Roth Ira Conversion of Post 86 After tax funds from a 401k
I have a 2 part question here that I have been getting many conflicting responses from collegues and online reads and even the irs guidlines.
1. When converting post 86 after tax assets from a qualified 401k plan to a Roth Ira ❓ . Can the ira owner take reciept of the after tax funds first and then do a 60 day indirect rollover of the after tax funds they choose to or does the full amount have to be converted either directly or indirectly. The reason I posed the ? this way is that the company that I am delaing with will not do a partial conversion of the after tax funds straight from the plan to the roth ira and at the same time send out a seperate check payable to the account older for the difference of the after tax contributions they need for income this year. Another contributing factor to this situation is since the after tax funds are post 86 they are subject to the pro rata rule on partial withdraws from the 401k plan.So do avoid tax liablity on the after tax growth on the funds now we are rolling over 100% of the qualifed funds to a rollover ira as well to free up the post 86 after tax contributions for the roth conversion and possible distribution.
2. Also Another question I have regarding this same case with regards to taking withdrawls from the roth ira after the intial conversion of the after tax funds have taken place. The question here is if we convert all the funds over to the roth ira first and then the account owner starts drawing income from the roth account immediately following in the same year will they be subject to the ten percent penalty since they would not have met the five year holding requirement even though they are age 65 and have met the 59.5 barrier.
Amy clarity on these long winded questions would be greatly appreciated. Thanks in Advance!
Permalink Submitted by Alan Spross on Thu, 2011-05-19 17:28
1) As you know, the IRS has issued Notices that require pro rating of all plan distributions between basis and pre tax amounts, other than PRE 87 after tax contributions. However, Sec 402(c)(2) of the tax code indicates that distributions RECEIVED BY the employee (not direct rollovers) and rolled over to IRA accounts are first deemed to be composed of the pre tax funds. This is fairly simple to accomplish with the exception of the mandatory 20% withholding for the pre tax portion. The employee receives the distribution and first rolls the pre tax amount to a TIRA and then the after tax amount to a Roth IRA (60 day rollover), but must replace the withheld amount as necessary to complete the rollovers. This provides a method for the employee to “isolate the basis” so that the pre tax and post tax amounts go into the desired IRA types. There is nothing inconsistent with this provision if the employee wants to retain some of the after tax funds. The balance desired can be rolled into the Roth IRA and reported appropriately on Form 8606.
2) There will be no penalty for two reasons:
a) Roth owner is over 59.5 at the time of distribution
b) The Roth conversion was tax free, composed entirely of after tax funds. The penalty only applies to the withdrawal of taxable conversion money, not tax free conversion money.
Either one of the above eliminates the early withdrawal penalty. Note that if the Roth owner had prior conversions that were pre tax and less than 5 years, that money would have to come out before the recent conversion, but this would only result in a penalty for those under 59.5.
Again, trying to do any part of these rollovers by direct rollover rather than indirect rollover means the employee does not receive the funds, and the pro rate rule then comes into play. If that happened some of the basis would end up in the TIRA and some of the conversion would be taxable, ie the isolation of basis would fail.