They are broken out because the pre 87 after tax contributions can be distributed separately from pre tax amounts and from their earnings. Therefore, an employee can request a tax free distribution of this balance separately from the rest of the plan, and this can be done in many cases while still employed. This balance could be directly converted to a Roth IRA without going through a TIRA account and becoming subject to the pro rate rules.

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There are quite a few ways to approach this, depending on client’s needs.
1) Is client subject to RMDs this year or next?
2) Is there any highly appreciated employer stock in the plan for possible NUA benefits?
3) Of the plan balance what is the approximate % of pre 87 after tax, other after tax, and pre tax (add to 100)?
4) Does client want to take any after tax for current needs or want to roll the full after tax amount to a Roth IRA? Needs any after tax for spending this year?

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Client could get the entire after tax balance into a Roth IRA if he has the money to replace the 20% withholding until he gets his tax refund or otherwise reduces his quarterly estimates to recover that withholding sooner.

To do that he would just ask for a lump sum distribution of the entire balance paid to him. He would receive roughly 43,200 less than the plan balance due to the 20% withholding on the pre tax amount. He would then first roll the gross pre tax amount to a TIRA and the next day roll the after tax total to a Roth IRA, replacing the 43,200 to complete these rollovers. These rollovers must be completed within 60 days of receipt of funds. This method will safely get the entire after tax balance into a Roth IRA. His pre tax IRA balance will be lower by the Roth amount and that will proportionately reduce future RMDs. This is a safe way to avoid pro rating as it is validated by Sec 402(c)2 of the tax code. Doing this makes the pre 87 after tax amount immaterial.

Another option would be simply to request a direct rollover of the pre 87 after tax balance to a Roth IRA and the rest to a TIRA account. This avoids fronting any withholding, but also adds 26,094 of basis to his TIRA that will require a Form 8606 to document and to pro rate RMDs to get credit for this basis. RMDs will also be slightly higher due to the additional TIRA balance of 26,094. In addition, he might have to provide the IRS with his plan statement showing the pre 87 after tax balance because there is no special 1099R reporting that flags these after tax amounts as pre 87.

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Sean,
Yes, client could do that as well. I just didn’t include that option after you indicated that client did not need any of the funds to live on. And doing this would eliminate the added basis in his TIRA requiring use of Form 8606 every year RMDs are taken if he does not already have a basis for the TIRA.

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OK, but if certain heirs are not expected to be in a high tax bracket when RMD or other distributions are taken, they will get less if he overconverts, ie if he pays higher marginal rates when converting than they will pay if they inherited part as a TIRA rather than a Roth IRA.

The actual tax liability for a conversion is often composed of widely varying rates when SS benefits and qualified dividends or LT gains are factored in. A conversion has the same tax impact as an RMD of the same amount. The following is an interesting breakdown when modest dividends and LT gains along with SS income for a couple exist along with conversions starting well down in the 15% bracket:

Converted amount: 0-4500 Rate 18.4
4500-26,000 27.75
26k to 33k 55.5 The consolidated rate for 4500-34,000 is 33.3
33k to 34k 35.0
34k to 103k 25.0
103 to 175k 28.0

This shows that while SS benefits are phased into AGI and LT gains are pushed out of the 15% bracket by conversions, the taxpayer ends up paying a higher rate for the first dollars converted than the additional dollars. While this can result in lower total taxes paid by bunching conversions into alternate years so that the consolidated higher rates shown above are only paid in alternate years, the resulting consolidated rate can still be higher than what a modest income beneficiary will pay. These beneficiaries will have more left after taxes if they inherit more because client did not convert the entire TIRA than if he did.

There is also the potential threats to relative Roth benefits that might occur such as Congress passing a VAT instead of higher income taxes, or various means testing such as the treatment muni bonds get when taxing SS benefits, or using Roth distributions to determine AGI for Medicare premiums or the new taxes on investment income starting next year.

In any event, the conversion plan is something that should and can be re assessed each year, and he still has the option to recharacterize conversions for any reason.

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