IRA/Roth Conversion
I am a financial advisors and have a client that has a $20,000 IRA with both deductable and non-deductable contributions. He also has a 401k from a previous employer with a balance of $200K. Can he convert his current IRA in February and then roll his 401k in March? I am trying to avoid the pro rata situation and when he completes the conversion in February he will convert his entire IRA balance that he has on that date.
Permalink Submitted by mk foss on Mon, 2010-01-25 23:23
The situation you describe would not get your desired result. The client must wait until the next year to do the 401k rollover to avoid the assets in that plan being considered part of the Pro rata pool for determining tax on the conversion.
Permalink Submitted by Alan Spross on Mon, 2010-01-25 23:28
The valuation date for the pro rate factor is the year end IRA balance, therefore a rollover of the 401k any time in the same year will dilute the tax free portion of the conversion. In this case, if the basis was 8,000, then the tax free portion would be 8000 divided by 220,000 or 3.636%. However, if the 401k rollover is postponed until 2011, the pro rate factor for the 2010 conversion would be 8000/20,000 or 40% tax free. This is how it would be in any other year.
However, in 2010 you have the added complication of the two year deferral on conversion taxes. The above example would hold true if the client opted out of the two year deferral and reported the entire 20,000 conversion in 2010. However, if the client wanted the two year deferral on the income instead, the valuation dates would also be deferred until the income was reported. This would cause the 401k rollover to be postponed until 2013 instead of 2011 if you wanted to take advantage of the much higher tax free portion on the conversion.
In the interest of full disclosure, I am not aware of the IRS Regulation that specifies the above. I have concluded that it would have to work that way, otherwise you would have multiple pro rate factors around in 2011 and 2012 to address distributions in those later years. This also follows suit that the income for a 2010 conversion is deferred, not the actual tax dollars. Therefore, when the Regs are released I am reasonably sure that the pro rate factor will also be deferred to the year in which the 2010 conversion is reported.
This is a rather complex response that would have much simpler for years prior to 2010 where all the income is reported in the year distributed.