401a post-tax conversion to a Roth
I know I’m beating this topic to death, but here it is Dec. 16 and as far as I can see there is no IRS ruling on the treatment of rolling qualified plan post-tax money directly into a Roth. I have just retired and I have a 401a that has post-tax money, capital gains and employer match funds in it. Fidelity has contacted me about rolling the post-tax money directly into a Roth and the rest into a TIRA; they will send 1099s for each conversion. My financial adviser is leery of this, but I would really like to get that post-tax money into a Roth and not have to pro-rate my IRA distributions in the future. If I took Fidelity up on this, how would I report this ? I have about $34,600 post-tax and $22,000 in the rest.
Thanks, Susan
Permalink Submitted by Alan Spross on Fri, 2010-12-17 02:23
You have two options to consider:
1) Safe option: Have Fidelity send you a check for the full 56,600 less 20% mandatory withholding on the pre tax amount which would be 4,400. Then first roll 22,000 into your TIRA account, and the next day roll the remainder plus 4,400 into your Roth IRA. You will have to come up with the 4,400 until you get your tax refund, assuming you are otherwise adequately withheld. You would report the full rollover on line 16a of Form 1040, and 16b will be -0- since the conversion will be tax free. That should conform to the 1099R (or possibly two 1099R) that Fidelity will issue.
2) Riskier option: This one if you do not have the money to front that 4,400 in withholding. This is where you advisor is correctly concerned over the ambigous IRS ruling of Oct, 2009. But if Fidelity issues separate 1099R forms showing 0 taxable on the after tax Roth conversion, you will probably be OK, since the IRS will likely follow the 1099R forms. One would show a direct rollover to a TIRA with no taxable amount, and the other would include the after tax funds and therefore also not be taxable. You would still report this the same way as above. Form 8606 does not apply since you are not converting through a TIRA, but directly from the employer plan.
Worse case scenario if you choose option 2, is that the IRS will issue a directive to Fidelity to revise the 1099R forms and you will have pro rated basis going to each IRA. While that would cause the conversion to be partly taxable, you could recharacterize it if you wanted to. Not a serious downside. You would also have some basis added to your TIRA and would need to report that on an 8606, and then be stuck pro rating until you totally converted or otherwise distributed your TIRA funds. But I don’t think there is much risk, because if the IRS was going to advise custodians to change the 1099R processing, they should have done so before now because custodians have already set up their systems for next month’s 1099R forms.
Your choice………..
Permalink Submitted by Susan Heller on Fri, 2010-12-17 21:25
Thanks for your suggestions! But they raise more questions — I have other IRAs and would I have to prorate the post-tax portion of the roll over with those if the IRS makes Fidelity issue new 1099s? Or are the funds in a 401a treated unto themselves?
I understand that when you take RMDs in the future, you have to take a RMD from the 401a and another from your combinded IRAs — that you can’t just take one big RMD from one or the other. If that is true, I could just leave the 401a alone and adjust the taxes on the RMD per the pre/post tax cost basis??? — Susan
Permalink Submitted by Alan Spross on Fri, 2010-12-17 21:59
The basis in an employer plan is NOT affected by your IRA balance if you do the conversions directly from the employer plan (as suggested earlier). However, if you rolled the after tax 401k balance into a TIRA, then you would have to consider your IRA balance and that would result in pro rating your basis against the total.
On the RMD question, employer plans cannot be aggregated with IRAs, so you are correct. While you could recover your basis gradually with your RMDs in retirement if you kept the plan in place, the point is that if you are able to get the after tax amount into a Roth IRA now, it is much more tax efficient since the Roth IRA will begin generating tax free earnings on the entire basis right away instead of receiving only a small trickle of your basis and never getting those funds into a Roth IRA. Your RMDs from the employer plan like all RMDs are not eligible for rollover or conversion. But if you converted the basis now, not only would you be generating tax free earnings, but the entire balance would never be subject to RMDs.
In fact, your after tax basis is so high (61% of the balance), it would be to your benefit to convert even if you had to convert the entire balance and pay tax on the 22k. Of course, being able to get the 34.6 into the Roth without paying any tax is better yet.