Mega Backdoor Roth (IRA or 401k) with Fidelity

What is Mega Backdoor Roth?

“Mega Backdoor Roth” was a sort of loophole that has recently been directly addressed and sanctioned by the IRS. It takes advantage of a third type of 401k account that is generally seen as no better than a normal brokerage of after-tax money and allows you to convert to a Roth where your earnings can grow tax free. As of 2021, Congress is thinking about closing this “loophole”, but they haven’t done it yet and you still have time to take advantage of it!

There are three types of 401k “types” you can generally contribute to. You’ll know them as:

1. Traditional
2. Roth
3. After-Tax

(Commonly, Roth will be referred to as after-tax contributions because there are no deductions beforehand, but this is separate from actually have an after-tax account. An “After-Tax” account differs from traditional and Roth in that you are taxed going into and out of the account. It’s really no different than a normal brokerage account. However, the reason you do it is because of possibly protections provided by ERISA but mainly because of the “mega backdoor roth” technique.)

Because “after-tax” is funded with “after-tax” money, you can convert it into a Roth account without penalty on contributions (earnings will create a taxable event). This is advantageous because as of 2021, you can contribute:

• $19,500 maximum employee elective deferral (basically to traditional or Roth 401k)
• BUT $58,000 as defined contribution maximum

How do we get $58,000 in our accounts? Add up the following:

• Maximum employee elective deferral: $19,500
• Employer match (let’s pretend of 3% of 100,000):100,000): $3,000
• Any other defined contribution plans (let’s pretend you have an ESOP): $1,000

That adds up to $23,500. Which means, we can still add $34,500 to our 401k plan (with a $58,000 maximum). How do we get there? If you are allowed an “After-Tax” 401k, you can add more money to your 401k plan through these “After-Tax” accounts (though, some employers limit how much you can add or do not have such an account because of Highly Compensated Employee (HCE) testing).

Why do this?

The purpose of adding money to After-Tax accounts is not to leave the money there since it is taxed both contributions going in and earnings coming out, but to convert it to Roth where earnings can become tax free.

When do I do this?

When depends on your 401k plan and what it allows.

It is best to convert frequently during market growth periods in order to avoid paying taxes if you choose to convert your after-tax earnings, as well. This will mean that your money can go tax-free longer. The main reason not to do it frequently is if your plan does not allow it or if there are fees associated. Generally, within the Fidelity family accounts, you will not incur such a fee (dependent on your plan).

Some plans only allow rollover withdrawals (out to an IRA), if you are leaving the company, some do not. It is best to check what your plan allows.

Prerequisites

• Have a 401k plan that allows after-tax contributions beyond elective deferrals ($19,500 in 2021)
• In-plan/ in-service conversion or withdrawals
• Nice to have: Automatic conversion option as part of your 401k1

Thoughts to Consider

There are three decision points depending on how your 401k plan is set-up and whether all options are allowed. Given that you have a traditional, Roth, and after-tax 401k and both in-plan conversions and withdrawals, you may:

Question 1. Decide where you want your money to go

1. Convert after-tax 401k to Roth 401k (only if your company has a Roth 401k, some companies just offer After Tax & Traditional 401k)
2. Rollover after-tax 401k to a Roth IRA (it is generally easiest to do it within your provider, so within Fidelity)

Question 2. How you want to split your contributions vs earnings

1. Convert BOTH after-tax contributions and earnings to Roth (you will be taxed on earnings and receive a 1099-B at the end of the year but all of the earnings end up going to Roth)
2. OR Split:: After-tax contributions to Roth, After-tax earnings to traditional

Note: If you intend on doing normal Backdoor Roth (this is: Traditional IRA to Roth IRA since you are over the Roth IRA contribution limit), choose to convert your after-tax earnings to After-tax, as well to avoid the pro-rata rule on IRAs. Learn about the pro-rata rule here but essentially, all of your IRA accounts are treated as one large conversion. In a 401k, the pro-rata rule generally does not apply with companies like Fidelity since they do track traditional, Roth, and After-Tax funds separately. If it is co-mingled, though, then you will need to pro-rata your 401k, as well.

