401k Rollover Question
I have a client who has $25,000 in an old 401k. $16,000 was contributed on a pre-tax basis. $9,000 was contributed on a post tax basis but was not in a ROTH 401K option. The client thought it was a ROTH but his company did not offer the option. So I have 3 questions:
1.) Fidelity told him he could take the $9,000 out and NOT have to pay taxes OR the 10% penalty. I believe they are correct about the taxes, but the 10% penalty should still apply correct?
2.) Can we roll the entire $25k into an IRA, then roll the $9,000 into a ROTH?
3.) Can we roll the $16,00 into an IRA, and have them cut him a check for the $9,000. We would then place the $9,000 into a ROTH before the 60 day window. If we did this, how does the $5,000 maximum contribution apply? The money is coming from a defined contribution plan.
thanks for any help.
Permalink Submitted by Alan Spross on Thu, 2011-02-10 20:04
1) The 10% penalty only applies to the taxable amount, not the post tax dollars.
2) You could do the rollover, but the 9,000 of after tax dollars would then be commingled in the IRA and all IRA distributions or conversions would have to be pro rated between to determine the tax free portion. The 9,000 cannot be isolated if you roll it all to a TIRA first.
3) You could also do this, but there is considerable risk that prior IRS rulings about pro rating plan distributions would result in the same situation as above. The amount of the rollover is not limited in dollars though, since this is a conversion and not a regular Roth contribution. The IRS has left the pro rate issue hanging, but could start enforcing it at anytime.
There is however, one way to do this that is not subject to pro rating or adverse IRS rulings. However, it does require the client to replace the 20% withholding with his own money until he can get a tax refund. This method is to request a full distribution to himself, but he will only receive 21,800 due to mandatory withholding. He would then within 60 days roll 16,000 to a TIRA and immediately thereafter roll the remaining 5,800 plus 3,200 from his own funds to a Roth IRA in a tax free conversion. This works because the tax code dictates this treatment ONLY IF the distribution is made to the employee, ie is NOT a direct rollover.
He might recover the 3,200 sooner if he reduces his withholding from a current job or reduces other current tax payments. That way he does not have to wait a year to recover the 3,200.