Roth Conversion
I have a 401(k) with both pre-tax and post-tax contributions. I recently changed firms and I am planning on rolling my 401(k) dollars over to an IRA r/o. If I created two IRA’s, pre-tax and post-tax IRA, could I then convert just the post-tax IRA to a ROTH IRA? If yes, would only pay the tax on the earnings of my post-tax contributions? Or would there be a different calcuation based on all my retirement assets?
Thanks
Permalink Submitted by Alan Spross on Tue, 2010-07-20 17:33
No, you could not convert just the post tax IRA account because all your traditional IRA accounts are combined together to determine the amount of basis you have.
There is another way to convert only the after tax amount, however it requires you to have enough money to replace the mandatory 20% withholding. The procedure works like this assuming your 401k value is 100,000 and the after portion is 20,000:
1) Ask for a distribution to YOU, not a direct rollover.
2) You will receive 84,000 because 20% of the pre tax amount of 80,000 must be withheld for federal taxes.
3) Roll 80,000 into a traditional IRA within 60 days. Do this prior to step 4.
4) Roll 20,000 into a Roth IRA within 60 days. But since you only have 4,000 from the distribution, you must come up with 16,000 to complete this Roth conversion.
5) The conversion will be tax free and so will the rollover. You will recover the 16,000 when you file your return for that year, or you can recover it sooner if you cut your withholding from other sources knowing that the IRS has 16,000 from the distribution.
Avoiding all this by doing two direct rollovers including a direct Roth conversion from the plan would be desirable, but the IRS has issued confusing rulings that suggest that all of the plan assets must be pro rated. That would cause 16,000 of the after tax amount to go to the TIRA and only 4,000 to the Roth. 16,000 of the 20,000 Roth conversion would be taxable. Several large firms that deal with employee benefits have pleaded with the IRS for almost a year now to clarify their ruling. You could wait to see if the IRS responds with a change in the ruling before acting if you do NOT have that 16,000 available to replace the withholding.