After Tax Basis and Earnings Rolled to ROTH
Client “accidentally” had BOTH is AFTER-Tax 401k Basis and Earnings rolled into a ROTH IRA as one check.
Basically client rolled out 401k and received one check for Pre-Tax Money to Traditional IRA and one check for After-Tax Money (Basis AND Earnings) to ROTH IRA.
Can the client simply pay the tax on the After-Tax Earnings (as indicated on his 1099-R) and treat the taxable After-Tax Earnings as a “Conversion” to ROTH status?
Permalink Submitted by Alan - IRA critic on Sun, 2019-03-03 20:56
Yes, usually the taxable earnings in a direct rollover from the after tax 401k sub account is small enough that it is not worth the trouble to roll it to a TIRA. Most people roll the entire after tax sub account to a Roth IRA and pay taxes on the amount of earnings, which will show in Box 2a of the 1099R. This qualified rollover contribution will have to be held 5 years to avoid the 10% penalty on the small taxable amount (unless client reaches 59.5 first). Such penalty would not likely amount to much however.
Permalink Submitted by Dustin DeFranco on Sun, 2019-03-03 21:21
Big Thank you. However, does the size of the taxable portion matter for IRS legality. For instance in this case his after-tax basis was $10k and his After-Tax Earnings were $40k for a total of $50k. This was an after tax contribution from 20 plus years ago…Client is over 59.5 but still young…62. He sees benefit in having a $50k ROTH for future tax benefits and just paying the taxes now and turning “mistake” from lemons into lemonade. Do you see any red flags because of those dolalr amounts?
Permalink Submitted by Alan - IRA critic on Sun, 2019-03-03 21:57
In this situation where the contributions date far back and the earnings are large, a split rollover would have prevented the tax bill on the 40k, although it would also impair back door Roth contributions due to the TIRA pre tax balance. There are no red flags here since people are still doing large taxable conversions and tax rates have just been reduced. If client is in a low marginal bracket the conversion could well be beneficial in the long run despite the tax bill. The 1099R will show the taxable amount in Box 2a, so client will not have to determine the taxable amount using Form 8606 as would be the case for an IRA to Roth IRA conversion.