IRS Notice 2014-54

Submitted by Peter Thomann on Thu, 2014-09-18 18:00

Anyone get a chance to read this notice? The notice is in reference to “Guidance on Allocation of After-Tax Amounts to Rollovers”. This has been a frequent question on this board.



Submitted by Alan - IRA critic on Thu, 2014-09-18 19:32

Do you have another Notice #?  2014-54 relates to HRAs, 125 plans, ACA etc

Submitted by Peter Thomann on Thu, 2014-09-18 19:56

If you type the notice number in Google it comes up.  It appears that a direct rollover to a Roth IRA is permitted when done in conjunction with a direct rollover of pre-tax money.  Trying to decifer if the pro-rata rules still apply if an individual rolls over pre-tax, but receives the post tax and does not rollover.

Submitted by Alan - IRA critic on Thu, 2014-09-18 20:19

  • Thank you! This is a very taxpayer friendly resolution from the IRS.  http://www.irs.gov/pub/irs-drop/n-14-54.pdf
  • The IRS has relented from the 2009 Notices and will allow the employee to decide their own allocation of where the basis goes. This means that doing two direct rollovers (Pre tax to TIRA and post tax to Roth) is acceptable to the IRS. The Notice includes some scenarios in example to illustrate the benefits of this Notice.

  

Submitted by Bruce Steiner on Thu, 2014-09-18 22:34

It still doesn’t seem that it will make sense very often to make nondeductible contributions to a qualified plan or IRA unless you expect to be able to take the money out in the near future to transfer it to a Roth or do a backdoor Roth conversion.  While the after-tax money is in the plan or IRA, the income and gains on it will become ordinary income.

Submitted by Alan - IRA critic on Fri, 2014-09-19 00:47

Bruce, some of these 401k after tax contributions are due to pre tax contributions being recharacterized by the plan as after tax when HCEs collectively fail the ADP test. In those cases, the participants intended their own deferrals and co matching contributions to be fully pre tax. But the bulk of after tax contributions are being contributed intentionally to after tax sub accounts which can receive unlimited amounts as long as the total plan contributions do not exceed 52k plus catchup. This becomes a way for higher income people to attain the effect of quite large regular Roth IRA contributions by rolling these to a Roth IRA. After separation from service, some plans do not allow the after tax account to be distributed separately as it typically can be while still employed. This has created the need to isolate basis to get only basis into the Roth IRA and pre tax amounts to a TIRA. Other employees do not roll the after tax contributions out of the sub account often enough and considerable earnings can be generated in the sub account before the sub account is rolled out. 

Submitted by fairira on Sat, 2014-09-20 17:27

Re IRS Notice 2014-54–Alan-iracritic, could you please comment on the following:   1.  On 9-18-14 at 12:56, info said “It appears that a direct rollover to a Roth IRA is permitted when done in conjunction with a direct rollover of pre-tax money.  Trying to decifer if the pro-rata rules still apply if an individual rolls over pre-tax, but receives the post tax and does not rollover.”  What is your opinion please?   2.  I also wonder if both direct rollovers must take place at the same time or close in time.  Could one now leave the pre-tax asset portion in one’s 401(k) and just directly roll over only the post-tax part of one’s 401(k) to a Roth IRA without pro rata concerns even if one also has other pre-tax assets in a TIRA?   3.  If one has made a nondeductible TIRA contribution and Roth converted it and in the same tax year one does the “twin” direct rollovers of one’s 401(k) assets, is there any pro rata consequence like changing part of the converted TIRA amount to pre-tax and creating basis in the pre-tax part of the 401(k) now in the TIRA?   Thank you for your help.

Submitted by Alan - IRA critic on Sat, 2014-09-20 18:13

  1. Pro rating would not apply, but the explanation why differs according to how the rollovers are done. If the individual did a direct rollover of the pre tax amount by requesting that the plan directly roll over only pre tax money, the plan can do that per this Notice. That leaves only the after tax check which individual can retain or roll to a Roth IRA. But if the individual receives the entire distribution and does the rollovers himself, the first rollover is automatically pre tax money first, so in order for the post tax money to go to a Roth, the pre tax money must be rolled to a TIRA before the Roth rollover. And 20% withholding must be replaced by the individual to make these rollovers complete. This rule has always existed, and in Notice 2014-54 the IRS uses this rule as a reason to allow the individual to direct the IRA destination of direct rollovers as well.
  2. Yes, direct rollovers/distributions must be executed fairly close together as part of a single request by the employee. Reasonable administrative time is allowed the plan to complete both direct rollovers. But the employee should not be allowed to request a direct rollover, and then a week later request that the plan change the character of that rollover OR request the plan to add other dollars to that prior request. The second request would be a separate distribution/transaction. And unlike IRA accounts and Form 8606, qualified plan distributions calculate the pre tax vs post tax amounts on the date of transaction, not at year end. The second part of your question cannot be done. The plan must still use pro rate rules (except for pre 87 after tax contributions or separate sub account distributions) to determine the mix of pre tax and post tax amount that are distributed. Therefore, employee could not just ask for the post tax amount to be distributed by itself and leave the pre tax in the plan if there is just one account. But many higher income employees are currently using the after tax sub account to do exactly as you asked, ie they make after tax contributions to that sub account and then roll them to a Roth IRA before much in earnings are generated on those contributions.
  3. Yes, there is a consequence because the pre tax direct rollover to the TIRA will increase the TIRA pre tax balance on line 6 of Form 8606 as of year end and that make the back door Roth conversion mostly taxable through 8606 pro rating. Without the rollover to the TIRA, if the TIRA held all basis, the conversion would have been tax free. There is also another more subtle consequence if this years Roth IRA conversions are distributed in less than 5 years and taxpayer is under 59.5. The Roth IRA is the rollover years is receiving a tax free Roth rollover from the qualified plan AND a Roth conversion that has been made mostly taxable on Form 8606. Later within 5 years, and Roth distributions of these converted amounts must be allocated first to the pre tax portion of these conversions. Therefore, the taxable portion of the IRA conversion comes out first and is subject to a 10% penalty. The tax free 401k Roth rollover comes out only after the taxable portions of the rollovers.
  4. If I missed anything, please advise.

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