Conversion of After Tax 401k Distributions to a Roth IRA
I’m looking for confirmation of a rule I heard recently. If an employee can take in-service distributions of prior after tax contributions to his/her 401k, can he/she roll these distributions directly to a Roth IRA and avoid aggregation rules if he/she already has other traditional IRAs (in essence, completing a partial conversion of a 401k to a Roth IRA)? If this is true, it appears it could make sense to for high income earners to over-contribute to their 401ks and convert the after tax amounts in order to diversify into Roth holdings.
Permalink Submitted by Alan Spross on Tue, 2012-09-11 21:13
Yes, this will work providing that the employee is only eligible to take in service distributions from the after tax account. In most 401k plans that sub account also includes the earnings on the after tax contributions. Therefore, the earnings buildup will be small if frequent direct Roth rollovers are done. The earnings would be taxable when rolled to the Roth.
However, if the employee is eligible to take other in service distributions, the employer should pro rate those distributions between basis and earnings. The employee can work around that as well using various strategies, but this requires more transactions and rollovers to get done.
Doing a direct Roth rollover rather than first rolling the funds to a TIRA will avoid the pro rating rules of Form 8606 which includes all TIRA, SEP and SIMPLE IRA values.
Permalink Submitted by Steve Peterman on Tue, 2012-09-11 21:25
Thank you for the confirmation!
Permalink Submitted by Patricia R. Johnson, CPA on Sun, 2012-09-16 04:21
Forgive me for crashing in on your current discussion question, but this is my first try at using this forum
and I can’t figure out how to start a new topic. I have read some earlier discussions on the use of Roths in
401k plans so I think you are the folks that know how these work. I have a tax client that is in a
401k plan for 2011 and has participated in adding to a Roth. He hasn’t converted any of his 401k
balance yet and he has also contributed to the pretax option and drawn the employer match.
My question has to do with an additional $5000 contribution that he made to his “outside” Roth
IRA account for 2011. He is under age 50 for 2011. His 2011 W2 shows the Roth contribution
under code AA of $5189. His Form 5498 shows the $5000 he added to his outside Roth. His income
is under the phaseout limits for 2011. Can he do both an “inside” and an “outside” Roth contribution
for 2011? The company he works for (a large company) does financial planning and he consulted
with one of their advisors in getting established with the inside Roth. I can’t say for sure that the
advisor knew that he was also contributing to the outside Roth, but my client said that he did.
What do you think? I think the inside Roth allows current contributions above $5000 but I just
could not find anything that even discusses having the outside contribution, which would be
limited to $5000. Can he do both?
Permalink Submitted by mk foss on Sun, 2012-09-16 22:49
Yes, it is possible to contribute to a Roth IRA and participate in a Roth 401k or 403b at the same time. The $5,000 limitation has no effect on the employer provided designated Roth accounts.
Permalink Submitted by Alan Spross on Mon, 2012-09-17 02:55
Note that contributing to the Roth 401k does not reduce his modified AGI like a pre tax contribution does. If he is in the income phaseout range for regular Roth IRA contributions because of his modified AGI, he has two choices to deal with the phaseout:
1) Remove the contributions that are above the phaseout allowance
2) Recharacterize those contributions as non deductible TIRA contributions. If he is in the Roth phaseout range, there is no way he could deduct TIRA contributions.
If he does not have any other balance in TIRA. SEP or SIMPLE IRAs, he could recharacterize the amount of the Roth IRA contribution that is not allowed as a non deductible TIRA contribution. He could then convert that amount to a Roth IRA and end up with a full Roth contribution, although indirectly.
To summarize, contributing to a Roth 401k does not directly affect Roth IRA contributions, but there is more modified AGI because of it, and once the taxpayer enter the phaseout range, it will begin to eliminate a regular Roth IRA contribution. For 2012, he might determine if the same thing is going to happen again, and determine how best to make adjustments between now and the end of 2012.
