Split 401k rollover to TIRA + ROTH
I am so confused. I have a 401k from a past employer that has both pretax and after-tax funds in it — the split is about 2/3 pretax, 1/3 after-tax. Fidelity says they can roll over the entire amount but isolate the after-tax funds to place directly in a Roth, and roll the pretax directly into my TIRA. It would be a full rollover, just going into two eligible accounts. They say they will produce two 1099 forms indicating these transactions, neither of which would indicate a taxable distribution. They also say they cannot give tax advice and I should check with my tax advisor. My tax advisor says he doesn’t know if this creates a taxable event. I don’t want to do the convoluted two step process or withhold 20%. My other option is to just roll it all into the TIRA and forget putting the after-tax funds into a Roth. Can you help?
Permalink Submitted by Alan Spross on Wed, 2010-11-17 18:34
The confusion has resulted from the IRS leaving the issue hanging since two revenue rulings a year ago that indicate that pro rating of the basis applies if direct rollovers are done. However, the IRS has not advised plan administrators how to report this on the 1099R forms. So if Fidelity does as they indicate and if the IRS does not issue new directives in the next 6 weeks that would change their reporting, you are probably home free. This problem began in 2008 when direct Roth conversions were first allowed, and so far the IRS has accepted the 1099R information as issued and it would create a tremendous amount of havoc if they ordered retroactive changes and re issued 1099R forms.
In summary, if you wait another 4 weeks and there has been no follow up directive from the IRS and Fidelity would still issue those 1099R forms as you indicated, it is worth the risk to proceed with the twin rollovers incl tax free conversion. You would have to report the conversion on the re designed Form 8606 for 2010, and would probably opt out of the two year deferral because there is no taxable income to defer.
There is not much downside for you even if the IRS rules against you and some of your conversion became taxable. If that unlikely event occurred, you could recharacterize the conversion if you did not want to pay the taxes. The recharacterization would go into a TIRA and then you would have the after tax basis in your TIRA from which is would have to be recovered pro rate with pre tax amounts. But I seriously doubt that the IRS would require retroactive adjustments on this matter. They have had a full year to clarify this issue and have not done it, perhaps because they have not yet resolved all the attendant issues.
Permalink Submitted by Toni Simonetti on Thu, 2010-11-18 03:21
Thank you! Very helpful perspective.