inherited 401k with after-tax money and transferring to an inherited IRA
Dear Alan et al,
I have a client who inherited a 401k from her father earlier this year. The money has been moved to her inherited 401k account and we are discussing next steps. Here are a few questions:
1. The total balance is $130K and she has $38K in after-tax dollars in this account. If she transfers the full balance of the inherited 401k into an inherited IRA, will this basis carry over to her inherited IRA so that future withdrawals will be a combination of non-taxable return of principal and taxable growth?
2. Can she segregate the account by transferring the pre-tax dollars into an inherited IRA and the after-tax dollars into an inherited Roth IRA? I realize this is possible when rolling a 401k over into an IRA but I’ve not done this with an inherited 401k.
3. I understand that she can convert an inherited 401k to an inherited Roth IRA, correct? I’m aware that an inherited IRA cannot be converted to an inherited Roth IRA.
Thanks in advance,
Chris
Permalink Submitted by Alan - IRA critic on Tue, 2021-12-21 17:55
Chris, yes the after tax basis would carry over to the inherited IRA, but Q 2 is the far better option.
Yes, it’s rare but two direct rollovers can be requested with the after tax amount going to an inherited Roth IRA and the pre tax amount to an inherited TIRA. These direct rollovers should be requested at the same time per Notice 2014-54. Since this is a rare transaction with an inherited 401k, extra effort should be made so the plan administrator clearly understands the request.
Yes, correct. Client is probably not an EDB, and therefore would be subject to the 10 year rule for both inherited accounts. But the inherited Roth would be better off untouched for the 10 years while it generates tax free gains. The inherited TIRA might be distributed earlier in some fashion to prevent a large taxable distribution in year 10.
Permalink Submitted by Christopher Combs on Wed, 2022-02-16 19:24
Dear Alan,Regarding option #2, the plan administrator is telling us that they could make a check for the after-tax money made payable directly to the participant (as opposed to her Roth IRA). They aren’t able to make a check for that portion payable to her Roth IRA. In light of this, am I correct that:1. She could do an indirect rollover by receiving the check and depositing this after-tax money into an inherited Roth IRA as long as it was within 60 days of receiving it?2. The 1099 that she’ll receive from the plan administrator for this after-tax distribution will confirm that it’s not a taxable event?Thanks in advance,Chris
Permalink Submitted by Alan - IRA critic on Wed, 2022-02-16 20:38
Chris, unfortunately as a non spouse beneficiary, no 60 day rollovers are allowed. By not issuing two separate direct rollovers, the plan is eliminating the chance for the beneficiary to get the 401k basis into a Roth IRA. If a single check for the entire balance is issued to her inherited TIRA, it will trigger the pro rate rules of Form 8606 whenever she takes a distribution. Perhaps this issue should be elevated to a plan supervisor to resolve as the plan may not realize that this option is supported by the IRS. Another deficient option is just asking for a distribution of the after tax amount and she can then invest it in a taxable account, or if still working use that money to subsidize larger 401k pre tax or Roth contributions.