You have to pay taxes on the gains the post-tax investments made between the time they were purchased and when you perform the rollover.
Hopefully this is not too much of a hijack from the original question. I am confused....On the differences between a backdoor Roth, and a mega backdoor Roth, aka Roth conversion ladder. Let's assume for purposes of my question, everything is at Vanguard without mystery fees and weird rules. Let's also assume that I am in the 25% tax bracket, just because it is an easy number to work with.
Scenario 1Suppose I contribute $18,500 to a 401(k). Then, I roll it over into a traditional IRA. Then, I roll that over/convert that into a Roth IRA. I do this all within a week or so, the shortest period of time that it will take to process the rollovers. It gained a negligible amount during that week or so. I'm taxed at my usual rate on that gain. It isn't much tax because it was not sitting in the Traditional IRA long enough to gain a lot. Yay, now I have $18,500 growing in a Roth IRA that I won't be taxed on later....Can you really do that? Or can I only roll over $5500 per year that way? So, see scenario 2 below:
Scenario 2Suppose I contribute $18,500 to a 401(k). It just sits there. Then, I open a separate Traditional IRA. I put $5,500 into that Traditional IRA, and immediately roll it into a Roth IRA I opened for such purpose. Yay, now I have $5,500 growing in the Roth IRA. Did I get that right?
Scenario 3Suppose I contribute $18,500 to a 401(k). No employer match made. Then, I make after-tax contributions to that same 401(k) to bring my total up to $55,000. Then, I roll over the pre-tax part into a traditional IRA and roll over the after-tax part into a Roth IRA. Now my $36,500 is growing in a Roth IRA. Yay! Can I do this?
Long story short, this is the tax issue that I have been struggling to understand since I first discovered GCC and MF a little over a year ago. I haven't optimized it because I don't have a strong grasp of it, and until January of this year, I did not know what my tax bracket would be for 2017 for reasons that I won't get into here. I did not do an employer match because I'm self employed and was told that it would offer me no immediate tax benefit. When I asked my CPA what CPA knew about Roth rollovers, it was scenario #2 that was described for me and I was told about the $5500 limit. CPA didn't get into any "mega" stuff.
Please correct any of my misunderstandings in the above scenarios. And, assuming they're correct, how might one determine which scenario is best for someone who is still working and not in a low tax bracket? I am still Roth eligible, but the taxes on funding a Roth "now" are painful enough to motivate me not to do it. So far, the last three years, I've just funded the $18,500 in the traditional 401(k) for the tax break and decided I would worry later about how to access the money early. But, I want to have a solid intellectual grasp of this stuff today in case I decide to withdraw the money in the next few years.
Thank you.....