Do 401k balances figure into IRA cost basis allocation?
I understand that when someone takes an IRA distribution (whether in retirement, or for Roth conversion), the IRA basis divided by the total balance across all IRAs will determine the percentage that is not subject to taxation. Are 401k balances included in this calculation? And if not, can you shelter Rollover IRA balances from the calculation by moving them back into a 401k prior to converting a non-deductible IRA to a Roth, resulting in a higher percentage of the conversion being tax-free?
Thanks
Permalink Submitted by Alan Spross on Mon, 2007-09-17 18:12
No, a 401k balance is not included. The IRA balance includes all SEP IRAs, SIMPLE IRAs, and traditional IRAs owned by the taxpayer.
In answer to your second question, yes you can do that, the trick being able to convince your plan administrator to accept as much of pre tax balances of the above accounts as possible. For most people, the rollover (aka conduit IRAs) contain most of the pre tax money, so just getting those accounts trasnferred should increase the IRA after tax amount considerably, and reduce the % taxation on Roth conversions. Even though a taxpayer would not want to transfer the basis per Form 8606 to an employer plan, because they want to convert it, that fact does not suffice for many employer plans to make them fully comfortable that they are not getting non deductible contributions by accident.
FInally, under the Pension Protection Act, an employee may be able to convert directly from an employer plan to a Roth IRA starting next year. There is no need to first transfer to a traditional IRA, so these conversions will circumvent the pro rating of IRA basis per Form 8606. Of course, the employee must first be eligible to take distributions, and most cannot until they separate from service. Complete regulations from the IRS on this direct Roth conversion option have not yet been issued.