QRP Distribution
I have a sole employee QRP Profit Sharing Plan with Schwab. It has not been funded in the past few years and I do not expect it will in the coming years. I will close it down and do a direct rollover, however, I am delaying that because it will dilute the portion of my current IRA conversions that are tax free due to non deductible contributions. I expect I will complete converting my IRA’s to Roth’s in the next three years.
I have discussed with Schwab the details of my QRP. It allows distribution at any point in time. Since I have had one plan for about an 8 year period, my understanding is that IRS rules allow me to take a distribution ‘in service’ since I have been a participant at least 5 years. Schwab indicates the plan allows for this.
Now to the problem and objective:
One of the funds I have in my QRP has closed and I would like to purchase more of, but I have run out of room in my QRP. In addition, since this fund is very tax-efficient, it really belongs in my taxable account at Schwab and replaced with a bond fund which is tax-inefficient and which I need more asset allocation. If I can transfer 1 share, with a current value of $31, of this fund from my QRP to my taxable account at Schwab, I can achieve my objective. I can sell all the shares of this fund in my QRP and replace them with the bond fund and simultaneously add to the 1 share I transferred to my taxable account.
Schwab indicates if I take an early distribution, I will incur a 10% penalty and a mandatory 20% withholding for not rolling it over to another pretax plan. Well, to meet the objective, to pay $3.10 penalty and $6.20 withholding, is certainly not a problem.
Alternatively and if preferable, since I also have an existing Roth with Schwab, possibly I should take the 1 share from my QRP and transfer it in my Roth and from my Roth transfer it to my taxable account. Prior to 60 days replace the 1 share to my Roth (I don’t think I could then transfer the 1 share back to my QRP because it is a qualified plan). However, I am not certain what this gains me and needless to say, since we are looking at a value of $31 for the 1 share, I only want to do what is the proper way in the eyes of the IRS.
Your thoughts on the best way to facilitate this transaction would greatly be appreciated.
Anovice
Permalink Submitted by Alan Spross on Wed, 2009-07-08 02:17
If the fund is closed, you may not be able to add to your position in the taxable account either.
A related question, with the thousands of funds out there that essentially duplicate each other, not to mention ETFs, would it not be easier to just use a substitute investment in the taxable account, and sell out the shares in the QRP?
If the above does not work for you, and if your modified AGI is less than 100,000 this year, doing the direct Roth conversion avoids the mandatory withholding requirement under which you would have to distribute some cash in addition to the single share for the withholding if you just took a distribution. You could then distribute the share from your Roth to the taxable account, and this would be probably be tax free under the Roth ordering rules.
You would just have normal rollover and distribution reporting on your tax return, no reason to be concerned with IRS problems.
Permalink Submitted by Anovice coatedfabrics on Wed, 2009-07-08 15:32
Thank you for your quick reply.
Regarding your first sentence in your first paragraph, Schwab indicates it is a “soft” close, meaning I could buy more of the fund from an already existing position, so if I would have had more room in my QRP I could have purchased additional shares. By transferring 1 share to my taxable account it will be looked upon as an already existing position in my taxable account and then I could purchase more shares. However, clearly this is a work around and Schwab even said that if the mutual fund company did an audit, they probably would not look upon this move favorably.
In so far as your second sentence in your first paragraph, since this is a low cost managed fund with a 15 year manager, a good 3, 5 and 10-year record and that fits in the style box of large value which I need, I find the fund a bit unique. In addition, it is tax-efficient, which is not the norm for a large cap value fund (one reason is the low turnover). Since I plan on dollar cost averaging each month, an ETF is not practical due to the commissions. All that said, I gather I could find a different fund for my taxable account, but if I do not need to from Schwab’s point of view and more importantly I will not run into an issue with the IRS by tranferring 1 share, I would rather not.
To your second paragraph. My modified AGI is below $100,000. From there, I want to make certain I undestand your thoughts. It appears you feel the best route is to take the 1 share from my QRP and transfer it to my Roth and then take the 1 share from my Roth and transfer it to my taxable account. I am at a loss when you say ” and this would be probably be tax free under the Roth ordering rules” (I am 52), but I am not certain that is important as the tax on 1 share of a $31 mutual fund does not amount to much.
In your last paragraph you say ” You would just have normal rollover and distribution reporting on your tax return, no reason to be concerned with IRS problems”. I am a bit familar with the reporting of IRA Rollovers and converting a traditional IRA to a Roth IRA (I will converting more in 2009), but I am unfamiliar with this reporting as I have never taken a distribution from a retirement plan. A CPA files my taxes and can I assume that most good accountants will be familiar with the proper reporting to the IRS?
Anovice
Permalink Submitted by Alan Spross on Wed, 2009-07-08 23:44
Yes, they use professional software programs if they have any appreciable tax prep business. These programs have all sorts of built in checks and balances. I suppose with the direct Roth conversion being new, they need to be alert to the fact that the 1099R is coming from a non IRA employer plan. When this type of conversion is done, there is no 8606 generated.
Although an extremely small dollar conversion, the software should capture this along with your entire Roth history. If you made prior Roth contributions in earlier years or prior conversions or distributions, this info needs to be provided to the CPA for your Roth distribution to be reported correctly even though it is very small. Distributions from Roths are deemed to come first from regular contributions, so even though you are transferring out the share that was contributed in a conversion, the tax reporting ignores what security is transferred, and follows the ordering rules. While avoiding tax is obviously no big deal with this small amount, the 8606 reporting the conversion still needs to be done correctly. To clarify, Form 8606 is not needed to report the conversion, but it IS needed to report the Roth distribution.
I can understand that your familiarity with this current investment is such that you would rather avoid the time spent researching a potential replacement investment when you are thoroughly familiar with the captioned investment. Hopefully, a soft close is not a precurser to a hard close.