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My employer allows after-tax 401k contributions, and has an option for automatic quarterly after-tax 401k -> Roth 401k in-plan conversions. The other option for executing the mega backdoor Roth is to do an out-of-plan conversion, in which I can convert the after-tax 401k contribution to a Roth IRA, and the earnings on the after-tax 401k to a TradIRA.

Let's set up some numbers as an example. Let's say I contribute $10k after-tax, and my earnings before conversion are $1k.

Case 1: In the first case (in-plan conversion), I will have $11k in my Roth 401k, and I will have to pay income tax on the $1k.

Case 2: In the second case (out-of-plan conversion), I will have $10k in my Roth IRA, and $1k in my TradIRA. And I pay no income taxes.

Let's say at this point I've left my employer and the 401ks have been rolled over into IRAs. My primary question is about the consequences for withdrawal of principal (not earnings) in these two scenarios. Say I need $10k now.

Case 1: I have $11k in a Roth IRA. I can withdraw $10k from this whenever I want without tax consequences or penalty.

Case 2: I have $10k in my Roth IRA, and $1k in my TradIRA. I can withdraw $10k from my Roth IRA whenever I want without tax consequences or penalty.

Is all of this right so far?

If this is all right, I have a followup question about the ordering of withdrawals. Say I did in-plan conversions for 2 years with my employer, every year contributing $10k, and earning $1k before the conversion happens. Now I have $22k in my Roth 401k. Now I leave my employer and roll this over into a Roth IRA. Can I withdraw $20k from the Roth IRA without penalty? I'm concerned about the order of contributions and that I will have to pay some penalty on the portion of the withdrawal that comes from the $1k that was taxed.

(Assume for all of this discussion that I am under 59 years old and have had a Roth account for less than 5 years. Since this is all about withdrawing principal, this shouldn't really matter.)

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3 Answers 3

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The key word is 'After-Tax' money - you started with after-tax money, so you already paid taxes on it.

Everything else is just moving it from freely available into ROTH, which locks it away a bit, but makes the interest tax-free.

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  • 5
    I paid taxes on the principal, yes. But the earnings of $1k are untaxed and were in a 401k. I agree that I can withdraw the principal without penalty, I'm concerned with the earnings. The earnings are treaded similarly to pre-tax 401k, and hence will have a 10% penalty attached to them if withdrawn within 5 years of Roth conversion.
    – Jimothy
    Commented Sep 17, 2017 at 22:12
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Your plan makes sense as long as the money in the Roth 401K is indeed eligible for immediate withdrawal.

If at all possible, do the conversion immediately so you don't have to fool around with accountng for earnings (which may be negative, remember.) It's disappointing that the 401K provider makes you wait until intervals.

Given a choice between a 401K and an IRA, always choose a 401K unless the investment options are hopelessly terrible. The reason is that 401K's have pretty much bulletproof liability protection. If you default on some credit cards, get in a car accident and get sued, have a health problem and declare medical bankruptcy, or just have a divorce, the 401K is practically untouchable. Whereas the IRA is less well protected, varying state by state.

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  • 401ks often have higher fees and fewer investment options, and I've never heard of the improved asset protection you speak of, can you provide any sources for that bit of information?
    – Glen Pierce
    Commented Dec 17, 2017 at 3:30
  • Ok I'll do a minute's worth. ERISA has an anti-alienation provision that prohibits transfer of an interest in a 401k to a third party. You couldn't give your 401k to your creditor if you wanted to. IRAs are not covered by ERISA unless something has changed. Asset Protection: Concepts and Strategies - Adkisson/Risser p. 103-106.
    – Harper - Reinstate Monica
    Commented Dec 17, 2017 at 3:40
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    @GlenPierce 401(k)s are protected in bankruptcy by federal laws whereas IRAs depend on state laws (though in most cases they are also protected).
    – Craig W
    Commented Dec 17, 2017 at 16:43
  • @GlenPierce These days, 401(k) providers tend to offer more options, especially if you're with a major provider — Fidelity has BrokerageLink, Schwab has Schwab Personal Choice Retirement Account, Vanguard has Self-Directed Brokerage… admittedly the federal immunity from civil judgements is a pretty niche upside, but the downside you name is also increasingly niche.
    – JamesTheAwesomeDude
    Commented Jun 19 at 0:52
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Case 1: I have $11k in a Roth IRA. I can withdraw $10k from this whenever I want without tax consequences or penalty.

Case 2: I have $10k in my Roth IRA, and $1k in my TradIRA. I can withdraw $10k from my Roth IRA whenever I want without tax consequences or penalty.

Is all of this right so far?

Yes, this is correct.

If this is all right, I have a followup question about the ordering of withdrawals. Say I did in-plan conversions for 2 years with my employer, every year contributing $10k, and earning $1k before the conversion happens. Now I have $22k in my Roth 401k. Now I leave my employer and roll this over into a Roth IRA. Can I withdraw $20k from the Roth IRA without penalty? I'm concerned about the order of contributions and that I will have to pay some penalty on the portion of the withdrawal that comes from the $1k that was taxed.

Yes, you can withdraw $20k from the Roth IRA without any tax or penalty. Contributions from the Roth 401(k) turn into contributions in the Roth IRA, and contributions come out first in withdrawals from Roth IRA.

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  • Do you have a source that after-tax 401(k) contributions, rolled into a Roth IRA (possibly via Roth 401(k)), are treated like direct Roth IRA contributions? It makes sense that they would be, but I haven't seen anything definitive. And is the rest treated as earnings or rollover?
    – Craig W
    Commented May 2, 2018 at 0:42
  • @CraigW: Roth 401(k) contributions rolled into a Roth IRA would be Roth IRA contributions. Traditional 401(k) amounts (pre-tax and after-tax) rolled into a Roth IRA should be treated as a conversion, not a contribution; in that case, only the part of the conversion that was taxable would have a penalty on withdrawal within 5 years. In the case where only the after-tax part was rolled over into Roth IRA (and the pre-tax part rolled over into Traditional IRA), the entire conversion would have been non-taxable, and thus there is no penalty on withdrawal even within 5 years.
    – user102008
    Commented May 2, 2018 at 0:55
  • OK, I think we're on the same page. But I'm not sure I agree with your last paragraph. Wouldn't the entire $22k be a non-taxable rollover, meaning if this was their only Roth IRA money, the whole amount could be withdrawn immediately without tax or penalty?
    – Craig W
    Commented May 2, 2018 at 1:08
  • @CraigW: Maybe; I wasn't sure about that last $2k so I only answered regarding the $20k since that was what was asked in the question. In-plan conversion to Roth 401(k) has a 5-year recapture period during which withdrawing the taxable portion has a 10% penalty. I am not exactly sure how this works when it is rolled over to Roth IRA. I will need to read further on this.
    – user102008
    Commented May 2, 2018 at 2:42
  • If the $2k maintains its taxable status after another rollover, then technically it would be withdrawn first and subject to a 10% early withdrawal penalty. So you actually couldn't withdraw $20k without tax or penalty.
    – Craig W
    Commented May 2, 2018 at 3:16

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