Transfer after tax contrib’s in 401K directly to a Roth IRA
A new client is 60 yr’s old and works overseas-he has an old 401K with Exxon that I am looking to do a NUA transfer on his Exxon stock in the plan and the balance (except after tax contrib’s) to a rollover IRA. My first question is whether their is tax due on a direct transfer of the after tax $’s to a Roth IRA (this is post 86 after tax contributions) and if so is it on the difference between the “basis” of the after tax congtributions and the current value of the after tax dollars or figured on the entire account balance. Also, since he works overseas and most of his earning are not taxed, is this a moot question?
Lance Hunt
Permalink Submitted by Alan Spross on Mon, 2008-02-11 18:34
You will at least have to wait until the IRS releases Regs with respect to the direct Roth transfer from the 401k, since there are many issues not yet resolved. However, the 100,000 MAGI income limits will apply to both these and regular Roth conversions until 2010. The foreign earned income and housing exclusions both have to be added back to AGI in determining if a taxpayer is eligible. As a result, if he is over the income limit, he would have to wait until 2010 to do either type of Roth conversion.
Complicating this further is the need to qualify for an LSD if NUA is to be utilized. His last triggering event was reaching 59.5, so any year in which he takes a distribution after 59.5 and prior to the LSD year would result in an intervening distribution and negate the NUA benefit. It appears that the NUA decision should drive the process, since opportunities for Roth coonversions will be unlimited come 2010.
The third factor is how to apply the after tax contributions, and this is partially dependent on plan accounting. If the after tax contributions can be applied to employer stock shares, the taxable cost basis of the NUA shares will be reduced, but the NUA dollars are unaffected. If the after tax contributions cannot be applied to employer stock, then they could be rolled over to an IRA tax free on a pro rated basis with pre tax amounts. Form 8606 would be filed to report the added basis in the IRA. If a Roth conversion is done in the same or subsequent year, the 8606 would be used to report it and the share allocated to basis would be tax free. In no event would taxes be paid a second time on the after tax amounts, but earnings on the after tax contributions are pre tax.
It is a good idea to start early in the LSD year, because any assets that do not get distributed by year end will negate the NUA. For that reason, you probably cannot wait too long for the IRS to publish the Regs on the direct Roth transfer, and may need to proceed with the usual plan of doing a direct rollover to a TIRA and then converting from there when he is income eligible. Three of the questions regarding the needed Regs on the direct Roth rollover from the plan relate to withholding requirements, ability to transfer the after tax amounts to the Roth while simultaneously sending the pre tax amounts to a TIRA, and recharacterization mechanics if all this is done and the income limits are exceeded.
This will be a real challenge with this many variables to deal with.