401k After Tax and Roth Question
I have a client with 950k in a 401k wanting to do a rollover – 830 pretax, 120k after tax. We are considering utilizing the Roth option on the after tax and having read as much as I can on the subject, a few key questions still remain. Our approach would be the following:
1) Take 100% distribution to him – 20% withheld on pre tax dollars
2) Deposit pretax dollars (along with other cash to makeup for 20%) into IRA
3) One day later, deposit after tax dollars into Roth IRA (not sure if this is vital)
4) 20% returned to client next year when he files taxes.
5) Result = 120k in Roth, 830k in traditional and no taxes owed
-I was directed to Notice 2009-68 and 408A9d)(3) as the legal backing to this approach.
Has anyone utlized this strategy? Many of the resources referncing this were dated to 2010 so I am curisou to any developments on this front since that time. Any assistance would be greatly appreciated.
Permalink Submitted by Alan Spross on Thu, 2012-02-23 16:11
There have been no material developments since Notice 2009-68, even though the Amercan Benefits Council has pleaded with the IRS to clarify the inconsistent treatment between direct rollovers and indirect rollovers.
The key support to the procedure you cited is Tax Code Section 402(c)2. At the end of this section, it clearly indicates that when an employee receives a distribution of pre tax and after tax dollars from an eligible plan, the amount rolled over is first composed of the taxable amount (ie the pre tax dollars). This is why the TIRA rollover must be done first. Because of this wording in the code, and because 2009-68 and 2009-75 do not contradict it, the strategy should bear little risk.
Just due to anecdotal posts about this strategy and related methods over the last 2 years, I think there have been several employees (taxpayers) that have done this, and there have been no indications that the IRS has challenged this.
Permalink Submitted by John Boardman on Thu, 2012-02-23 16:15
It is fair to assume that a “worst case scenario” is that he is audited, the IRS rules against the strategy and he would be required to do what?
Permalink Submitted by Alan Spross on Thu, 2012-02-23 16:43
Worst case scenario is that his basis would be pro rated to each type of IRA.
1) TIRA would have around 6/7 of the after tax money in it and he would have to file an 8606 adding that basis to the TIRA
2) The Roth rollover would be around 6/7 taxable. If the IRS allows an extended date to recharacterize, then the rollover could be recharacterized to a TIRA at no cost and all the 120k of basis would be in the TIRA.
Very unlikely this would happen, since the tax code clearly supports this. Here is a copy of 402(c)2 – see final paragraph:
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(2) Maximum amount which may be rolled over
In the case of any eligible rollover distribution, the maximum amount transferred to which paragraph (1) applies shall not exceed the portion of such distribution which is includible in gross income (determined without regard to paragraph (1)). The preceding sentence shall not apply to such distribution to the extent—
(A) such portion is transferred in a direct trustee-to-trustee transfer to a qualified trust or to an annuity contract described in section 403 (b) and such trust or contract provides for separate accounting for amounts so transferred (and earnings thereon), including separately accounting for the portion of such distribution which is includible in gross income and the portion of such distribution which is not so includible, or
(B) such portion is transferred to an eligible retirement plan described in clause (i) or (ii) of paragraph (8)(B).
In the case of a transfer described in subparagraph (A) or (B), the amount transferred shall be treated as consisting first of the portion of such distribution that is includible in gross income (determined without regard to paragraph (1)).
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Permalink Submitted by John Boardman on Thu, 2012-02-23 19:39
Thanks for your help. It would be nice if the IRS gave us more clarity here but this strategy does follow the word of the law.