Pro Rata rule
Client has 9,000 in a Roth 401k and 16,000 in the regular part of the 401k.
He is leaving the employer and wants to get the pretax dollars into a regular IRA so he can use some of the money for graduate school and not have to pay the 10% penalty. He also thought is would be nice to get the other money into a Roth IRA.
One option as I see it would be to do the take a whole distribution with the 20% withheld and then one day roll the pretax part into an IRA, including the additional 20% he had to make up; and another day roll the after-tax money onto the Roth IRA.
Would another option also be that if the employer allowed him to keep the Roth money with the employer for the rest of this year and only roll over the pretax money into an IRA would that work, or is any money coming out of the employer plan still considered to be pro-rata? If so, I guess he would just have mixed money in his TIRA.
Lee
Permalink Submitted by Alan Spross on Wed, 2012-06-13 23:22
Hi Lee,
The pro rate rules should not come into play here, at least you did not indicate that there were any after tax contributions included in the 16k portion. The two sides of the 401k account are totally separate from each other.
Following separation, the plan might allow him to roll over one account but not the other or might require a full LSD. In any event, the only IRA options here are:
1) The pre tax account can go to either a TIRA or a Roth IRA if client opts for that
2) The designated Roth account can only go a Roth IRA.
There should not be any isolation of basis issues here as there would be if client had after tax amounts in the regular 401k account. Therefore, direct rollovers are the way to go and the withholding can be avoided.
Of course, there are also rules with respect to the designated Roth account if the funds were distributed to the client. 20% withholding does not apply to designated Roth accounts, so if the client received the full 9,000 and if 1,000 of that were earnings, the first 1,000 of any amount client rolled to a Roth IRA would be deemed to be the taxable 1,000. He could then keep the other 8,000 any pay no tax. On the other hand, if he took out less than the full amount from the plan, the amount received would include pro rated earnings, and if client then did a rollover, the earnings amount would again be deemed the first dollars rolled over. But more than likely, client’s best move would simply be to move the entire 9,000 designated Roth to a Roth IRA by direct rollover.