Permalink Submitted by Joe Private on Wed, 2012-09-19 22:44
Hello – Like the prior poster, I also couldn’t figure out how to start a new thread, and so forgive me for crashing this post. Anyway, by attempting self-help in this complicated area, I think that I’ve created some problems for myself on which I would like to solicit your thoughts. Specifically, in 2006, I used an online service to create a solo Roth 401k plan. The online service acted as the third party administrator of the plan. I opened a solo Roth 401k account at T.D. Ameritrade and made contributions in each of the years 2006-2011. In 2008, I terminated the online service as the third party administrator, obtained another set of solo Roth 401k plan documents, and restated the plan using those new plan documents. I took over functioning as the plan administrator (probably a big mistake). Because the plan assets are less than $250,000, I never did a Form 5500 EZ filing. Based on some internet research that I had done, I thought that I could roll part or all of the plan assets over into a Roth IRA without consequence, even though I am “only” 58 (i.e., not 59-1/2 years old). So, twice in 2011 I rolled part of the Roth solo 401k assets into a Roth IRA, but I did not file a Form 1099-R. Earlier this year (2012), I rolled the remaining balance into the Roth IRA, and TD Ameritrade closed my solo Roth 401k account with them. Based on some recent internet research I’ve done, it now appears that I’ve done a couple of things wrong. First, since I was the plan administrator, apparently I had the duty of filing a Form 1099-R for the two 2011 distributions from the solo Roth 401k (and I will have to file one this coming January for the 2012 distribution). Also, my online research leads me to believe that since I am not yet 59-1/2, these were not “qualified distributions,” even if I were to terminate the plan. If I am right, then what taxes and/or penalties do I owe? Any thoughts on how I might fix this mess? Thanks much, John
Permalink Submitted by Alan Spross on Thu, 2012-09-20 00:29
Yes, you should have issued a 1099R if you were the plan administrator. The 1099R Inst should help you in getting all the boxes completed properly. I assume you did a direct rollover to the Roth IRA, and not an indirect 60 day rollover. Please advise if you did an indirect rollover and if you did not roll the entire distribution over to the Roth IRA. Also, did you only make employee deferrals to the Roth 401k or did you also made profit sharing contributions (which must go into the pre tax account, NOT the Roth).
Rollover to a Roth IRA from the Roth 401k account is not a taxable event even though your Roth 401k was not yet qualified (5 years and 59.5). Basically, you have transferred your basis (your own contributions) to the Roth IRA and your Roth IRA basis from regular contributions is increased by the amount you contributed to the Roth 401k. There is a specific box on the 1099R to show your basis. If your plan generated earnings, then those earnings become Roth IRA earnings. However, if you also rolled over funds from your pre tax solo K account, that portion WOULD BE taxable.
The 5 year holding period is not transferable to the Roth IRA, and your Roth IRA holding period governs. This means that if you made your first Roth IRA contribution some years back then that year begins your Roth IRA holding period. Therefore, if you have an older Roth IRA, all you need to do is wait until you reach 59.5 and your Roth IRA will be fully qualified along with all the funds rolled in from the Roth 401k.
Your Roth IRA custodian should also have issued a Form 5498 showing the receipt of a rollover contribution for each year you did a rollover.
So you should not have any current tax consequences. But you might have a DOL problem from rolling over your elective Roth deferrals prior to age 59.5. Your adoption agreement may have provided for in service distributions of your profit sharing contributions, but not elective deferrals.
Therefore, more info is needed about these rollovers that you did, ie what were they composed of, were they direct rollovers etc?
Permalink Submitted by Joe Private on Thu, 2012-09-20 05:08
You guys are terrific for responding so quickly and in-depth. In answer to your questions/assumptions:
1. Yes, they were all direct rollovers, and all of each rollover went into the Roth IRA.
2. I never made any pre-tax contributions under the Roth solo 401k plan. Any pre-tax contributions were done in separate SEP-IRA accounts. All contributions to the solo Roth 401k were Roth elective deferrals.
3. My first Roth IRA contribution (into the account to which the solo Roth 401k funds were later transferred) was made no later than in 2006 (and perhaps earlier – I haven’t yet looked at my pre-2006 tax documents).
4. Just to make sure that I was clear about the facts, the solo Roth 401k plan was created in November 2006 and first funded on December 22, 2006, and the Roth IRA into which those funds ultimately were distributed was created in 2006 (or earlier). The first partial distribution from the solo Roth 401k was on December 30, 2012 (just over 5 years after the initial contribution was made). I’m not sure if that satisfies the 5-year period as defined by the IRS (which “begins on the first day of [the] taxable year for which [the participant] first made designated Roth contribution to the plan” and ending “when 5 consecutive taxable years have passed”), although it seems it should, according to how I read that definition.
