan it involves making after tax voluntary contributions and then converting them to roth inside the Plan. This usually only works in 1 man plans where you don't need to worry about ACP testing, plans that cover only HCEs so again no ACP testing, or larger plans that easily pass the ACP test even with the voluntary after tax contributions.

As for the back door IRA you seem to know what that is and how and when it works which is separate from the plan so I won't go over that one.

[david rigby]

Time for a DB plan?

[MWeddell]

There is nothing wrong with what your client is doing.  The 415 limit on annual additions is not affected by IRA contributions.

[CuseFan]

Backdoor Roth via traditional IRA - OK, provided it was thru non-deductible IRA contributions and all conversion rules followed.

Agree with David that it could be time for a DBP, especially if this is a solo/no employees situation.

 

[AndyH]

On 9/8/2020 at 5:58 PM, Lou S. said:

Typically when you hear backdoor roth inside a plan it involves making after tax voluntary contributions and then converting them to roth inside the Plan. This usually only works in 1 man plans where you don't need to worry about ACP testing, plans that cover only HCEs so again no ACP testing, or larger plans that easily pass the ACP test even with the voluntary after tax contributions.

Lou describes it well as usual.

But I'll add that it also obviously works for NHCEs.   (including situations involving Top Paid Group election or first employment year for example)

[AJC]

Thank you all for sharing your expertise!

[austin3515]

6 hours ago, CuseFan said:

provided it was thru non-deductible IRA contributions and all conversion rules followed.

I want to add some emphasis here.  If your client has a rollover IRA with Fidelity that has $100,000, and then contributes $6,000 nondeductible to a Charles Schwab IRA, then youre client has made a big mistake.  Why?  Because when you convert $6,000, $100,000 / $106,000 * $6,000 is taxable income.  You have to add up ALL IRA's when figuring out how much of the conversion is taxable.

The workaround is to roll that $100,000 into the qualified plan.  But I'm sure this is missed all the time which is why I mentioned it here.

[acm_acm]

15 hours ago, austin3515 said:

I want to add some emphasis here.  If your client has a rollover IRA with Fidelity that has $100,000, and then contributes $6,000 nondeductible to a Charles Schwab IRA, then youre client has made a big mistake.  Why?  Because when you convert $6,000, $100,000 / $106,000 * $6,000 is taxable income.  You have to add up ALL IRA's when figuring out how much of the conversion is taxable.

The workaround is to roll that $100,000 into the qualified plan.  But I'm sure this is missed all the time which is why I mentioned it here.

Correct.  An individual only has *one* IRA of each type, traditional and Roth, with the former being composed of deductible and nondeductible contributions.  All of the separate *accounts* in the traditional IRA are to be considered together as a single traditional IRA.