Rollover of after tax contributions
Client has a substantial sum of after tax contributions in his company plan that are clearly deliniated on his year end statement. He is retiring and ready to rollover to and IRA with our firm. Can the after tax money go to a Roth and the rest to a Traditional?
Permalink Submitted by Alan Spross on Thu, 2012-02-09 17:15
Possibly, but not without issues due to Notices (2009-68 and 2009-75) issued by the IRS in 2009 regarding the pro rating of such amounts between pre tax and after tax amounts.
One method of doing this that should hold up according to tax code wording is to proceed as follows:
1) Client requests a full distribution to the client, not a direct rollover
2) Client then FIRST rolls the pre tax amount to a TIRA, replacing the 20% withholding as needed
3) Finally, client rolls the after tax amount to a Roth IRA replacing withholding
The obvious disadvantage of this is that client must have the funds to replace the 20% mandatory withholding on the pre tax amount, and will not recover it until filing his return, or by reducing other withholding or quarterly estimates. But this procedure works to avoid pro rating only because the funds were distributed to the client rather than directly.
Using tandem direct rollovers MAY also work, but are subject to IRS guidance to issuers at any time telling them how to issue the 1099R forms to indicate pro rating. If you want to take this risk, there is less risk at the end of the tax year because at that point there is no time for plans to change their tax reporting. Many people have been able to accomplish this by direct rollovers, but only because the IRS has not followed up their 2009 Notices with specific instructions to 1099R issuers.
Note that if pro rating were required, the client would end up with some basis in his TIRA account and most of the direct Roth rollover would become taxable. Quite possibly, the client could recharacterize the Roth rollover to a TIRA and then all the basis would end up in the TIRA documented on Form 8606.
Permalink Submitted by Donald L Born on Thu, 2012-02-09 19:15
Alan, Thanks for the great explanation. I think we will take the least risky path. Don
Permalink Submitted by Aaron Roush on Thu, 2012-02-16 20:34
I am concerned that the one rollover per year limit might shoot this idea in the foot. I just spent 1:15 on the phone with the IRS, :30 minutes to get to someone, :30 minutes of her talking unintelligible gibberish, :02 minutes of me explaining what I was trying to accomplish, :11 minutes of her interrupting, and then :01 minute for her to respond once she actually shut up and listened to my question. I asked her what she thought of me taking a distribution from my 401(k) of the after-tax portion and the taxable portion of my after-tax account and rolling the taxable portion over to an IRA and also rolling the after-tax portion over to a Roth IRA. She said that this couldn’t be done because a rollover could only be done once per 12 month period…. Is this a fatal flaw of this tactic, or is she full of hot air?
Also I’ve read that if you have an IRA with nondeductible contributions you could attempt to roll the whole thing into a qualified retirement plan (ex. 401(k)), they would only accept the pre-tax portion, therefore you would be left with all basis in an IRA, which could convert tax-free to a Roth. It sounds great. Taking it one step further could you forget the strategy above and roll the entire amount into aTIRA, then after waiting a year to satisfy the waiting period try to roll that back into the qualified retirement plan, which they would only take the pre-tax portion, leaving you with the basis, which you could convert all tax-free.
I’m skeptical of doing anything that seperates these two and gets the post-tax into a Roth and pre-tax into a TIRA simply because I don’t think the IRS intended for that to be allowed to happen. Is the risk worth it?
Permalink Submitted by Alan Spross on Thu, 2012-02-16 23:38
Hot air.
With respect to the one rollover limit, it only applies to IRA to IRA rollovers. It also does not apply to Roth conversions, but this is not a Roth conversion. The two rollovers are therefore categorized as follows:
1) Rollover of the pre tax amount to a TIRA is a plan to TIRA rollover, not an IRA to IRA rollover
2) Rollover of the post tax amount to a Roth IRA is also a plan to Roth IRA rollover, not an IRA to IRA rollover.
With respect to your other question, it is correct that the plan cannot accept after tax amounts from an IRA, but if the plan is willing to accept IRA rollovers, the pre tax amount of all your TIRAs could be rolled into the plan, leaving behind the basis amount which has been documented on Form 8606. That amount could be converted tax free to a Roth IRA. Therefore, if you did a direct rollover of the entire plan balance including after tax contributions in the plan to a TIRA, and then were able to transfer the pre tax amount into the same or subsequent retirement plan, the remainder could be converted tax free. The after tax contributions would be entered on line 2 of Form 8606, the same 8606 used to report the conversion to the Roth.
Using either of the above approaches is supported by the tax code. But doing direct rollovers from the plan itself where the taxpayer does not receive the funds is not so clearly supported and the IRS could challenge it following their reasoning in Notice 2009-68.