Accidental deposit of after tax contribution to IRA
My client accidentally contributed the after tax portion of his 401(k) rollover into his traditional IRA. He wants it back so we are processing a return of excess withdrawal for the after tax amount plus the accrued interest generated from the funds. The client is receiving his first year of 72(t) distributions. My question is how will the return of after tax be treated at tax time, and how does he report it?
Permalink Submitted by Alan Spross on Wed, 2011-05-18 19:06
Assuming he reported the entire contribution as a rollover contribution and not a regular contribution, he is stuck with it and cannot reverse it. He has added after tax contributions to his TIRA and must report the added basis on line 2 of Form 8606.
There is an exception to the above when the rollover is due to incorrect information provided to him by the 401k plan, eg he was not told that his rollover included after tax dollars. But most plans would have sent the after tax money to him in a separate check and he would then have rolled over the funds himself. If you can provide more details how this happened, we can determine if there are any options.
The situation is considerably more complicated due to the start of a 72t plan since activity related to the above could bust his plan.
1) How was this rollover done, and what were the dates of the rollover and the date of the first 72t distribution?
2) Was the rollover amount included in the account balance used to calculate the 72t annual distribution?
3) Did he do the rollover himself or were the after tax dollars included in the total direct rollover from the 401k plan?
4) Is the after tax amount significant or small? Does he already have non deductible contributions made to his IRA for which he filed an 8606 in prior years?
Note that if he reports his basis on Form 8606, a portion of every future distribution including the 72t distributions will be tax free as the after tax dollars are returned to him pro rated with IRA pre tax dollars.
Permalink Submitted by Paul Duncan on Wed, 2011-05-18 20:52
1) The rollover was conducted via telephone on 2/28/11; two separate checks were delivered to the client from the plan. The client gave the checks to the receptionist in our office and she forwarded them to the BD on 3/11/2011. The after-tax check ($7k) was made out to the client while the pre-tax portion ($250k) was made out to the clearing firm. The first distribution took place on 4/1/2011
2) No
3) Separate checks
4) Insignificant, his total balance is $750k and the ATB is $7k. He has no non-deductible contributions to his IRA and has not filed an 8606.
Permalink Submitted by Alan Spross on Wed, 2011-05-18 21:40
That eliminates using incorrect plan information to try to pull back the 7k rollover, and this issue is now baked into the 72t calculation as well. Note that even if the BD treated the 7k as a regular contribution rather than a rollover in order to issue a corrective distribution, the client would get an additional 1099R with the special corrective code on it, and that would probably trigger an unpredictable IRS response to the 72t plan. My guess is that the IRS would include it in the 72t distributions since it would occur after the plan started, but it is just an extremely rare combination of events, which is the last thing you want when the IRS already struggles to understand 72t plans. In fact, I have never encountered this exact set of circumstances before, and I strongly suggest that client should forget about the extra 7k and just address the 72t plan implications to follow.
The calculation for the 72t plan may be a problem. While the IRA balance on any date back to 12/31 could be used, there cannot be any distributions, transfers or rollovers changing the IRA balance between the date used and the first 72t plan distribution. A statement as of the date used should be printed out for a permanent record of the account balance. The window is therefore down to the final two weeks in March. Note that the 72 plan is deemed to start on the date of the distribution, not the date the client receives it. If the distribution was 4/1, client could use a 3/31 balance since the plan starts in April.
If the 250k rollover and the 7k (endorsed?) check went to the BD on the same date, they should have hit the account on the same date or very close. It sounds like the calculation was done using an approximate figure for the balance, but this can be “reconstructed” since the plan just began and the IRS does not have the calcs in hand.
So if the plan balance is higher by around 7k, the calculation must use that actual higher balance, will therefore yield a slightly higher annual distribution, and the distributions between 4/1 and 12/31 can be juggled to exactly match the annual calculated amount (or 75% if client is pro rating the annual distribution for 2011). If the distributions are already set up (not good to use 1st of month because of unintended consequences if the Jan distribution is issued early), the original calculation can be reproduced by offsetting the higher balance by using a slightly lower interest rate than used in the original calculation.
Therefore, the 72t plan can probably be fixed, but nothing can be done about the post tax 7k at this point. If the 8606 is filed showing the basis, at least there will be no double taxation. About 99% of the distributions will be taxable. Tax software can handle the 8606 with ease, so this is NOT the challenge it used to be when doing a paper return.