Roth Conversions from 401(k) w/pre-and post-tax assets
An individual with both pre-tax and elective after-tax contributions (but not Roth) would like to convert their after-tax assets only into a Roth IRA. The assumption is that the individual will first distribute the pre-tax assets into their traditional IRA and then the 401(k) plan will cut a check to the participant for the after tax assets (let’s assume that the client has additional assets to cover the 20% withholding). Can the individual transact a rollover conversion of just those after-tax assets without getting hit with the pro-rata rules?
Would it make a differece if they rolled the pre-tax assets to the IRA and then did a [i][b]direct [/b][/i]rollover conversion to the Roth of the after-tax assets?
Thanks!
Permalink Submitted by Bradley Bofford on Mon, 2010-05-10 01:11
I am curious to a response to this inquiry as well.
Until recently it was my understanding that Post Tax Rollovers can be invested in Roth IRA’s without the pro-rata calculations or taxes due. However, we recently were advised by another national Roth IRA expert, James Lange, that there is an IRS ruling that is stating otherwise. The following explanation comes from Mr Lange’s office:
“You can find IRS Notice 2009-68 on the web. It was actually published in 9/09 but no one really realized the implications of it until early in 2010. Here is Natalie Choate’s summary of the same.
http://pfp.aicpa.org/NR/rdonlyres/7B86FE43-9C11-48F7-BB99-EDBF2096F27E/1…
You’ll see that the Notice strongly indicates that the right treatment is to pro-rate the conversion so that most of the conversion is taxable. Some companies are issuing separate checks and then plan to issue separate 1099s (one for the rollover (tax deferred) and one for the conversion (treat it as tax-free). If only one Form 1099 is issued, then I think your client is in a difficult spot and that it would be hard to argue tax-free Roth IRA conversion based on this notice. If multiple Form 1099s are issued, then your client at least has an argument to report a tax-free Roth IRA conversion based on reporting the conversion in accordance with the corresponding Form 1099.
We are hopeful that there will be clarification on this issue before the end of 2010 that is favorable to taxpayers since the planning community has assumed that the proposed tax-free conversion has been possible for several years.
As of today, no clarification has been issued regarding this issue. Hopefully, the clarification (if it comes) will make clear that the conversion will not have to be pro-rated”
I hope to hear an opinion from Ed Slott’s office or someone else knowledgeable in this area.
Thank you,
Brad Bofford
Permalink Submitted by Alan Spross on Mon, 2010-05-10 04:31
Brad,
Yes, this issue remains in limbo as described in detail in your links. The only sure fire way to direct the pre tax amounts to a TIRA and the after tax amounts to a Roth IRA is by going the indirect rollover route and that includes having the funds to replace the 20% withheld. The pre tax amount is first rolled to the TIRA and finally the after tax amount supplemented with replacement funds for the withholding, to the Roth. This is firmly in the tax code 402(c)(2).
But doing a direct rollover will trigger the pro rate rules according to 2009-68. However, from a practical standpoint the IRS has still not advised 1099R issuers how to dissect the post and pre tax amounts on the 1099R. Accordingly, most issuers are proceeding like they always have when they used to cut two checks with the after tax amount being cashed out by the employee. 2009-68 indicates that the pro rate rules apply to that situation as well, and no one ever talks about that. DIrect Roth conversions were first made available in 2008. I feel that for 2008 and 2009 those taxpayers who reported in accord with the 1099R forms that were (incorrectly) issued are probably home free, as it would cause major havoc to reconstruct those distributions in a different way. You have a boat load of revised 1099R forms and large amounts of amended returns with taxes due. Therefore, this is extremely unlikely.
That said, there is still a chance that the IRS issues an actual clarification that would affect 2010 distributions, including the large amounts of Roth conversions this year due to the 2 year deferral. Tough to put the odds on this, but the IRS is well aware of the problem. I am not aware that the Employee Benefits Council has ever received a reply to their October, 2009 letter pleading for clarification.
If a taxpayer cannot replace the 20% withholding on a large distribution, they could roll the dice and hope that the 2010 1099R retains the status quo, and they therefore squeak through with their tax free Roth conversion of after tax amounts. If the 1099R shows the pro rated amounts, they can always recharacterize the conversion to a TIRA and add an 8606 to report the added basis in their TIRA which they can then convert using the pro rated regime of Form 8606. Only problem is that 2010 is over by then and they would be back to year by year conversions which would be partially taxable.
Other than that, we will all watch for further IRS Notices on this issue. We have found out that the IRS acts when they please and no amount of appeals for clarification seem to speed up the process.
Permalink Submitted by Alan Spross on Thu, 2010-06-03 02:52
Attached is the reply to the reply and clearly shows that the ABC is still pushing for needed IRS guidance after receiving a less than acceptable response. I guess you could say that if the tax code was similar to a large spider web, it has grown somewhat too large for the spider………….
http://www.americanbenefitscouncil.org/documents/followup_letter_re_402c…
Permalink Submitted by Alanna Crawford on Mon, 2014-01-27 21:55
Has there been any updated guidance regarding the question in this initial post (strategy to convert only after-tax plan assets to a Roth IRA)?
Permalink Submitted by Alan - IRA critic on Mon, 2014-01-27 22:13