What’s Wrong with Back Door 401k Contributions
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What’s Wrong with Back Door 401k Contributions

To Find out What’s Right About Backdoor Roth 401k Contributions go to the Blog at https://www.401keasy.com/blog

To Find Out What’s Wrong with Back Door 401k Contributions, Read the Following:

1) An employee using the Back Door Roth Contribution (BDC) feature must earn less than $140,000 in adjusted gross income if filing as a single taxpayer or $208,000 if filing jointly with a spouse.

2) The BDC strategy was devised in 2010 but never formally approved by the IRS. Experts disagree on how the IRS will ultimately treat the BDC. Still, if the IRS rules against the BDC, all BDC money will be subject to a 6% excise tax penalty, plus taxes. The BDC could also potentially harm the company’s 401k and expose it to audits and penalties.

3) Suppose the employer is exceedingly generous with profit-sharing contributions and gives employees significant vested matching. In that case, this will narrow the amount of the BDC the employee can utilize.

4) The Pro-Rata Rule: 401k withdrawals are generally subject to the IRS “pro-rata” rule. This rule states that a 401k participant cannot exclusively withdraw pre-tax or post-tax 401k contributions. The 401k participant must withdraw amounts equal in ratio to the contribution sources.

Example:

Suppose the 401k participant has a balance of $100,000. $80,000 of this balance came from pre-tax contributions, and $20,000 of this balance came from post-tax Roth contributions. Because of the pro-rata rule, 80% of the in-service withdrawal must be from pre-tax contributions. It must be transferred to a regular IRA Rollover. The remaining 20% of the withdrawal must be from Roth or other after-tax contributions and transferred directly into a Roth IRA Rollover. The Regular IRA Rollover can never be co-mingled with the Roth IRA Rollover. Essentially, for every dollar the 401k participant withdraws using the in-service feature, 80 cents must be from pre-tax 401k savings, and 20 cents must be from post-tax 401k savings, thus preserving the ratio.