Income splitting, rollovers, and the aggregation rules
Client will be converting TIRA ($75K) w/basis ($40K) in 2010. Will elect to split income ratably over 2011 and 2012. Would like to roll 401(k) ($300K) in 2011 to TIRA. Will the aggragation rules apply in 2011?
Example:
If 401(k) funds are included in the calculation, would the pro-rata calculation be:
Balance: $337,500 (401(k) plus 1/2 the TIRA)
Basis: $20,000
Tax-free precentage: $20,000/$337,500 = 5.9%
If this is the case, it would not be wise to do the rollover. Instead, keep the funds in the 401(k) and wait until after 2012.
Thanks,
Doug
Permalink Submitted by Alan Spross on Fri, 2010-02-26 00:25
By using the two year deferral, your suspicion is correct that it will create a pro rating situation under which the rollover should be delayed until 2013. Either that, or opt out of the deferral and report the taxable conversion of 35k in 2010. Then the rollover can be done as early as January, 2011 without diluting the tax free %.
Your math is also correct if the rollover is done in 2011 with the two year conversion deferral.
Permalink Submitted by [email protected] on Fri, 2010-03-12 15:15
I am concerned that my math is not correct. In Ed’s Financial Planning article and in the monthly newsletter (15 Roth conversion traps), concerning trap #5 – rolling to an IRA mid-year -the new balance (denominator) at the end-of-year after the individual rolls the 401(k) to a TIRA is the converted amount plus the 401(k).
Now, circling back to my example, should’t the denominator be $375,000 instead of $337,500? I know you said my math was correct, but the more I think about it the more I am questioning it. After all, even if the client chooses income splitting, technically the client still converted a $75,000 TIRA balance. Doesn’t that need to be accounted for in the denominator at year end. Am I wrong? If so, could you provide me with guidance? Is there anything from the IRS on this?
-Client has a Traditional IRA (TIRA) balance of $75,000 with a basis of $40,000
-Client would like to convert this year (2010) but report income generated rateably over 2011 and 2012
-Client would like to roll 401(k) balance of $300,000 to a TIRA next year (2011) [*]
[b]Here’s the math (2011):[/b]
End-of year balance = $337,500 [Rollover TIRA plus ½ the 2010 Converted TIRA]
Basis = $20,000 [½ the 2010 Converted TIRA basis)]
Tax-free percentage = 5.9% [$20,000/$337,500]
Tax-free amount = $2,212
Thanks, Doug
Permalink Submitted by Alan Spross on Sat, 2010-03-13 19:30
Doug,
Glad you stuck with this. Upon further investigation, 375,000 will be the correct denominator IF Form 8606 for 2010 will be designed as it was in 1998 when Roth conversions were reported over 4 years. I pulled up the 1998 8606 and Inst. The taxable portion of a conversion with basis is fully determined in the conversion year using the full amount converted for the total account balance. For 1998 conversions 25% of that amount was added to income for each of the 4 years.
Therefore, the QRP rollover need only be delayed until Jan, 2011 if the client wants to reduce the conversion tax bills since the rollover will then not be included in the year end 2010 balance. The denominator would just be the 75,000 converted, and 35,000 would be the taxable amount. This 35,000 would be reported @ 17,500 each in 2011 and 2012. If any part of the QRP rollover is converted in 2011 when there is no basis left, that amount would be added to the 17,500 taxable amount from 2010.
This is all based on the assumption that this will be handled the same as 1998 in principle, and most of the 2010 rules are consistent with the 1998 provisions. Note that 2010 does differ from 1998 in that 2010 itself does not include any of the converted amounts. For 1998 conversions, the first 25% was reportable in 1998, the year of the conversion, and that is not true for 2010.
Therefore, while 375,000 is the most likely denominator and seems to make the most sense, this is still not guaranteed until we see the actual Form and instructions for the 2010 8606. The client should wait until 2011 anyway for the rollover, and by January we hopefully will have a 2010 8606 to confirm that the methology will be carried forward from 1998. If the form confirms expectations, the QRP could then be rolled over without affecting the 2011 and 2012 tax bills.
Permalink Submitted by [email protected] on Mon, 2010-03-15 17:14
Alan,
Thank you. In my example, I assumed client would roll 401(k) in 2011. That was my concern. How income splitting would effect subsequent rollovers. So, if client decides to convert TIRA this year and then roll 401(k) next year, the math would be (if Form 8606 for 2010 will be dsigned as it was in 1998):
[b]2010[/b]
End-of-year balance = $75,000
Basis = $40,000
Taxable amount = $35,000
Elects to report income ratably
[b]2011[/b]
End-of-year balance = $317,500*
Taxable amount = $317,500
[b]2012[/b]
End-of-year balance = $17,500**
Taxable amount = $17,500
* Assuming no price appreciation on the 401(k)
** Assuming no rollovers or new IRA account balances
Thanks again for your help.
Doug
Permalink Submitted by Alan Spross on Mon, 2010-03-15 22:25
In your 2011 example, you show taxable amount 317,000. I think that was a typo error and you meant 17,500. as taxable. That would be correct unless you converted the 300,000 rollover in 2011 and had to report all of that plus the 17,500 deferred from 2010. In that case you would have 317,500 taxable.
What were you planning to do with the 300,000 rollover? Leave it in the TIRA or convert it in 2011 in addition to the 17,500 income to be reported from 2010? In other words, I expect the 2011 8606 to be just like the ones we have had in 2009 and before, except that there would be a place at the end to add in the 17,500 income deferred from 2010. There would be no basis left in 2011 since it was all applied to the 2010 conversion.
For example, if you rolled the 300k to a TIRA in 2011 and then converted 100k, your 2011 taxable income would be 100k plus 17.5k deferred from 2010. But the adjusted account value would be 300k, the actual dollars in the TIRA adjusted for any 2011 conversion.
Permalink Submitted by [email protected] on Tue, 2010-03-16 12:17
Alan,
You’re right. Thanks for catching that. The client woould roll the 401(k) in 2011 but not convert. So the math would be:
[b]2010[/b]
End-of-year balance = $75,000
Basis = $40,000
Taxable amount = $35,000
Elects to report income ratably
[b]2011[/b]
End-of-year balance = $317,500*
Taxable amount = $17,500
[b]2012[/b]
End-of-year balance = $317,500*
Taxable amount = $17,500
* Assuming no price appreciation on the 401(k), no rollovers, and no new IRA account balances
Thanks again for your help.
Doug