Roth 401(k) in-Plan Conversions Transferred to Roth IRA
There is an entry in the page 262 Table in Ed Slott’s NEW Retirement Savings Time Bomb book that I suspect isn’t correct. But I’d like to see what others think about this.
The entire Table (pages 261 & 262) deals with various cases of transferring Roth 401(k) funds over to Roth IRAs. The bottom row in this table deals with the case where the Roth 401(k) account contains in-plan conversions that have not yet exceeded the 5-year holding period for Sec. 72(t) penalty-free distributions. [Note – this is NOT the 5-year period for determination of qualified / nonqualified distribution status.]
According to this Table row, that 5-year holding period follows the transferred funds after they are moved to the receiving Roth IRA. EXAMPLE: In January 2021 Art makes an in-plan 401(k) conversion of all $10,000 of previous 401(k) salary deferral contributions into that plan’s Roth 401(k). In Feb. 2021 Art moves to a new employer and decides to perform a direct trustee transfer of his Roth 401(k) funds to an existing Roth IRA. According to this table row, the $10,000 of Roth 401(k) funds will be categorized as Type 2a “Conversion Contributions” (using IRS-speak) and maintain their 5-year tracking period within the Roth IRA.
However, this approach appears to contradict the regulations contained in CFR § 1.408A-10 A-3(a) Coordination between designated Roth Accounts and Roth IRAs:
“A-3. (a) Under section 408A(d)(4), distributions from Roth IRAs are deemed to consist first of regular contributions, then of conversion contributions, and finally, of earnings. For purposes of section 408A(d)(4), the amount of a rollover contribution that is treated as a regular contribution is the portion of the distribution that is treated as investment in the contract under A-6 of § 1.402A-1, and the remainder of the rollover contribution is treated as earnings. “
According to the plain reading of this regulation, funds transferred from a Roth 401(k) into a Roth IRA are divided between regular contributions and earnings within the Roth IRA. Nothing is categorized as conversion contributions.
The reference to “investment in the contract under A-6 of § 1.402A-1” means any portion of the transfer that, if instead it had been distributed to the account owner, would not be included in Gross Income and hence not subjected to income tax. Thus all $10,000 of the in-plan conversion in my previous example would qualify as “investment in the contract” and hence, according to the regulation, end up being classified as a regular contribution after the Roth 401(k) to Roth IRA transfer. But regular contributions within a Roth IRA are never subject to a 5-year period / never subject to Sec. 72(t) 10% penalty tax. If this is correct, IT IS NOT TRUE that the 5-year period follows the Roth 401(k) funds into the Roth IRA. Hence the bottom row of the Table on page 262 is incorrect.
So, what are your thoughts? Are you aware of any other regulations, IRS Notices, PLRs, etc. that modify the interpretation of CFR § 1.408A-10 A-3(a) ?
Permalink Submitted by Alan - IRA critic on Wed, 2021-10-06 20:47
Yes, the Regs back up your contention and so do the Form 8606 Inst on p 9, which state that the regular Roth contribution basis shown on line 22 is increased by amounts rolled in from a Roth 401k that are treated as investment in the contract. Thus, the investment in the contract composed of the IRR is treated as a regular Roth IRA contribution after the rollover. As such there is no mechanism to determine when or how the former IRR money is distributed when it is pooled with regular Roth contributions.
The recapture chart in Pub 590 B (Appendix C, p 63), is intended to collect the 10% recapture tax by determining the composition of what was withdrawn from the Roth IRA. It was never updated to reflect IRRs that were rolled over to a Roth IRA, and the current chart is already quite gruesome. However, by first applying the line 22 amount on Form 8606 as regular Roth basis and because these IRRs are treated as regular Roth contributions, any recapture tax is avoided.
Therefore, if a taxpayer needs to withdraw taxable IRRs amounts in the first 5 years, if possible the Roth 401k or at least the distributable portions thereof should be rolled to a Roth IRA and then distributed from the Roth IRA.
Permalink Submitted by ssel on Thu, 2021-10-28 00:17
Alan,I read this bogleheads post to mean you have changed your opinion on this. Is that the case?
Permalink Submitted by David Mertz on Thu, 2021-10-28 01:22
IRS Notice 2010-84 Q&A-12 indicates that the recapture tax applies under these circumstances: “the rule does apply to subsequent distributions made from such other designated Roth account or Roth IRA within the 5-taxable-year period.” Since Roth IRAs are aggregated, it doesn’t matter which of the individual’s Roth IRAs the distribution comes from.
Permalink Submitted by Alan - IRA critic on Thu, 2021-10-28 01:44
DMx – welcome back!
Permalink Submitted by David Mertz on Thu, 2021-10-28 02:37
Thanks. Helping an ill family member left me no time to participate in this forum for the past six months or so, but that’s changing.