Transferring a 401k to IRAs
Hello Alan and others
My wife (62) and I (67) are both retired. She has a company 401K valued at $480K total, with $20K in after-ax contributions and $36K in after-tax gains. We want to roll this over to an existing TIRA and Roth IRA but are confused about the IRS guidance issues, the mechanics of how we handle this, and the advantages and disadvantages of the process. After reading through previous posts, I gather it is better for us to do a direct rollover of the pre-tax money, including after-tax gains, to the TIRA, and take the after-tax contributions as a tax-free distribution and roll that into the Roth. If there are possible IRS reporting complications, we could move the after-tax money to our taxable account. Is this correct? Many thanks for your patience.
Jeff
Permalink Submitted by Alan Spross on Thu, 2012-11-08 17:39
Yes, there are IRS issues if you want to isolate your 20k of after tax contributions to the Roth IRA.
The only safe way to do this is would require her to take a full distribution, then do her own rollovers to the TIRA first and the Roth last. This would require you to have to come up with 92,000 of cash to replace the 20% mandatory withholding on the 260k pre tax portion. You recover the withholding when you file your tax return in about 4 months.
If you want to take on a small amount of risk to avoid the withholding problem, she could do as you indicated – a direct rollover of the 460k to a TIRA and then get a check for the 20k. She can either keep the 20k in taxable or roll it to a Roth IRA within 60 days of receipt. The risks are very low in doing this and the consequence in the unlikely case the IRS would object is that the conversion would be taxable and most of the 20k basis would be assigned to the TIRA. But if that happened she could likely recharacterize the conversion to eliminate the tax bill, and that would leave the basis in the TIRA.
Permalink Submitted by Jeff Watkins on Mon, 2012-11-12 17:03
Hello Alan
I am confused about your answer:
“If you want to take on a small amount of risk to avoid the withholding problem, she could do as you indicated – a direct rollover of the 460k to a TIRA and then get a check for the 20k. She can either keep the 20k in taxable or roll it to a Roth IRA within 60 days of receipt. The risks are very low in doing this and the consequence in the unlikely case the IRS would object is that the conversion would be taxable and most of the 20k basis would be assigned to the TIRA. But if that happened she could likely recharacterize the conversion to eliminate the tax bill, and that would leave the basis in the TIRA.”
Is the “conversion” the $20k in after-tax money we could put in her Roth? How can after-tax contributions be taxable? Is this considered a Roth conversion? Why would any part of the $20k basis be be assigned to the TIRA? Would you please elaborate more on your explanation? We accept the small risks you discuss but we want to understand the entire issue. We want to make the right decision the first time around.
Many thanks!
Jeff
Permalink Submitted by Alan Spross on Mon, 2012-11-12 23:09
Technically, a Roth conversion is only from a TIRA to a Roth IRA. This is a rollover from an employer plan, but it follows the same rules as conversions.
Since this would be tax free money according to the 1099R, the Roth rollover would be tax free.
The risk is that the IRS could conceivably rule that the rollovers to the TIRA and the Roth IRA cannot be separated and must be treated as if they were first rolled to a TIRA and then converted. In such a conversion 460/480 of the amount converted would be taxable (pro rating the total). This what the IRS indicated in Notice 2009-68.
However, they never followed up on the Notice with guidance on how plans should issue the 1099R. So plans have continued to issue them just like they always have, when after tax amounts were distributed to the employee. That 1099R will not show any amount taxable. And neither will the other 1099R show a taxable amount because it was a direct rollover to a TIRA account. As indicated, employees have basically been free to ignore Notice 2009-68. Employer consultants have written several times to the IRS to clarify that Notice, but the IRS has never responded. The reason the risk is low late in the year is that any guidance to employers now is too late to be incorporated into their tax reporting software. To make a retroactive ruling would create such a massive can of worms for both employers and employees causing 3 years worth of returns to be amended etc. There is no way any ruling will be retroactive. This is why it is safer to do this before year end, but after year gives the IRS an entire additional year to issue guidance to the plans and the 1099R.
There are dozens of threads on this site that have discussed this issue, usually containing the words “isolation of basis”. You could locate some of them, but it will still be difficult to understand the technical questions. The most difficult question is why an indirect rollover should be treated differently than direct rollovers for tax purposes! The following is a link to one of those letter to the IRS from the American Benefits Council:
http://www.americanbenefitscouncil.org/documents/402f_notice_abc-cmnts_1…
Permalink Submitted by Steve Blankenship on Sun, 2012-11-25 05:41
Alan,
Simple procedural followup on this. Assuming that there is sufficient cash to replace the withholding, when a client receives the physical check(s), should he/she endorse the pre-tax rollover money check over to their IRA or is it important that they deposit the check in their checking account and then write a check to the IRA custodian for the rollover. Generally, most clients know not to cash rollover checks not knowing that they can roll that money over within 60 days and be ok. It’s an easier battle to win mentally with most clients if they can endorse the check over and never deposit it and of course add an additional personal check to make up for the withholding rather than deposit everything and then write one check. I just hate to see people slip up if there is a right and wrong way to execute this procedurally.
Steve
Permalink Submitted by Alan Spross on Sun, 2012-11-25 17:30
Steve,
Either way will suffice as long as TIRA rollover is complete before the Roth portion is done. Documenting those dates should be easy in the unlikely event the IRS requests such documentation. The Roth portion should be delayed until the full TIRA contribution shows up in that account. I wouldn’t just send out the checks two days apart and risk the TIRA custodian taking 3 days longer to deposit theirs as that would result in the Roth portion being completed first with potentially disastrous consequences.