401K-in-plan Roth Conversion and Roth IRA Rollover
I have a couple questions on 401K Roth-in-plan-conversions and subsequent rollover to a Roth IRA.
1. Is it allowed to do 401K Roth-in-plan conversions in 2021 (the conversion would be composed of 10K pretax contributions, 5K earnings from the pretax contributions, 12K after tax contributions, and 8K earnings from these after tax contributions), and then to do a rollover at the end of 2021 to a ROTH IRA? None of this would be qualified as age less than 59.5. Want to make sure there are not restrictions/penalties/other issue with doing 401k in-plan-conversion to Roth and then rolling out to Roth IRA.
2. My second question is given the scenario in 1 assuming this is allowed, what would be my basis adjustment to add to the Roth IRA? Would it just be the 12K of after tax contributions and all of the other conversions would not count as basis or is it the full 35K that was converted, or something else?
3. My third question is given the scenario in 1 and 2, What would be the 5 year rule that would apply to the converted money that is rolled over to the Roth IRA? Is it the date the conversion was done in the 401K, the date the rollover occurs to the Roth IRA, or the owners first Roth contribution to their first Roth IRA? I am thinking it would be based on the date of the 401K in-plan-conversion but not sure.
Thanks.
Permalink Submitted by Alan - IRA critic on Thu, 2021-11-18 16:58
You would have to check if your plan allows in service distributions from the 401k to your Roth IRA. This is a plan option if you are still working there, but under IRS rules if you are still employed you cannot roll out the portion of the IRR (in plan Roth rollover) sourced to your elective deferrals (10k) and per plan provisions probably not the earnings on those deferrals prior to age 59.5. Therefore, you would have to ask the plan administrator which components of your IRR could be rolled out.
If you are separated from service when you do the direct rollover, but still under 59.5, your regular Roth IRA basis would be increased by 22k (10 + 12). The remaining 13k (5 + 8) would be treated as Roth IRA earnings. If you reached 59.5 and had your Roth 401k at least 5 years, then the entire 35k would be treated as regular Roth IRA basis. Also, if your Roth IRA had met the 5 year holding and you were 59.5, your Roth IRA would be qualified including all the funds rolled into it from the Roth 401k.
Assuming your Roth 401k is not yet qualified, then your Roth IRA needs to be held 5 years itself and you must be 59.5 in order for your Roth IRA to be qualified. There are several dates to track prior to qualification, but your questions appear to assume that neither account will yet be qualified since all these transactions would occur prior to 59.5. If so, the year of the IRR only counts in determining whether you would owe a 10% penalty (no income tax), if you withdrew the funds attributed to the IRR before the 5 years passed or you reached 59.5.
You are wise to be concerned with proper Roth IRA basis tracking after such a direct rollover from your 401k into the Roth IRA, if there is any chance you would take a non qualified Roth IRA distribution. That distribution would require you to report the proper amounts on lines 22 and 24 of Form 8606 to determine if you owe any tax under the Roth IRA ordering rules. The 10% penalty is a separate issue to be reported on Form 5329 if it applies. This can of worms will all go away once your Roth IRA becomes qualified.
Permalink Submitted by Steven Vitullo on Thu, 2021-11-18 18:34
In regard to 1 the plan does allow in-service partial rollouts of after tax contributions + the earnings on those after tax contributions. I guess I was wondering if after doing the 401K Roth in-plan-conversion on pretax deferrals and earing on those pretax deferrals if that would now make the money considered aftertax for the purposes of the rollover but it sounds like the answer is no. Looks like you get more options after seperation of service or the 401K account becomes qualified.
Do the plan administrator of the 402K typically not allow transactions that are probibited like what I proposed in 1 of doing in-service rollover of pretax money that was converted to Roth in-plan? From your response it makes it sound like that is the case.
How are rollover contributions treated for updating the basis of a ROTH IRA assuming NOT 59.5 or older? There are a couple different cases:
Roth rollover (containing roth contribution +earnings, but no pretax monies or earning on them)? only the contribution rolled over +and regualr yearly contributions would be tax and penalty free for early withdrawl right?
Rollover of after tax contributions +earnings on those after tax contribution? This one I am not sure on?
My fourth question is assuming you do track your Roth IRA basis and contributions and report as your supose to contributions and rollovers through your 5498 (contribution) and 5498 +1099R for rollover. Then you take a distribution before 59.5 and claim you withdrawl is just contributions acording to IRS witdrawl ordering contributions come out first. If the IRS disagrees and say they are not contributions how do you prove the IRS is wrong. I would guess you would need to show the 5498s showing all the Roth contributions? If the withdrawl included after tax money that had prevoiusly been rolled over from another plan that would be basis and tax free as well since taxes are paid but would be subject to 10% penalty before 59.5, is that correct? I am assuming that to show this you would have to show the 1099R that had the rollover of that basis and the 5498 showing the rollover contribution to the ROTH IRA.
Permalink Submitted by Alan - IRA critic on Thu, 2021-11-18 22:07
Yes, the after tax sub accounts are generally distributable out of the plan, however it is possible that after an IRR of those amounts to the Roth 401k, the plan might not allow such distributions, since some plans may offer IRRs in order to retain such balances in the plan until a certain age or until separation.
IRS rules require that in service distributions of elective deferrals is not allowed before 59.5 at the earliest, however, the plan might allow the earnings on those deferrals to be distributed out. A plan with the broadest options therefore would allow all but the 10k from elective deferrals to be rolled out to the Roth.
Yes, any portion of which taxes have already been paid will be treated as regular or conversion Roth IRA basis. Earnings not yet taxed would be treated as Roth IRA earnings unless the Roth IRA was qualified. One of them might not be qualified due to not yet meeting the 5 year holding requirement.
You have to be careful when using just the 5498 alone to track contributions because if a contribution is excess or returned as part of a distribution, or the contribution was recharacterized to a different IRA, you would have to incorporate those changes. A 5498 is not revised to reflect subsequent changes to those contributions. As for your question, we don’t know what the IRS would request for documentation since they almost never ask. They already have all the 5498 forms for regular and conversion contributions and for recharacterizations of contributions that could adjust the original basis, but there is no 5498 to reflect a returned contribution, therefore the 1099R forms would have to be included. The IRS has no desire to dive into that can of worms, but they might do so if the values were high enough to warrant the investigation, such as 7 figure Roths with high basis being reported. Same for the 10% recapture penalty for conversions, which is even more difficult to track since the 5 years runs from the IRR through to the Roth IRA.