Mega backdoor: After-tax 401k -> Roth IRA in employer's plan while having an existing pre-tax traditional IRA with a different institution

Question

I've read up on the mega backdoor - the limits, the rules, 55k IRS limit (for 2018), how withdrawals work etc. While going through all of it I happened to come across some people saying - to avoid tax complications, make sure to either not have any pre-tax traditional IRAs or, if you do, roll them over to your employer's pre-tax 401k before doing the mega backdoor conversions.

Now the question is, would this problem exist in my situation where I have:

• pre-tax 401k rolled over into Betterment's trad. IRA from prev. employer
• Roth 401k rolled over into Betterment's Roth IRA from that same employer
• intention to start after-tax 401k with new employer in a Vanguard account and roll the funds over to a Roth IRA in the same Vanguard account

Basically, I'm not going to mix pre-tax, after-tax or untaxed funds in any of my accounts. Do I still need to roll over the Betterment traditional IRA to my employer's 401k to avoid additional tax complication?

Answer 1

I'm guessing you heard about how an existing pre-tax Traditional IRA interferes with the regular backdoor Roth IRA. To avoid income limits on direct Roth IRA contributions, you first make a non-deductible Traditional IRA contribution (no income limits) and then quickly convert. Since there are minimal earnings the taxes are nominal. However, if you have existing pre-tax IRA money, the conversion considers all your accounts, and the money comes proportionally from pre-tax and after-tax balances (the pro rata rule). Converting pre-tax money means it is taxed like regular income.

With the mega backdoor Roth, you contribute to an after-tax (but non-Roth) 401(k). When you do a rollover, the after-tax contributions can be moved into a Roth IRA, and the earnings on those contributions can either be moved into a Traditional IRA, or you can pay regular income tax on them to convert them to the Roth IRA as well. Since you are doing a conversion of pre-tax money anyway, it doesn't matter if you have other pre-tax money, as you are already paying regular income tax on it. Anyway, since it's a 401(k) to IRA conversion, I don't believe the pro rata rule applies.

So, having an existing pre-tax Traditional IRA does not interfere with the mega backdoor Roth. If you wanted to do a regular backdoor Roth in addition, it would indeed be an issue, and you'd have to roll it in to your pre-tax 401(k).

Answer 2

Yes, you will have the issue.

It doesn’t matter if the moneys are practically separated by accounts, providers, or even by time; the IRS considers them ‘mixed’ if they were in the same class of savings during the same calendar year.

The consequence of the mixing is not that you cannot do it, it just makes the tax filing a lot more complex. Your different providers will not know about each other, so their statements will not reflect the mix. You will have to do all the math during the filing, and it becomes complicated to follow the instructions.