I’m a bit confused by some things I’ve found on the internet. The IRS website seems to suggest that unless my plan has been in existence for at least 5 years and I’m at least 59-1/2 years old, any distribution from my solo Roth 401k would be a “nonqualified distribution” and would be subject to an early withdrawal tax/penalty. However, a Forbes Magazine article suggested that so long as the plan was in existence for 5 years and the distribution was of employee after-tax contributions and profits (which all my distributions were), then I could roll the money directly into a Roth IRA without tax consequence, even if I’m not yet 59-1/2. So, I’m not sure what to think. Any thoughts?
You mention that I “might have a DOL problem from rolling over [the] elective Roth deferrals prior to age 59.5,” because the “adoption agreement may have provided for in service distributions of your profit sharing contributions, but not elective deferrals.” I tried reading the plan, but it’s a bit like Greek to me. Do you know if the IRS will allow rolling over of elective Roth deferrals before age 59-1/2 (but after 5 years) without any tax/penalty, assuming that the plan allows it? What sort of DOL problem might I have?
Anyway, if I file a Form 1099-R for the 2011 distribution (from the solo Roth 401k to the Roth IRA), file a Form 1099-R for the 2012 distributions, is everything okay? Any penalties or taxes due that you can see?
Thanks again for your thoughts,
John
Permalink Submitted by Patricia R. Johnson, CPA on Sun, 2012-10-07 08:19
Thank you all for answering my question. You really know your stuff!!
Permalink Submitted by Denise Appleby on Sun, 2012-10-07 10:32
[quote=”[email protected]“]You guys are terrific for responding so quickly and in-depth. In answer to your questions/assumptions:
1. Yes, they were all direct rollovers, and all of each rollover went into the Roth IRA.
2. I never made any pre-tax contributions under the Roth solo 401k plan. Any pre-tax contributions were done in separate SEP-IRA accounts. All contributions to the solo Roth 401k were Roth elective deferrals.
3. My first Roth IRA contribution (into the account to which the solo Roth 401k funds were later transferred) was made no later than in 2006 (and perhaps earlier – I haven’t yet looked at my pre-2006 tax documents).
4. Just to make sure that I was clear about the facts, the solo Roth 401k plan was created in November 2006 and first funded on December 22, 2006, and the Roth IRA into which those funds ultimately were distributed was created in 2006 (or earlier). The first partial distribution from the solo Roth 401k was on December 30, 2012 (just over 5 years after the initial contribution was made). I’m not sure if that satisfies the 5-year period as defined by the IRS (which “begins on the first day of [the] taxable year for which [the participant] first made designated Roth contribution to the plan” and ending “when 5 consecutive taxable years have passed”), although it seems it should, according to how I read that definition.
I’m a bit confused by some things I’ve found on the internet. The IRS website seems to suggest that unless my plan has been in existence for at least 5 years and I’m at least 59-1/2 years old, any distribution from my solo Roth 401k would be a “nonqualified distribution” and would be subject to an early withdrawal tax/penalty. However, a Forbes Magazine article suggested that so long as the plan was in existence for 5 years and the distribution was of employee after-tax contributions and profits (which all my distributions were), then I could roll the money directly into a Roth IRA without tax consequence, even if I’m not yet 59-1/2. So, I’m not sure what to think. Any thoughts?
You mention that I “might have a DOL problem from rolling over [the] elective Roth deferrals prior to age 59.5,” because the “adoption agreement may have provided for in service distributions of your profit sharing contributions, but not elective deferrals.” I tried reading the plan, but it’s a bit like Greek to me. Do you know if the IRS will allow rolling over of elective Roth deferrals before age 59-1/2 (but after 5 years) without any tax/penalty, assuming that the plan allows it? What sort of DOL problem might I have?
Anyway, if I file a Form 1099-R for the 2011 distribution (from the solo Roth 401k to the Roth IRA), file a Form 1099-R for the 2012 distributions, is everything okay? Any penalties or taxes due that you can see?
Thanks again for your thoughts,
John[/quote]
John,
You may want to contact the retirement plans department at TD or some other professional to review your case in detail. This message board is a good place to start, but it seems you need much more.