After Tax Assets in Employer Plan
My client has after-tax assets in his employer’s 401(k) and wants to take advantage of the 2010 Roth conversion rules. I am considering advising him to roll the non-taxable portion (basis) into IRA#1 and the taxable portion (growth) into IRA#2. Assuming his employer’s plan allows it, can he roll IRA#2 BACK into his employer’s plan, thereby eliminating all other (taxable) IRAs except for (the non-taxable) IRA#1 and then convert IRA#1 to a Roth? I believe this would allow the client to avoid a taxable event on this conversion. Lastly, would IRA#2 have to be rolled back in to the employer plan before converting IRA #1 to a Roth or doesn’t it matter when it goes back in as long as it takes place before the end of the tax year?
Permalink Submitted by Alan Spross on Tue, 2009-12-08 02:31
I am assuming the client already knows that he is eligible to take in service distributions from the plan. Most plans do not allow them before 59.5.
Since the IRS has not yet clarified doing tandem direct rollovers (pre tax to TIRA and after tax to Roth), there is another way to get the after tax assets into the Roth IRA, but it requires having the funds to replace 20% withholding. For example if a client had 200,000 in the 401k and 50,000 of that was after tax, he would first ask for a full distribution. 20% would be wittheld from the pre tax portion or $30,000. He would receive 170,000. Next he would roll 150,000 to his TIRA. Rollovers are first deemed to be pre tax amounts per Sec 402c if employee does the rollovers. He would then roll the remaining 20,000 to a Roth IRA but must come up with the other 30,000 to make the Roth conversion complete at 50,000. Since both rollovers are tax free, he would then recover the withholding when he filed his tax return.
Your approach would also work, but it requires the employer plan to accept the funds right back, and many might not be willing to. It also requires active employment with that employer. But if the client has NO other IRAs other than the two created here, and the employer accepted the pre tax amount back, this would work. Client could then convert the after tax IRA to a Roth in a tax free conversion. He would report the after tax rollover on Form 8606, and the tax free conversion on that same 8606. IRA#2 could be rolled back to the employer plan anytime prior to year end and it would not show up in the year end balance OR on line 7 of Form 8606. Accordingly, the Roth conversion could be done PRIOR to the other IRA going back to the employer plan. This approach works better if the client has NO OTHER IRAs but these two. The first option in the prior paragraph works better if the client has other IRA accounts that dilute his basis and therefore does not want the after tax 401k funds to be deposited in an IRA at all. But it requires fronting the 20% withholding money.
Permalink Submitted by charles lore on Sun, 2009-12-13 16:56
Alan why would you need IRA 1 and IRA 2.. Why not just roll all to IRA 1 and then roll back all pre tax to QP . Since after cannot be rolled back this should work.
I believe this is the stategy Natalie calls “basisectomy”
Permalink Submitted by Alan Spross on Sun, 2009-12-13 18:00
You could do that as well. Splitting the pre tax amount into it’s own IRA just makes the transaction somewhat simpler because you are transferring the entire account into the employer plan and it eliminates the possibility of making an error in the amount that would result in some basis going to the employer plan in error. Less chance for a foul up. But you are correct that there is absolutely no tax related impact based on the account setup.