Excess Roth Deferrals Moved to IRA

Submitted by Jonathan Sard on Mon, 2019-04-22 14:07

A client made excess Roth 401k deferrals in 2018 for $18,500 because he changed employers in 2018 and contributed $18,500 to BOTH plans. After he left the first company in May of last year he rolled over his $18,500 Roth 401k to his personal Roth IRA. Does he now need to take out his excess Roth contribution of $18,500 (plus earnings) from his Roth IRA since his old Roth 401k is terminated? Thank you!

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Permalink Submitted by Alan - IRA critic on Mon, 2019-04-22 17:51

Excess Roth deferrals present a potential mess. The first employer is not likely to amend the 1099R for the direct rollover to a Roth IRA, leaving the excess Roth deferral in the current plan. But it is now after 4/15, so any return from the current plan is going to be double taxed since it was post tax when contributed, but will be taxable again if a corrective distribution is made after 4/15 despite it being a Roth contribution.
As such the client has a choice. Either explain the situation to the current plan and request a distribution (no earnings) of the excess and it should be reported as taxable on the 1099R for 2019. Otherwise, the current plan will never know about this excess, but the IRS will due to the W-2 coding of deferrals for 2018. Client is not obligated to remove the excess but future 1099R forms will not correctly report the distributions as taxable, meaning the client will eventually have to explain this to the IRS when reporting distributions from the Roth 401k. This situation will be even more complex once the current Roth 401k is rolled over to a Roth IRA.

Permalink Submitted by Jonathan Sard on Mon, 2019-04-22 18:02

Thank you. I am a bit confused. So can he not just take out the excess contribution from his first employer of $19,102 from his existing Roth IRA where the $19,102 was rolled into?

Permalink Submitted by Alan - IRA critic on Mon, 2019-04-22 18:25

Yes, if he could get that employer to issue corrected 1099R forms for 2018 coded as a return of excess deferrals plus earnings. The 602 of earnings would have to show in Box 2a as taxable on the 2018 return. Then he could use this 1099R to show the Roth IRA custodian to treat the entire rollover as an excess regular Roth IRA contribution to be returned with earnings while the Roth IRA held this rollover. Again, any earnings in the Roth IRA would also be taxable in 2018, the year the Roth IRA contribution was made. Problem is, the former employer plan is not likely to cooperate and revise their 1099R since at the time of the termination and rollover, there was no excess. Client could try, but I don’t expect he would get any cooperation from the former employer. No employer is required to return excess contributions (or treat distributions already made as corrective distributions), but in the case of two employers, it is almost always the current employer that makes the distributions.

Permalink Submitted by Jonathan Sard on Mon, 2019-04-22 18:53

I want to assume his former and current employer will be uncooperative. His total deferral was actually $19,102 due to the catch up contribution. How can someone calculate the earnings from that account considering it was from deferrals over a few months period, and was then transferred to a Roth IRA and has since been transferred to another Roth IRA? Where do we begin to try and determine the earnings? I thought the earnings would be taxable in 2019 since it was withdrawn this year?

Permalink Submitted by Alan - IRA critic on Tue, 2019-04-23 00:19

Since he qualified for catch up contributions, his total allowed deferrals for 2018 was 24,500, so that should reduce the excess amount somewhat. The rollover to the Roth IRA was in 2018. The chances of his current employer cooperating with a late distribution are much better than the former employer as there is about 0 change the former employer will change anything due to the circumstances including already having reported the direct rollover to the Roth IRA.
With no action on the part of either plan, the choice comes down to doing nothing and dealing with any fallout down the road because of the IRS knowledge of excess 2018 deferrals, or going down the road of trying to convince the IRS directly that the direct rollover of the former plan balance should be treated as a distribution of the excess deferrals to the extent of the excess amount (amount the total deferrals exceed 24,500) plus earnings. Those earnings rolled over to the Roth IRA attributed to the excess deferral amount can be calculated, but would first need to know the total W-2 coded Roth deferrals for both plans. That 602 distributed was gains unless the W-2 shows the entire 19102 as deferrals, which is unlikely. Once those first figures are known, then it would be possible to determine the amount of gains rolled over, but I don’t know how to convince the IRS that they should treat that first rollover as a corrective distribution when the 1099R does not show that and treats it as an eligible rollover. The Roth IRA custodian would probably be looking for some evidence that the amount rolled in was not eligible for rollover, and the W-2 copies are only an indication, not proof. There is no predicting what the IRS will do in this situation, may depend on how it is presented to them.

Permalink Submitted by Jonathan Sard on Mon, 2019-04-29 18:36

If the client decides to take the excess deferral from the Roth IRA as opposed to the second 401k plan, does he also need to take out the earnings? If so, how would we calculate the earnings on that $19,102 deferral that was made in 2018? That $19,102 was directly rolled over to a Roth IRA at one institution in the middle of 2018, and then was directly transferred again a few months later to an existing Roth IRA with roughly $75,000. Now that these Roth IRAs are combined, how do I calculate the earnings on that initial $19,102 over contribution that was made in 2018?Also, on what amount is the 6% excise tax calculated since it is now past April 15th and is the excise tax mandatory? Thank you!

Permalink Submitted by Alan - IRA critic on Tue, 2019-04-30 18:09

Even if client could convince the current 401k plan to distribute the excess deferral amount, it is past the 4/15 deadline and therefore the distribution would be taxable, so that is not a good solution as it might have been prior to 4/15 when such a distribution (with earnings) would not have been taxable except for the earnings. Therefore, the choice at this time is to simply leave the excess amount in the plan when it will eventually be taxed (but not clear how or when since the plan is not even aware of any excess due to the first plan) OR to attempt a makeshift solution such as your proposal.
Simply attempting to resolve the entire problem with the removal of the excess from the Roth IRA is not guaranteed to work without a corrected 1099R from the first plan. The first plan will almost surely refuse to correct the H coded 1099R they already issued, but there is no harm in trying to convince them by providing them with both W-2 forms. Assuming no help from the first 401k administrator, it will also be difficult to get the Roth IRA custodian to treat the removal as an excess contribution. Since there is no corrected 1099R from the first 401k plan coded 8B to show distribution of a Roth excess, those W-2 forms are the only documentation left to show the Roth IRA custodian. Further, due to transfer of the first Roth IRA balance to the current Roth IRA custodian, the current custodian has no way of calculating the earnings, so would have to improvise. Roughly, the excess Roth IRA contribution WOULD HAVE been the difference between 24,500 and the total shown on the W-2 forms as Roth 401k deferrals. That is the amount to be returned plus whatever method the custodian chooses for calculating the earnings in the two Roth IRA account. They might ask the client to provide the earnings calculation for the first Roth IRA custodian, but they can easily determine the earnings on this amount in their own Roth account. First, what is the total showing on the 2 W-2 forms for Roth 401k contributions. No point in basing the removal on 19,102 when the excess is probably less than that. Again, there is no assurance that even if the Roth custodian cooperates, that there might not be some issue down the road because the IRS will NOT have any 1099R from either Roth 401k plan indicating the return of the excess and might deem the excess to still exist in the current 401k.
If the client is on extension or filed the 2018 return by 4/15, any Roth IRA excess can be removed with earnings up to 10/15. However, technically right now the excess is in the current 401k plan, not in the Roth IRA because at the time of the direct rollover and according to the H coded 1099R, the amount was eligible for rollover to a Roth IRA.
In summary, removal of Roth IRA funds with the proper 1099R from the Roth IRA custodian is a good faith effort to resolve the problem, but since there is no line to connect the dots, this is not guaranteed to work.

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