Possible invalid IRA rollover to 401K

Submitted by R. MICHAEL SHAW on Tue, 2022-09-13 22:35

I am a mostly retired CPA in Palm Springs, CA.

I have a client with an IRA and she is subject to RMD’s as she was born in 1948. She had an IRA at Vanguard with a balance of around $775,0000 at 12.31.2021 and her 2020 RMD was calculated by Vanguard at about $30,500. She and her husband have a law corporation with a 401K plan also with Vanguard and no other employees. Her husband has a substantial rollover balance in the 401k from prior years. They decided to rollover her IRA to the 401K plan in order to make some “alternative” investments.

They contacted Vanguard and asked them to rollover the entire balance of the IRA to the 401K plan. This was completed 7/22/2022.

When I found out about it, I had a conversation with my clients and they told me that Vanguard told them they didn’t have to make the RMD from the IRA before the rollover but could instead make it out of the 401K in 2022 (as well as an RMD for the husband from the 401K in 2022).

My research indicates that the IRA rollover may be invalid since made before any RMD was made from the IRA.

The things that have been discussed with Vanguard are:
Return the rollover (plus subsequent earnings) to the IRA from the 401K; then make the $30,500 RMD & then rollover the balance to the 401K again in 2022
Return the $30,500 (plus subsequent earnings) to the IRA and then make the RMD from the IRA in 2022 leaving the rest of the funds in the 401K
Leave the funds in the 401K and make the $30,500 RMD from the 401K. This is what Vanguard is recommending
We don’t want to be in a position where there could be an annual excise tax on the improper rollover and/or taxes on the entire rollover.

Any thoughts?



Submitted by Alan - IRA critic on Tue, 2022-09-13 23:52

  • Under the tax code 30,500 of the direct rollover was actually an IRA RMD, and as such was not eligible for rollover. It also constitutes an excess amount in the 401k which must be distributed back out with allocated earnings (more likely a loss given recent market results). Further, since she is probably a >5% owner of the law firm, 2022 would also be an RMD distribution year for her 401k meaning the first 401k distribution is also an RMD also not eligible for rollover.
  • Therefore, none of VG’s suggestions complies with the tax code, despite the fact that Option 1 would eliminate a ton of tax reporting issues caused by the 1099R forms not conforming to the actual tax reporting situation described above. Part of this is the IRA 1099R will show a direct non taxable rollover, while the 30,500 is a taxable RMD distribution on line 4b of Form 1040. So Option 1 would repeat this infraction from the 401k unless the 401k RMD itself has already been completed. 
  • All of VG’s suggestions technically violate the tax code, and depend on the IRS never being aware of the order these transactions were done.  They also depend on the amount of cooperation from the 401k plan and perhaps not disclosing this problem to the 401k.
  • VG’s last suggestion is the worst since it will not even solve the problem because an IRA RMD cannot be satisfied by a 401k distribution. The second suggestion is the best of the 3, but again depends on both the IRS and the plan not becoming aware of the transaction order and/or that an RMD was technically rolled over.

 



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