Rollover IRA set up instead of Roth IRA

Submitted by Emily Resseger on Mon, 2021-03-29 15:35

Hello-

My wife rolled over a Roth 401k into a new IRA back in 2015. This year she contributed to that Roth IRA (first time since the rollover), and only then did we learn that the account setup back in 2015 was a Rollover IRA not a Roth IRA, as we assumed. So this post-tax money has been building up pre-tax earnings for 6 years, and there is nothing associated with this IRA indicating the money rolled over was post-tax.

We have a 2015 1099-R from the Roth 401k company indicating a distribution code of H, but we can’t find any of the IRA setup forms to understand if she requested a Roth IRA or not at that time. It’s definitely possible she made a mistake on sign-up, however I also believe the money sent from the 401k company should have made clear it was from a Roth 401k and was post-tax, and the rollover should have been rejected. (the IRA company is one of the well-respected behemoths and should have checks for this in place)

What recourse do we have now, 6 years later? We’re not talking about a lot of money so my wife sort of wants to let it go, but I object to her paying tax on this money twice on principle. She is having her 2020 $6000 contribution to this account recharacterized into a new Roth IRA account now, so the errant Rollover IRA will be back to just having money in it from that one time Roth 401K rollover, plus earnings.

Thanks!
Emily



Submitted by Alan - IRA critic on Mon, 2021-03-29 17:23

This is unfortunate because the time delay reduces her chance of the current custodian seriously looking into this. Most likely, they will indicate that this should have been brought to their attention shortly after the rollover landed in the wrong account. A form 5498 was also issued to her and the IRS reporting that the rollover contribution was made to a TIRA rather than a Roth IRA. Everyone should check to see that the result of any transfer is as ordered immediately afterward. Even then it is sometimes difficult to secure custodian cooperation.
This rollover does more damage than loss of Roth status. Technically, it turned the 2015 transfer into a taxable distribution (but 2015 is a closed year now). The distribution was then rolled into an IRA type for which it was ineligible creating an excess TIRA contribution and an annual 6% excise tax from 2015-2020. If the excess (but not the earnings) are removed from the TIRA by the end of this year the excise taxes will end with 2020. There is no statute of limitations for excess IRA contributions. Removal of the excess from the TIRA would require evidence be submitted to the custodian such as a copy of the 2015 H coded 1099R     for the custodian to be able to treat the distribution as non taxable as if a non deductible contribution had been made to a TIRA. 
Review the following IRS Notice regarding self certification to extend the 60 day rollover period. You will see that the IRS never intended this to allow a rollover 6 years later, but it may be worth a try to submit the form to the current custodian using the reason that the rollover was deposited into an account that she believed to be a Roth IRA. This is very much a long shot, but do not overlook the excess TIRA contribution issue if the custodian does not reform the rollover.  A copy of the rollover check would help if it was made payable to”wife Roth IRA”, as that is further evidence of current custodian error.

Submitted by Emily Resseger on Mon, 2021-03-29 18:56

Oof, this is way beyond my knowledge/skills. Thank you for your thoughts. And agreed, we should have checked…lesson learned 6 years too late 🙂  I found the 5498 for this conversion that clearly indicates it was never treated as a Roth by the current company.
If we consider it the way you stated, where she got a Roth 401k distribution in 2015 (only the earnings would have been taxable with penalty, right?) and then immediately put it in her Rollover IRA, would that be a excess contribution if it was under $5500? Wouldn’t it just count as her 2015 IRA contribution?  If this is the case, and it’s not considered an excess TIRA contribution, it sounds like we just may be stuck leaving it in this rollover IRA and letting it go? Is there any way we could get in trouble in this case?
She is going to call them and see if they will re-title the account. She has notes indicating she was very aware she needed a Roth IRA for this rollover and called to set it up. She also had a non-Roth 401k, so she set up two accounts that day, intending one to be rollover and one Roth. They set them both up as rollover. We don’t have a copy of the rollover check because it was a custodian to custodian transfer, we only have the 1099-R from first company with Code H marked.

