Converting after-tax 401k money to roth
2 questions:
Example:
Under 100k agi. 30k after tax, 70k pre-tax. Plan sponsor will write 2 separate checks. Can the 30k after-tax be rolled directly into a roth ira and the 70k into a traditional IRA?
Second example:
Over 100k agi. 30k after tax, 70k pre-tax. Plan sponsor will write 2 separate checks. Person rolls 30k after-tax into traditional after-tax ira, and 70k pre-tax into traditional ira. Can the after-tax trad. ira be converted to a roth in 2010 without converting any of the pre-tax ira assuming the income restrictions on conversions go away in 2010?
Permalink Submitted by Alan Spross on Tue, 2009-04-28 19:22
Example #1:
Due to lack of specific IRS clarification on this issue, the answer is not definite. Most likely, each direct rollover would consist of a pro rated share of after tax basis, and this is NOT the desired outcome. It would cause part of the Roth conversion to be taxable, and would also result in added basis in the TIRA which would have to be eventually recovered on Form 8606.
Example #2:
When an indirect rollover is done following distribution to the employee, the first dollars rolled over are the pre tax dollars. The first 70 k rolled over would be pre tax, and if additional dollars are rolled over, they would be post tax and basis would be added to the TIRA which would eventually recovered on Form 8606. There would also be 20% withholding on the 70k, which would have to be replaced to complete the after tax rollover. SInce all TIRA accounts are combined for tax purposes, a 2010 conversion would be partially taxable on Form 8606 based on the pro rata factor for all TIRA, SEP and SIMPLE IRA accounts held.
Best option in this situation is to wait until 2010, when the income limit disappears. Then request a total distribution, and roll 70,000 over to a TIRA tax free, followed by replacing the withholding and rolling 30,000 to a Roth IRA. This would get all 30,000 into the Roth tax free, and would also get the 70,000 into a TIRA tax free. Only drawback is that 14,000 of withholding would have to be fronted to complete the conversion. Perhaps future IRA guidance would provide clearance for doing tandem direct rollovers to avoid the withholding problem, but at present this may well not be allowable under the pro rate rules between after and post tax amounts.
Permalink Submitted by Michael Thurman on Tue, 2009-04-28 19:40
Thank you.
Permalink Submitted by [email protected] on Thu, 2009-05-28 17:33
Follow-up question – If after-tax (AT) dollars in 401(k) are allowed to be distributed to the participant as a non-taxable return of basis (not rolled over) then why would the same amount converted to a Roth (direct or through 60 day rollover) be subject to pro-rata rules like in IRAs, SEP IRAs and Simple IRAs? Prior to EGTRRA, the only option was to pay AT basis directly to the participant and that amount was not taxable. By definition, there is no pro-rata calculation to pre-87 or post-86 basis payable to participant and the rollover of earnings attributable to those is commonly rolled over to IRA. Something is not adding up here.
Permalink Submitted by Alan Spross on Thu, 2009-05-28 20:03
There is further guidance needed, to be sure. However, it helps to separate this issue into segments:
1) A direct rollover or a simple distribution to the employee follow the rules of Sec 72(e)8. This states that all distributions from a qualified plan are pro rated between pre tax and after tax amounts EXCEPT for pre 1987 after tax contributions, which can come out separately. Assuming no pre 87 after tax contributions then, everything comes out pro rata. This suggests that an amount being directly rolled to a TIRA would be pro rated, as well as any amount being directly rolled to a Roth IRA in a conversion.
2) Employee indirect rollover exception: In 2002, the JCWAA added under Sec 402(c)2 a provision stating that if an employee receives a distribution from a qualified plan, a rollover is considered FIRST to come from pre tax amounts. So if the employee first rollovers over the pre tax amount to a TIRA (must make up any withholding amounts), the remainder of after tax amounts can then go into a Roth IRA. This is the best outcome. The problem, however, is that 402(c)2 does not specifically address what happens in a direct rollover, which is the best way to move funds and avoids withholding. So it is not real clear that first doing a direct rollover to a TIRA will ONLY result in pre tax amounts going into the TIRA. Not only that, but plan administrators are also guessing how they would complete the 1099R reporting these direct rollovers. I am surprised that the IRS has not issued more detailed instructions than Notice 2008-30 when it comes to direct Roth conversions. This release just assumes that the entire plan balance will be going to the Roth, and that is not realistic since it would produce a huge tax bill.
I therefore agree that there are some loose ends that need clarifying.
Permalink Submitted by Susan Lombardo on Fri, 2009-06-12 18:36
I understand about prorating the basis and all, however, one of the checks that are received from the employer is the after tax contributions. Why can’t this after tax check be rolled over into the Roth?
Permalink Submitted by Alan Spross on Sat, 2009-06-13 03:59
It can be, subject to modified AGI limits. However, the question is whether such a conversion would be tax free or not. While the check is for the amount of after tax contributions, whether it actually is or not depends on what happened to the other funds in the plan and when. For example, if they were directly rolled into a TIRA account, the question is whether the pro rate rules will spread the after tax amount between the Roth and TIRA, or not. This will be reflected in the 1099R forms that are issued, and the IRS has not released instructions to plan administrators on this issue as far as I can tell.
If the other funds were distributed to the employee, and then the employee rolls the funds over himself, then the first dollars rolled over by the employee are considered the pre tax dollars according to Sec 402(c). But this rule MAY not apply to direct rollovers. Also, pre 1987 after tax amounts are exempt from the pro rate rules if the plan separately accounts for them. This balance would show on the employee’s prior 401k statements.
The plan administrator should be asked now how the 1099R forms they issue next January will look like.
Permalink Submitted by [email protected] on Sat, 2009-06-13 04:46
Since the pre-tax portions of the 401(k) are actually being rolled over directly to the TIRA and the after-tax basis is paid to the participant directly and subsequently “converted” to Roth, wouldn’t this satisfy the ordering issue referenced in sec 402(c) whereby pre-tax amounts are considered to be rolled over first and likely would hit the IRA prior to the AT basis hitting the Roth. I don’t see how the lump-sum with 20% withholding would be a necessary step. I would think the plans would report on the 1099R the same way they have for decades when dealing with pre-tax direct rollovers and after-tax basis paid back to participant.