Roth Conversion from Comingled Retirement Plan
A client has approximately $1,500,000 in a company sponsored profit sharing plan, of which she is the only employee and she is 65 years old. The $1,500,000 is comprised of employer profit sharing plan money, salary deferral, old money from a money purchase pension plan, old pre tax IRA money, and old “after tax” IRA contributions. If she wants to convert a portion of her profit sharing plan to a Roth IRA in 2010, how will she take into account her $44,000 of after tax contributions that were made to her IRA that is now part of her profit sharing plan? Also, are there any quirky rules to be aware of regarding the dollars that were part of her money purchase pension plan. She commingled all of these accounts many years ago and she has no record of how much was from which type of account, except she did keep her 8606 forms which is how we know she made $44,000 worth of after tax IRA contributions.
I am wondering, as an example, if she is able to convert $100,000 of the profit sharing plan money to a Roth IRA, and then have to only pay the tax on $56,000 ($100,000 – $44,000 of after tax IRA contributions), but I am not sure if that is possible because she really doesn’t know how much of the $1,500,000 is from the original IRA account.
Thank you for any input and guidance!
Permalink Submitted by Alan Spross on Wed, 2009-09-23 21:34
The problem here is that the after tax IRA money was never eligible for rollover to the qualified plan. Attached you will find a rollover chart for 2009, but this particular requirement has applied ever since IRA rollovers to QRPs were authorized. ONLY pre tax IRA funds can be rolled over without potential problems of disqualification of the QRP due to the rollover.
Therefore, her basis from the 8606 is essentially gone unless she had another IRA that continued. The corrective procedures for QRP plan infractions have changed considerably over the last couple years, and I do not know exactly what, if any corrective measures would be allowable now for this past rollover. And even if the the plan correction procedure was properly identified, I do not know that it would restore the after tax character of the 44,000 that previously existed. She would have to ask the plan custodian about this, since any corrective action would include their issue of reporting documents to the IRS.
If she converts any amount next year directly to a Roth IRA, any 1099R forms will certainly show the conversion as 100% taxable.
If the records for the year of IRA transfer can be located, that might be the place to start to determine if her recollection is correct. Perhaps this after tax rollover did not actually happen. Perhaps she had another IRA account of at least 44,000 to which the basis would have been applied (8606 basis floats and is not locked to any particular TIRA account) She was evidently aware of her 8606 basis in the IRA at the time, and the transfer documents should have addressed after tax amounts at the time.
Permalink Submitted by Jonathan Sard on Wed, 2009-10-21 20:06
I was finally able to speak to an ERISA lawyer and she feels we could take corrective action and move out the $44,000 of after tax IRA contributions without any negative consequences. However, this now raises another question. Of the $1,500,000 in her profit sharing plan, a portion of the money is profit sharing plan money, a portion is pre-tax IRA money and a portion is athe fter tax IRA money. When she makes this correction and moves the $44,000 back to an IRA, is the pre-tax IRA money remaining in her profit sharing plan tracked separately for Roth Conversion purposes? My question is, if she decides to do a Roth conversion of just the $44,000 from the IRA, does the IRS make the account owner count, as part of the pro-rata formula for determining how much tax is owed on the conversion, the amount in her profit sharing plan attributable to her pre-tax IRAs? Thank you!!
Permalink Submitted by Alan Spross on Wed, 2009-10-21 21:01
The IRS recently ruled in Notice 2009-75 that a direct Roth conversion from a QRP would be taxable in the same manner as if it had been distributed to the employee. Distributions from QRPs, other than pre 1987 after tax contributions, come out pro rated between after tax and before tax. That makes any direct Roth conversion on which the plan indicates any basis, tax free only to the extent of the portion of after tax funds in the plan, ie. about 3% tax free in this case. But since the source of the after tax funds came from an unapproved source, whatever correction procedure the plan arrives at will determine the values on the 1099R that the IRS will receive.
In other words, even assuming a valid after tax balance, the basis could not be separately converted to a Roth IRA tax free. However, unlike an IRA conversion, the responsibility for identifying the amount of basis lies with the employer plan, not with the taxpayer. Form 8606 is not used in a direct Roth conversion.
Permalink Submitted by Jonathan Sard on Thu, 2009-10-22 19:09
Thank you for your prompt replies! The ERISA attorney recommends we move the $44,000 back to an IRA and then convert to a Roth IRA. If we take that approach as opposed to directly converting to a Roth from the QRP, does that change of any of your comments below as it relates to paying tax on a pro rata basis. My understanding is that the IRS treats QRP and IRA assets separately when determining cost basis and how much tax will be owed when doing a Roth conversion. The ERISA attorney is saying that the correction of the $44,000 will not be a “distribution” when we move it back to the IRA and that there is a box on the 1099 indicating that it was a “correction”.
Permalink Submitted by Alan Spross on Thu, 2009-10-22 23:10
That approach is a possibility, but depends again on whether this is an acceptable corrective procedure for the QRP to take. See the 2nd paragraph in my first post. I don’t know whether the IRS would agree to this corrective measure assuming their 1099R reflects a reversal of after tax basis. It might be worth a try, for lack of any other clear solution to salvaging the after tax character of these funds. A technician which expertise in EPCRS corrective procedures perhaps should be consulted, and since these procedures change fairly frequently, the date of the original error may be material. This is a very complex field and I do not attempt to keep well informed on the technicalities.