After tax part of 401k rollover to Roth IRA
I’ve been reading the Discussion Forum history here and elsewhere and there still seems to be some conflicting information and ambugity about how the IRS might view the tax consequences associated with rolling over an “after-tax” portion of an existing 401k to a ROTH IRA. I wondered if I could get your input for the following situation: Existing employee age 57 with an in-service distribution option of the entire balance. Severing from service in a couple of weeks. Current 401k balance of $250,000; of which $13,880 is after-tax (post 1986) contributions. The earnings associated with the after-tax contributions are only an additional $275. If the entire $250,000 401k balance is currently eligible for an “in-service” rollover or distribution, but we only do a Rollover of the after-tax portion and after-tax earnings out of the plan to a ROTH IRA, do we have a definitive handle on how the IRS will look at that biforcated type of 401k distribution / rollover?
We would rather not go through a taxable distribution of the entire 401k and make up the 20% withholding.
Can the distribution of the after-tax contribution and earnings be handled as a direct “rollover” to a ROTH IRA out of the the 401k? Assuming the Custodian (Fidelity) will allow it. We are not currently interested in doing a Conversion of the pre-tax 401k assets to a ROTH IRA. Thought we might look at that later when the AGI and tax bracket are lower.
Appreciate your input. Thanks
Permalink Submitted by Alan Spross on Thu, 2012-08-23 18:35
There is still a large gap between the IRS guidance in Notice 2009-68 and how many QRP administrators issue their 1099R forms. There have been cases where plans have issued a single 1099R coded G for a direct rollover and showed no taxable amount in Box 2a, and participants have lucked into a tax free bifurcated rollover. Fidelity might be one of them. If you can get confirmation that they will issue the 1099R that way, it is probably worth a try.
I don’t understand how he is eligible for distribution of his pre tax deferrals prior to age 59.5 while still in service. This is not permitted. However, if his deferrals were left in place, he still would have a high ratio of eligible pre tax amounts as compared to the 13,880.
Many plans restrict the in service distributions to the after tax account and it’s earnings only. If that were the case, the solution would ordinarily be to do a direct Roth rollover of the 13,880 plus the 275, then delay the remainder of the rollover until 2013 to avoid a 2012 combined 1099R.
Now if the participant can get assurance of a 1099R as indicated in my first paragraph, he would wait and just order the tandem direct rollovers after separation, directing just the 13,880 to the Roth. After separation the earnings on the 13,880 can just be combined with the other pre tax balance. Then, if either the Fidelity 1099R does not conform to their indication OR if the IRS issues late guidance changing the 1099R format for 2012 (this probably could not happen after November due to programming time limits for 1099Rs), the participant could either pay taxes on part of the Roth rollover OR recharacterize it entirely to avoid the taxable part. That would leave him with the 13,880 as additional 8606 basis in his TIRA.
As you noted, the only “safe” way to handle this is a total distribution to the participant, who then does his own rollovers (TIRA first), but would have to replace 20% withholding until his tax refund. 20% in this case would be over $47,000 and most participants would not be able to come up with that cash in order to complete 60 day rollovers.
Permalink Submitted by Kevin Vasilik on Thu, 2012-08-23 23:21
Thank you. I will double check with Fidelity regarding whether his plan allows for in-service distribution on the pre-tax portion. I have had some plans that do. Thanks again.