Roll after tax 401k funds to Roth IRA
i am new to this forum so please forgive me if this has already been aswered. i have a client who just retired is 65 and has 1.1mil in 401k, 90k is after tax. he also has 127,000.00 in traditional IRA’s. can he roll the after tax portion of 401k directly to a Roth using a 60 day rollover(his 401k custodain will not transfer direct)? Or does he have to pay tax using a ratio, and what is it? thank you, Mike
Permalink Submitted by Alan Spross on Mon, 2011-03-28 19:25
While it is immaterial to your question, the 401k plan must by law offer a direct rollover, which avoids withholding.
But ironically, the only way the tax code supports the ability to isolate the basis to a Roth IRA is to have the distribution paid to the client and then have the client first roll the pre tax amount to a TIRA and then roll the after tax amount to a Roth IRA. The downside here is that the client will have to replace the 20% withholding on the pre tax portion until a tax refund is issued.
Doing a direct rollover brings the pro rate rules into play according to IRS Notices in the fall of 2009. However, the IRS has not addressed appeals from employee benefit firms and also has not directed custodians how to issue the 1099R forms to identify the taxable amounts of each direct rollover. So the client may still be able to escape pro rating by doing direct rollovers like others have done the last 3 years, but the IRS could button things down any time prior to the issue of 2011 1099R forms. Therefore, doing a direct rollover is a gamble if client wants to avoid pro rating. Pro rating would result in some after tax money going to the TIRA and some pre tax money going to the Roth IRA and being taxable. According to his balances, the taxable amount of the Roth conversion would be 91.9% of the amount rolled to the Roth IRA.
Replacing the pre tax withholding will take 200,000 to complete the rollovers and most clients will not have that much freely available. But client could do a partial rollover, ie roll 25% of the balance out and that will reduce the replaced withholding to 50,000. But doing that would only get 22,500 into the Roth IRA. It would take 4 years to complete that process.