Question 3. If to a Roth IRA, where your Roth IRA is located

1. Within Fidelity is easiest and waives general fees (often, this is $20)
2. Outside of Fidelity, you want to try and get a direct rollover or trustee-to-trustee transfer. If you do a 60-day rollover (the checks are made directly to you), then there are some restrictions that may be in place.* See IRS explanation here. You will likely get two checks:

• 1 check will have your after-tax contributions — these may be deposited to any Roth IRA without incurring tax
• 1 check will have your after-tax earnings — these can be deposited to traditional accounts. If you deposit them to an after-tax account, you will likely get a 1099-B indicating that you have converted

How To’s with Fidelity

Step 1: Contribute to your after-tax 401k

Update your contributions so that you are contributing to your after-tax 401k.

1. Navigate to the NetBenefits.com portion of the site by: Either logging into Fidelity, selecting your 401k account, and clicking on Go to NetBenefits.com at the top right. Or logging into NetBenefits directly
2. Once you’re on the main page, select your 401k account (you may have several from previous employers)
3. Click on the Contributions tab
4. Click on the Contribution Amount link
5. If you have automatic conversion options1, then you can ignore the rest of the instructions. Just select to Convert My After-Tax Contributions

After each paycheck, your employer sends money to Fidelity. By law, the 401k provider must deposit the funds within 15 days of being deducted from your paycheck. This may vary with your employer.

To check whether your money has hit the account, go to the Summary tab of your 401k account and then scroll down. There should indicating what investments you have. This is the quickest summary of your fund allocation and sources. There should be a Show Details link under each to see the exact values allocated.

To check whether your money has hit the account, go to the Summary tab of your 401k account and then scroll down. There should indicating what investments you have. This is the quickest summary of your fund allocation and sources. There should be a Show Details link under each to see the exact values allocated.

Fidelity Investment Sources — make sure your after-tax contributions have actually shown up before contacting Fidelity. Show Details link is beneath each to evaluate in more detail.

Step 2: Convert After-Tax to Roth

There are generally two options:

1. Automatic after-tax conversions (this is available only if your company has this enabled with Fidelity. You can check with the Fidelity Workplace Planning Consultant if you don’t have that information
2. Calling in via phone

Step 2. Option 1 — Automatic conversions

If your plan supports automatic after-tax conversions (this is done within the 401k), then go ahead and select that. It is the easiest and quickest way of converting after-tax dollars to Roth and completing the Mega Backdoor Roth.

Automatic Roth In-Plan conversion

Step 2. Option 2 — via Phone

Unfortunately, there is no option to do an in-plan conversion or rollover of your after-tax portion of your 401k to Roth online for many 401ks.

If you do not have automated after-tax to Roth conversion, here is what you should do:

1. Call Fidelity Workplace Planning Consultants at: 866–630–9722

What to expect on the call:

1. Put in your social security number or username into automated system to identify and login with password if you have an online account
2. Record a message about what you would like (something like “rollover/convert after-tax to roth” is sufficient)
3. During the call, they’ll remind you to:

• Read the tax disclosure or have done this before. If you haven’t, they’ll explain to you some things. If you have, just say you have already
• Rep will indicate that any estimated gains that take place won’t be confirmed until the market closes (if you are making a call after the market closes, it’ll take place the next business day)
• Your conversion will be settled generally 2 days afterwards

4. They’ll typically also confirm your current address, etc

5. Check what you would like to do if rolling from 401k to IRA if the funds (generally institutional shares) are not available in our account. Basically, you can transfer in-kind or as cash. Anything that is not available in your normal Roth IRA would be transferred as cash.

• in kind - keep the mutual funds/ETFs as-is for those that qualify; investments that are institutional funds or those not available to individual accounts will be liquidated and transferred as cash
• OR in cash -sell/liquidate the stock and transfer the cash. This is the case if you are moving out of Fidelity.

Step 3: Viewing your results

Depending on what choices you made above, you can check your accounts to see where your money is once everything is settled.

After-Tax 401k to Roth IRA will show up in your Roth IRA account

After-Tax 401k to Roth 401k conversion will show up as a “Roth in-plan conversion”