Rollover of After Tax Contributions (variation)
I refer to February 9 reply to the thread on the referenced subject, which says:
“…One method of doing this (i.e., rollover of after tax amount to Roth IRA) that should hold up according to tax code wording is to proceed as follows:
1) Client requests a full distribution to the client, not a direct rollover
2) Client then FIRST rolls the pre tax amount to a TIRA, replacing the 20% withholding as needed
3) Finally, client rolls the after tax amount to a Roth IRA replacing withholding…”
I saw this strategy described in some detail in http://www.fairmark.com/rothira/09030801-401k-basis.htm.
If the LSD were all in employer shares, there would be no withholding. Presumably shares equivalent to the pre-tax amount could be rolled to a TIRA. Could shares equivalent to the after-tax amount be rolled to the Roth? In other words, could the strategy be executed using in kind amounts (FMV of employer shares), instead of cash? Thus avoiding the complication of withholding.
Nick
Permalink Submitted by Alan Spross on Wed, 2012-02-22 20:59
Yes, withholding would be avoided. Withholding does not apply to distributions of employer shares, while the tax code clearly allows the employee to “decide” that he would rather do an IRA rollover rather than utilizing the NUA option. A withholding loophole exists here for what would otherwise be an eligible rollover distribution with mandatory 20% withholding. The employee could also sell the shares and roll the proceeds over to an IRA. But then in the former example, there was only 66k in after tax contributions that would roll last to a Roth IRA.
Now if the client wants to mix and match NUA on some shares with rollovers on other shares, there are problems since the taxable amount for NUA purposes is totally different than the taxable amount based on after tax contributions to the plan. In this respect there are conflicts between IRS Notices 2009-68 and those older PLRs that seemed to authorize aggregating the NUA taxable amount over all the shares rather than calculating an NUA cost basis per share. You would have one definition of the “taxable amount” for NUA purposes and a totally different one to reflect after tax contributions to the plan.
Permalink Submitted by Nicholas Ciani on Thu, 2012-02-23 03:00
Thank you for confirming this loophole.
The working hypothesis is that at least the share tax basis (i.e., total cost of shares purchased by the plan) would be rolled to a TIRA and the most, if not all, of the NUA would be retained at zero basis. Also, the USD 66k after tax contributions would be rolled into a Roth as in kind shares, following the same strategy as outlined for cash (i.e., the after tax gets rolled only after the tax basis gets rolled). I presume that the same logic applied to cash would apply to an in kind share transaction.
The 401-k Plan administrator may resist doing a LSD of 100% employer stock. They generally do direct rollovers and handle NUA as a taxable event, based on the conventional practice of taxing any before tax cost basis that is removed from the qualified tax deferred regime. The administrator seems to have done few 100% stock LSD to the distributees and feels uncomfortable not doing withholding (for fear of being found to be out of compliance).