Timing of After tax rollover to Roth IRA
Taxpayer, still currently employed has 401k balance worth $3,000,000 which is comprised of $400,000 of after tax contributions; $1,200,000 of earnings associated with the after tax contributions, and the balance of $1,400,000 which is pretax contributions and earnings.
Their plan allows for the after tax contributions of $400,0000 to be rolled to Roth IRA while still employed but will not allow in service withdrawals for the balance.
Taxpayer contemplating retirement 12/31 of this year.
Is the only way to get funds into Roth IRA without paying tax for taxpayer to roll out entire balance ($3,000,000) at same time – in essence rolling after tax contributions of $400,000 to the Roth IRA and the balance $2,600,000 to an IRA?
Concerned that this needs to be completed prior to 12/31 due to possible law change and also to comply with how IRA wants you to allocate rollovers out of a plan.
If so maybe taxpayer can retire Dec 1 to give enough time to get rollovers completed.
Thanks
Howard
Permalink Submitted by Alan - IRA critic on Tue, 2021-09-28 18:01
Perhaps taxpayer should elevate this issue to someone with the plan administrator with more expertise on qualified plans. The after tax account must distribute the earnings with the after tax contributions or pro rata of each or not allow any in service distributions. If this cannot be resolved soon, moving up the retirement date and then doing a split rollover per Notice 2014-54 would should get the job done. If taxpayer decides to do this, they need to have the papers prepared for the direct rollovers to be submitted immediately, maybe even before the retirement date, but to take effect the day after the retirement date. Has taxpayer attempted to do rollovers from the after tax account before and always received the same answer? If there are other high earners in this company, there are probably others who are very concerned right now as well.
Tax code Sec 72(d)(2) addresses separate accounts for after tax (aka employee) contributions, copied below:
(2)Treatment of employee contributions under defined contribution plansFor purposes of this section, employee contributions (and any income allocable thereto) under a defined contribution plan may be treated as a separate contract.
Permalink Submitted by Howard Hook on Tue, 2021-09-28 18:19
Thanks Alan. It may be case of taxpayer not misunderstaning what they were told.Do not think taxpayer has done any prior rolloversIs your concern for urgency due to possible change in law or that entire account must be rolled over prior to year end to allow for pretax and earnings to go to IRA and after tax contributions to go to Roth IRA?Put another way – if the law does not change can we wait until January 1 to rollover entire account and split into IRA and Roth IRA the most tax efficient way.Thanks as always Howard
Permalink Submitted by Alan - IRA critic on Tue, 2021-09-28 19:21
Yes, the proposed tax law change which will make it impossible to roll after tax contributions to a Roth IRA would be very costly to this taxpayer. In recent years such major tax changes have been signed into law in late December. If this provision is modified or eliminated, then there would not be a problem waiting until taxpayer has retired and doing a split rollover in early 2022, with the after tax amount going to the Roth IRA and the balance of the plan to a rollover TIRA. However, since the taxpayer’s understanding of the plan’s in service distribution options reflects an abnormal plan document, there is a good chance that the split rollover might be able to be done prior to retirement, and retirement would not have to be moved up to get this done.
Permalink Submitted by Howard Hook on Thu, 2021-09-30 13:43
Thanks Alan. Could you answer one last question? -Assuming that the taxpayer misunderstood and the plan allows for after tax contributions and the earnings associated with those contributions to be withdrawn in service – Would the only way to achieve no current taxation on doing those rollovers be for taxpayer to rollout the pretax money as well (in this case by retiring)? In other words does the prorata rule include the pretax earnings if they remain in the 401k Plan.Thanks again for all of your help!Howard
Permalink Submitted by Alan - IRA critic on Thu, 2021-09-30 15:45
If the plan treats the after tax sub account as a separate account, and almost all do, a specific request to roll out the after tax sub account balance should not invoke any pro rating with the rest of the plan. However, the earnings on the after tax contributions would have to be rolled to a TIRA and the after tax contributions to a Roth IRA for the entire transfer to be tax free. Such a request should clearly specify that only the sub account should be distributed. The 1099R should then have no balance in box 2a.
From now until late November, there is time to monitor this legislation to see if it stalls or the particular provision eliminating conversion of after tax amounts is modified. If that happens, there is no need to change the retirement date because the direct rollovers could be done in January under the present rules.
If taxpayer can get assurance that the plan will handle this as desired, taxpayer could do the in service rollover soon and still stick with the 12/31 retirement date. If not, best to move the retirement date to early Dec so that the rollovers can be done before year end as a retiree and would not hinge on the plan treating the after tax sub account as separate.
In both cases, the rollover of after tax and pre tax amounts must be requested as a single request for a split rollover per Notice 2014-54.
Permalink Submitted by Howard Hook on Thu, 2021-09-30 17:35
Thank you Alan for all of your help!Howard