Submitted by Alan - IRA critic on Mon, 2021-03-29 21:52

First, sorry to have omitted the link to delayed rollovers in prior post. It follows below:
Microsoft Word – rp-20-46.docx (benefitslink.com)
You are correct that if the Roth 401k distribution was reported, much of it probably would have been non taxable as a return of contributions. Any earnings would have been taxable, but 2015 is closed now so tax on any earnings is avoided. 
If the amount is under 5500, and IRA contribution space for 2015 was not used, the rollover could be treated as a non deductible TIRA contribution. The IRS accepts retroactive 8606 forms reporting non deductible contributions. In this case, there would be no excess TIRA contribution and excise taxes for the intervening years would not apply, and there is no need to withdraw the amount from the TIRA.
Most direct rollovers are issued with a direct rollover check mailed to the participant and the participant forwards it to new custodian. That is when the participant could make a copy, but most do not bother. If there was a copy retained with the payee being the Roth IRA, additional leverage could be applied to the custodian. However, it is not possible to know whether the custodian would still resist or not. Wife could also ask why she would have set up a Roth IRA if at least part of the rollover wasn’t to be rolled to the Roth IRA.  Please let us know if the present custodian is even willing to listen to her case, or simply states it is too late as expected.
 

Submitted by Emily Resseger on Wed, 2021-03-31 15:36

Thanks again for your help.
She’s called once and of course they just want her to talk to a tax professional about the tax consequences. She’s planning to call back and make the point more forcefully that this is their mistake, not hers.  Unfortunately the check was direct custodian-to-custodian. New custodian found a copy of the check (they say) and it apparently just contained the name of new company and the account number. 
She is also putting together a RP 2016-47 60-day waiver letter, because why not?  She figures she’ll mention putting together the letter in her next call, in hopes that convinces them to re-title the account (the ideal situation).
In your understanding, if the company accepts the RP 16-47 letter and is willing to accept the late rollover, how are the earnings on the money from the last 6 years treated? Let’s say she put in $5000 and it’s now worth $9000. We would specifically ask that the $5000 contribution be moved into a Roth IRA. Would the $4000 stay in the Rollover? Would it be moved to the Roth with the contribution amount? Would there be taxes on the earnings? One of the reasons given in the letter is “(c) the distribution was deposited into and remained in an account that the taxpayer mistakenly thought was an eligible retirement plan”, which definitely fits her situation. But it doesn’t say what should happen if it has earnings from being in an in-eligible retirement plan. 

Submitted by Alan - IRA critic on Wed, 2021-03-31 18:46

As you indicated, the ideal situation would be to have the custodian reconstruct the original direct rollover as going to the Roth IRA from the start. The earnings would go with it. One big issue is that several years of custodian tax reporting must be redone, for example the year end value on Form 5498 would change from TIRA to Roth values, and the original 5498 reporting the rollover contribution would have to be reissued as a Roth rollover contribution. 
Plan B is much inferior as it would allow a rollover now instead of then. The gains would likely remain in the TIRA and an annual excise tax would be due on the TIRA excess (ineligible) contribution. The gains would not be lost but they would be pre tax dollars in a TIRA and would eventually be taxed. And of course a 6% excise tax would be due each year on the original excess amount. The late rollover would be for the original distribution from the plan so would not include gains, but would prevent the Roth 401k distribution from having any taxable component due to the late rollover. Again, this does not relieve the excise tax or the excess contribution to the TIRA, which must be corrected on it’s own.
Hopefully, the custodian will consider reason c) to include a deposit made in a direct rollover error that the taxpayer did not make or notice that the type of account was ineligible. 
I don’t know how often the IRS overrules the custodian’s decision, but as you can see from the RP the IRS has the option to do so if they choose to.  I have not heard whether the RP has often been used successfully or whether custodian’s resist it. 
You did not indicate whether the account number shown on the check was the correct (Roth) AC # or the incorrect TIRA AC @?? That may be the main driver of the custodian’s decision.

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