IRA Rollover with Pre-tax and After-tax contributions
I have a rollover IRA with majority after tax contributions and some pre tax conributions (match and earnings) that want to convert to a Roth. Is it possible to convert the after tax portion prior to converting the pre-tax? I would do this to delay paying the taxes on the after tax portion. I have never made a non-deductible contribution to a traditional IRA and only own a Roth. Please advise.
Permalink Submitted by Alan Spross on Thu, 2007-09-20 19:31
Roth conversions are taxed based on the percentage of pre tax amounts in all your TIRA accounts. You cannot convert the after tax amounts separately or up front. If you rolled over after tax 401k amounts to a TIRA, you should have filed Form 8606 for the year of rollover reporting the after tax amount as basis in your TIRA, the same as if you made non deductible contributions. The 8606 documents with the IRS the portion of your IRA that is after tax. If you have not done that, do it ASAP since the IRS has been accepting these retroactively without penalty.
You also do not have to convert the entire rollover IRA in the same year, as doing so may increase your tax bracket.
It is fairly unique that a rollover IRA have the majority of funds after tax. You should have two 1099R forms from the plan, one for the pre tax amount and the other for the after tax amount, so it would be wise to check this all out before you do a conversion and find that most of it is taxable. Of course, you can later recharacterize (reverse) any conversion within the time limit to “undo” any errors, or if your income is too high, or even if you simply do not want to pay the taxes on the conversion.
Permalink Submitted by Charlie Reed on Thu, 2007-09-20 20:19
Thanks for your reply. I just rolled over the 401k to TIRA a couple of days ago. So I have not needed to file 8606 nor have I received any 1099’s yet. However, I’m confident about the portion of pre/after tax monies in the account. My company generously matched 6% on my 30% after tax contributions. That’s where the pretax money comes in.
The instructions for 8606 and Pub 590 do not do a good job of discerning 401K’s or other qrp’s from ‘non-deductible contributions’.
Anyways, Thanks Again!
Permalink Submitted by Alan Spross on Thu, 2007-09-20 22:48
You are correct. They do not do a good job of that. Per Inst for Form 8606, p 5 for line 2:
“You rolled over any nontaxable portion of your qualified employer plan to a traditional or SEP IRA. Include the non taxable portion on line 2”.
That’s about the only place this is mentioned.
Did you actually elect to make after tax contributions? One way to check that out is by conparing Boxes 1 and 3 of your W-2 for any of the years you contributed.
Permalink Submitted by Charlie Reed on Thu, 2007-09-20 23:42
I know it seems strange but I did choose to make the after tax contributions bc I believe the Roth will serve my family’s future situation much better than pre-tax accounts (barring any legislation changing the benefits of the Roth). In hindsight I could have made pretax contributions and delayed giving the government their $, however I wanted to make sure at least I had a substantial after tax basis in case I was unable to convert. We’ll jump a few tax brackets in the coming years and we are still pretty young… so this seemed like a great way to pad a Roth.
Permalink Submitted by Alan Spross on Fri, 2007-09-21 01:12
OK, I think we are getting somewhere, because I did not initially understand that your contributions were to a Roth 401k account.
It is true that Roth 401k contributions are after tax, but generally they are still referred to specifically as Roth 401k contributions to distinguish them from after tax 401k contributions to a regular tax deferred 401k account. And when you mentioned a Roth conversion, that would also be immaterial relative to a Roth 401k balance.
The Roth 401k first became available in 2006, so that is the first year that your contributions could have been separated into a Roth account. Of course, you could also have pre 2006 non Roth after tax regular 401k contributions.
Here is where there could be a problem. If you indeed had Roth 401k contributions, those would never have been rolled over to a TIRA, but should have been transferred to a Roth IRA. Since they should have gone to a Roth, there would be no need to convert them because they are already in a Roth IRA. The pre tax employer match contributions however would have to go to a TIRA, and from there be converted to a Roth IRA.
So, did your Roth contributions to the Roth 401k end up in a traditional IRA or a Roth IRA?
Permalink Submitted by Charlie Reed on Fri, 2007-09-21 02:20
I did not have access to a Roth 401K. Standard 401K with after tax contributions that upon conversion to a Roth I should only owe taxes on the pretax employer match and any earnings associated with my contributions and employer match…right? Thanks again for your diligence…
Permalink Submitted by Alan Spross on Fri, 2007-09-21 03:53
Then we are back to my very first post. Be sure to file the 8606 with your 2007 tax return reporting the addition of after tax basis to your TIRA. From there you can convert using the pro rate rules, and the 8606 is also the form used to calculate the taxable amount of each conversion. It also shows how much basis is left in your TIRA after the conversion.
If you have an other TIRA accounts, SEP IRAs or SIMPLE IRA account, they all have to be added together when you complete an 8606. The taxable % of the conversion is the same no matter which account you use to fund the conversion or how much the conversion is.
For purposes of the 100,000 conversion income limit that applies until 2010, the conversion amount itself does not count against the 100,000. But even with the taxable amount reduced due to your after tax basis, you should not convert so much in a single year that you inflate your marginal tax rate. For accounting reasons, it is best to convert to a new Roth account and not add it to your existing Roth for at least a couple years when there is no longer a chance you would recharacterize all or part of the conversion.
Permalink Submitted by Aaron Roush on Thu, 2007-09-27 13:18
What if his employer allowed him to do an inservice of only the after-tax contributions? Could he then roll these over into a non-deductible IRA and then convert to a roth. His aggregation would be with any other TIRA’s, SIMPLES or SEP’s, but if this is his only account then it would be nearly 100% tax-free. Even if they sent the tax-free contributions from his 401(k) payable directly to him, wouldn’t he have 60 days to open a TIRA and make the deposit, as well as filing the 8606 to say that it is all after-tax? Thanks for you help.
Permalink Submitted by Alan Spross on Thu, 2007-09-27 22:22
Yes, it is possible that the plan would allow an inservice distribution under certain circumstances such as age attainment. However, only pre 1987 after tax contributions can come out separately and not pro rated by after tax vrs pre tax. For the last 20 years of contributions, any distributions MUST be pro rated.
Therefore, IF he was allowed separate pre 1987 after tax distribution or transfer to an IRA, filed Form 8606 as you indicated and had modest pre tax assets in all his IRAs, he could convert mostly tax free. Any additional rollover of pre tax amounts would have to be done in the next calendar year to prevent them from diluting the % of after tax basis as of year end.
However, the original post gave me the impression that the entire 401k was rolled over of a recent employer, and that most of the the assets were after tax. That would be odd unless we were only dealing with the pre 1987 after tax amounts.