Roth 401k to Roth IRA transfer
I recently transferred funds from a Roth 401(k) to a Roth IRA and fear I may have triggered a taxable event through a misunderstanding of the 5-year rule. Since 2008, I have contributed $83,000 to Roth 401(k); with earnings, the account had grown in value to $96,000. Having turned 59-1/2 in September, I recently transferred the entire $96,000 balance in the Roth 401(k) account to a Roth IRA, which was an allowed in-service transfer under my employer’s plan. The Roth 401(k) and the Roth IRA are both managed by Fidelity, so this was a direct transfer. Upon receiving a summary of the transaction, I am alarmed to see that the total taxable amount is listed as $13,000. I assume this is because the Roth 401(k) account was not open for 5 years before the transfer was performed, and therefore this is considered to be a nonqualified distribution. However, it had been my understanding that there would be no tax consequences because the transfer was to a Roth IRA. Incidentally, the Roth IRA account was established more than 5 years ago, although that is probably not relevant.
My intent had been to continue contributing to the Roth 401(k) but to periodically transfer these funds to the Roth IRA. The effect would be to reserve the 401(k) primarily for pre-tax money and to use the Roth IRA for Roth contributions and earnings.
My questions: Will I need to pay tax on the $13,000 in Roth earnings? If not, how do I report this on my income tax return to avoid being taxed? Any tax consequences of periodically transferring from Roth 401(k) to Roth IRA as described in the preceding paragraph?
Permalink Submitted by Alan Spross on Sun, 2011-10-23 04:48
You have absolutely nothing to worry about here. There is no taxable distribution to you because you rolled over the entire balance of your designated Roth account to your Roth IRA. Moreover, since your Roth IRA is now fully qualified (5 years plus age 59.5), all amounts in your Roth IRA are tax free upon distribution, even the $13,000 in earnings from your non qualified designated Roth. Therefore, your Roth IRA holding period is very relevant to future distributions you might take. I assume you did a direct rollover to the Roth IRA as that would avoid 20% withholding on the 13,000 taxable portion had you received a check made out to you.
Reporting this on Form 1040 is very simple. You will show the 96,000 on line 16a and nothing on 16b with “rollover” entered next to 16b. You do not need Form 8606. Nor will you need Form 8606 any longer once your take distributions from your Roth IRA because it is now qualified.
Any additional in service distributions you are allowed to take would be handled the same way. As long as you roll them over to your Roth IRA, there is no taxable event.
Permalink Submitted by Peter Lingane on Sun, 2011-10-23 05:02
I suspect that you have misinterpreted the confirmation statement. The sending custodian must inform the receiving custodian as to the taxable and nontaxable amounts as of the date of the rollover. The taxable and nontaxable amounts were likely listed to fulfill this obligation. That does not mean that the rollover is a taxable event. See Reg. 1.402A-1, Q&A5.
Permalink Submitted by David Cannon on Sun, 2011-10-23 06:43
Thank you very much for the prompt and reassuring replies. Yes, the transfer was a direct rollover to the Roth IRA account, so there was no check made out to me and no 20% withholding. It turns out that I will be using Parts I and II of Form 8606 for another reason. Because of income limitations, I am not eligible to contribute directly to a Roth IRA, but instead contributed the maximum annual amount to a traditional IRA account and then converted the full amount to my Roth IRA the next day. I believe this is reported on Form 8603. Given that I am using Form 8606 anyway, would I also report the direct rollover from the Roth 401(k) to Roth IRA on Part III of Form 8606? Perhaps report the full $96,000 on line 21 (amount rolled over), $96,000 on line 22 (basis) with 0 on line 23 (taxable amount)?
Permalink Submitted by Alan Spross on Mon, 2011-10-24 03:08
No, you would not use the 8606 for reporting the designated Roth transfer, just use it for the other purposes you mentioned. The 2011 8606 may also differ from the 2010 edition because 2010 was a year of special conversion options not allowed in 2011.
The 8606 Inst for 2010 (p 7) indicate that Part III does not apply to transfers from designated Roth accounts.