For participants under 59.5, many plan docs allow only the in service distributions for after tax contributions and the earnings they generated. That would allow such a participant to do a Roth rollover and pay taxes on only the earnings. But since your client is over that age, her plan likely considers the entire balance eligible for distribution. That causes problems due to the IRS position on pro rating the basis to both types of IRAs. Client would not be able to convert ONLY the after tax portion.

There is only one safe way to circumvent that outcome under the tax code, but it requires alot of liquidity. She would have to request a full distribution paid to her personally. The plan must withhold 20% of the pre tax amount ($106,000) so she would receive only 494,000. She would first roll 530,000 to her TIRA within 60 days, making up the withholding shortfall. Once that is completed the final step would be to roll 70,000 to her Roth IRA. If she did this late in the year she could have the large tax refund within a couple months or so.

Now if she does not have 106,000 in available cash, she could do this for only a part of the 600k and then only have to come up with a pro rated amount of cash and the same pro rated amount would go to her TIRA and Roth.

There still is another possibility if the plan will complete two rollovers, 530k to the TIRA and 70k to the Roth IRA, and show NO taxable income in Box 2a of the 1099R. This has an uncertain outcome. The IRS has never issued clear guidance for plans on how to issue the 1099R in this situation, so for 3 years now many taxpayers have lucked out and been able to isolate their basis and also avoid the withholding challenge. If the plan will do this AND the IRS does not issue 1099R guidance in the next 3 months or so that would eliminate that type of 1099R treatment, 2012 will be another year where some taxpayers will get away with isolating their basis to the Roth.

But the first step is to determine if the total plan balance is eligible for distribution…..or not.

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The first rollover must be to the TIRA after the distribution is first made to the participant, because the tax code indicates that the first dollars rolled over are deemed to be the taxable (pre tax) amounts. While this probably would not matter if you did direct rollovers instead, given a choice it would still be best to do the TIRA first just in case the IRS comes out with guidance indicating that direct rollovers are to get the same treatment as indirect rollovers.

If the 1099R indicates that part of the rollover is taxable, it means that some of the pre tax amount went to the Roth (the taxable portion) and some after tax amount went to the TIRA causing your TIRA to have basis. You would then have to file an 8606 to get credit for the basis in your TIRA.

For the taxable portion that went to the Roth IRA, you could recharacterize the full Roth rollover if you caught it by the recharacterization deadline. That would result in the entire distribution ending up in your TIRA including even more basis (the after tax portion that went initially to the Roth). That would eliminate the tax bill, but you would then have extra basis in your TIRA that would have to come out pro rate over the years. One solution to this outcome would be if a future employer allowed you to roll the pre tax amount of your TIRA into their employer plan, it would leave only after tax basis in your TIRA that you could then convert tax free. So there is some flexibility if the unexpected happens.

If you wanted to try the dual direct rollovers late in the year, it would probably be too late for the IRS to issue 1099R instructions to plan administrators for 2012, and there is very little chance that IRS guidance would require retroactive adjustments to 1099 forms already issued or in process.

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