Upstream Rollover/Roth Conversion
Dear Alan et al,
I have a client who has a Traditional IRA. Our goal is to roll the growth upstream into her 401(K) plan followed by a conversion of the basis to her Roth IRA. Here are my proposed steps:
1. She makes a $5,500 non-deductible contribution for 2014 before April 15, 2015. This brings her basis to $16,000 and her account balance to $39,000.
2. She rolls the growth ($23,000) into her 401(K) plan.
3. She converts the basis ($16,000) over to her Roth IRA tax-free.
We do all of this before Dec 31, 2015. Does the timing of all of this sound correct?
Thank you,
Chris
Permalink Submitted by [email protected] on Wed, 2015-03-04 18:30
I believe you have this exactly right in theory. In practice, there may be a challenge with moving the taxable portion to the 401k FIRST, followed by the basis conversion to Roth. The reason is there may be a market adjustment that occurs after the removal of the taxable portion, leaving a residual taxable portion that is converted (and subject to tax). This may not be consequential, but it is possible.My question to Alan to clarify what we are doing is that we actually convert the equivalent of the basis FIRST, since it is unchanging except for contributions. Once that conversion is done, we liquidate, via transer, the IRA of the rest of the account, representing fully taxable portion, regardless of market action post conversion. Is there any specific rules that prohibit the ordering it this way? Since the reporting is all done post 12/31 and the 12/31 value of the account is now zero, does it matter which was done first during the year?
Permalink Submitted by Alan - IRA critic on Wed, 2015-03-04 19:24
No, the order does not matter. Doing the conversion first is cleaner since the converted amount will exactly equal the basis. There will be no taxable earnings and no remaining basis in the event of a loss occurring prior to the conversion if the conversion is done last. The only downside would be if the rollover to the 401k does not get completed on time, then the taxpayer will probably not want to pay the taxes and will have to recharacterize the conversion. Probably the most frequent cause for this is a 401k plan that will not accept IRA rollovers unless it comes from a rollover IRA. and this restriction was not known to the taxpayer when the conversion was done.
Permalink Submitted by Christopher Combs on Wed, 2015-03-04 19:41
Thanks to both of you for your input and clarification. With best regards, Chris
Permalink Submitted by Charles Voight on Wed, 2015-03-25 00:03
Rather than start a new thread, I wanted to add a twist. All of the above from Chris’ client apply to me, i.e. I have earnings on my non-deductible IRA that I would like to roll over into my employer 401k before converting to a Roth. My employer’s 401k administrator, Great-West, will accept Traditional IRA contributions, with this caveat: “The only money being rolled over is from deductible IRA contributions and their earnings. No non-deductible contributions or amounts attributable to Roth IRAs are included” What gives? If I do not roll over the earnings from this IRA, they are taxable. Shouldn’t that be all that they care about really? Further, to scare folks, they ask that I sign the following statement:”I understand that the plan will rely on the truth of these certifications and that if any of these certifications are false, there may be severe financial consequences to me and the plan. In consideration for the acceptance of my rollover contribution from my rollover IRA or traditional IRA, I agree to be financially responsible for these consequences” Confused…
Permalink Submitted by Alan - IRA critic on Wed, 2015-03-25 00:24
A qualified plan is NOT allowed to receive IRA basis in a rollover and is subject to fines or penalties if it turns out that IRA basis was included in the rollover. For many years these plans refused to accept IRA rollovers from IRA accounts that were not rollover IRA accounts because of this concern. But last year the IRS published guidance that if the plan relies on the employee’s certification that there is NO basis included in the rollover, they will be relieved of any severe penalties. Therefore, the strong wording you are looking at is designed to both allow the plan to accept your non rollover IRA, but also to reduce exposure to IRS consequences if an error is made by the employee. This is better for you compared to the plan simply refusing to accept your IRA. If you are careful and are confident that your Form 8606 is up to date and correct, you shouldn’t have anything to worry about.
Permalink Submitted by Charles Voight on Wed, 2015-03-25 15:59
Thank you Alan. I have been diligent in keeping my 8606 updated with my basis and will leave the basis (and a sufficient cushion for market fluctuations before I convert) out of the rollover. I will rollover just the earnings, which would have been taxable anyway had I not rolled them into the 401k.I read the new IRA rule in p525 which allowed just the basis to be left out of the rollover to minimize taxes now, which gave me hope. Thanks again!
Permalink Submitted by Jose Morales on Wed, 2015-03-25 17:45
I’m impressed that they are actually following the rules and having the employee certify the nature of the amounts being rolled over. Every single direct rollover request from an IRA to an employer plan that I have received to date has required that I, on behalf of the IRA Custodian, certify that no basis will be rolled over. No matter how many times I’ve picked up the phone and asked the plan administrator exactly how it is that they expect the IRA Custodian to make such certification they all insist that it must be done this way.
Permalink Submitted by Alan - IRA critic on Wed, 2015-03-25 18:59
Surprising. This is the IRS Notice describing a safe harbor procedure: http://www.irs.gov/irb/2014-17_IRB/ar05.html. Throughout it refers to employee certifications quite clearly. Some plan administrators need to re read this.
Permalink Submitted by Jose Morales on Wed, 2015-03-25 19:53
I’ve shown them this and it was of no help. Once it’s on the forms or in their procedure people tend to not waiver, even with evidence they are wrong. It’s always very frustrating. TIAA-CREF is the biggest headache when it comes to this topic.