Consider the following scenario:
- John Q. Public has a high enough MAGI that he is not eligible to make Roth IRA contributions (and hence also cannot deduct traditional IRA contributions).
- John also has an employer-provided 401(k) with the following features:
- A Roth 401(k) is available.
- In-plan Roth conversions are available.
- The plan can be retained even after John ceases to be employed.
- Cessation of employment makes John eligible for distributions from the 401(k), subject to the usual penalties.
- John wishes to retire prior to the age of 59½, meaning that he will not have access to anything in his 401(k) or IRA, with the exception of Roth principal that has had 5 years to season.
- John, like all rational actors, wishes to avoid taxes to the extent permitted by law.
Given this scenario, consider the following plan:
- John never contributes to a traditional IRA, except to make contributions that are immediately backdoored into a Roth IRA. This ensures that John never pays taxes pro rata on the traditional fraction of his IRA balance.
- While John is employed, John makes yearly backdoor Roth IRA contributions and traditional 401(k) contributions up to the IRS limit. This saves John taxes at his marginal rate on the amount contributed to the 401(k).
- John quits his job sometime before the age of 59½.
- Starting in the year he quits, and continuing for 5 years, John subsists on money from taxable accounts, plus Roth IRA principal, plus 5-year-seasoned earnings from his Roth IRA. John only pays long term capital gains taxes on money from his taxable accounts, which could be $0 if John's taxable income stays within the 15% bracket.
- Starting in the year he quits, and continuing until he turns 54½, John performs an in-plan conversion on his 401(k) to bring his income up to some suitable level (say, the top of the 15% income bracket, or whatever its future equivalent is). John pays regular income taxes on the converted amount, at a low marginal rate.
- Starting 5 years after he quits, and continuing until he turns 59½, John subsists on whatever principal plus 5-year-seasoned earnings is left in his Roth IRA, plus the newly-available principal plus 5-year-seasoned earnings from his converted Roth 401(k). John pays no taxes on this specifically, but continues to pay taxes on the ongoing conversions (above) until he turns 54½.
- Starting when John turns 59½, he does whatever, since all his retirement savings are now available.
My question is basically "does that all sound right?".
The reason I ask is that under most circumstances, backdoor Roth IRA contributions are incompatible with a Roth conversion ladder. For the former, you want to have zero traditional IRA assets so you're not taxed on the conversion; for the latter, you obviously have to have tax-deferred assets to convert.
However, by putting the tax-deferred assets into a 401(k) and doing the entirety of the laddering within the 401(k), it seems like you can both have your cake and eat it, too - you can do backdoor Roth IRAs without ever paying the pro rata tax on the traditional fraction of your total IRA balances and still have a ladder going within the 401(k).
So - does that all sound right?
(I'm aware that there's risk involved in this plan if Congress decides to make changes to how retirement account taxes work; ignore that for now and assume that current tax law prevails for the rest of time.)
