After tax part of 401K roll over to Roth IRA
I do not have an existing Roth IRA. However, I am eligible to convert an old 401K (from a previous employer) to an IRA account. When I was discussing that with the management company (Vanguard) of my old 401K, they reminded me that I have about $50,000 after tax portion to consider further for roll over process. Of course, I can take a check to open an investment account with it. I asked them the question about converting that amount to Roth IRA since I do not need a cash at this point and also take the advantage of growing it tax free.
They said that the tax code is not so clear wheather I would be asked to pay tax again if I convert this after tax portion of my old 401k to a new Roth IRA account. Logically, they agree that I do not be taxed but they would not guarantee that IRS would do the same. They are asking me to consult with tax advisors. I checked a few of them and all of them dancing around it by claiming that tax code is not clear about this point. Asking IRS in this heavy tax season is almost impossible for a quick answer. One of the tax advisors recomended this forum and advise me to ask the question. I checked the forum and did not find a topic on this question. I decided to start the discussion.
I’d appreciate if any of you had faced a smiliar case and how you handled it. Being double taxed is no fun and dumb thing to do. If I am not so sure about the answer, I will pass on Roth IRA idea.
Permalink Submitted by Alan Spross on Mon, 2012-03-26 19:15
In no event would you be paying double tax on the same money, but the question of “isolating your basis” (the after tax dollars) to the Roth IRA has been hanging for over two years now due to lack of IRS clarity on this subject. There have been several posts on this issue. The following response of mine is copied from another forum, but addresses the questions and outlines one way to get your after tax money into your Roth IRA without concern for IRS challenges as a result of Notice 2009-68:
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The 1099R instructions that currently exist do not support the intent of the IRS per their Notice 2009-68. The risk is that the IRS changes the 1099R instuctions to require the pro rating of the basis to each IRA type and this would probably also require a different 1099R for each of the two direct rollovers. If the IRS orders these changes before November, there is time to require them for 2012 tax year reporting. The odds of that happening are probably 25% or less, but there must be no easy solution since the IRS has been aware of this problem after since they issued the Notice over two years ago and have not been able to offer further guidance.
So what would happen if you completed these rollovers as stated and the IRS changed the reporting? Your total basis is 1/3 so you would end up with 133,333 of after tax contributions in your TIRA and you would end up with 2/3 of your Roth rollover being of pre tax funds and you would owe taxes on the 133,333 portion of the Roth rollover. If this happened, you could recharacterize your conversion if you wanted, and then you would end up with all 200,000 of basis in your TIRA which you would eventually get credit for on Form 8606. That would leave you with no current tax, but the 200,000 would be in the TIRA which was not your intent. Thousands of taxpayers have done these “tandem rollovers” in the past without consequence, so it is probably worth the risk if you don’t want to use the safer strategy.
The safer strategy requires you to front the withholding tax of 20% of the pre tax amount ($80,000). You request the plan to distribute the entire 600k to you, then YOU do the rollovers first to the TIRA of 400k and then 200k to the Roth the next day, coming up with the 80,000 to complete the indirect 60 day rollovers. Then you get the 80,000 back through reduced withholding or when you file your return. The difference between this procedure and the direct rollovers is that Sec 402(c)(2) of the tax code indicates that when the distribution is made to the employee (as opposed to directly to the IRAs), the amount the employee rolls over first is deemed to be the pre tax amount. This is reflected in Fidelity’s proposed procedure order as well, the difference there apparently being that Fidelity thinks that doing direct rollovers is the same as distributing to the employee. No one knows for sure whether the IRS would agree with that thinking, thus the small amount of risk in Fidelity’s procedure.
Most people doing this do not have the earnings buildup on their after tax contributions, and their plan allows them to do frequent direct rollovers to a Roth IRA in a situation where the earnings are so small it is no problem to report a small part of these rollovers as taxable. The more often these rollovers are done the less likely to have no more than inconsequential earnings included.
Although plans tell you to consult a tax advisor for mostly anything you ask them, in this case they are correct, but the problem is that no tax advisors know what the IRS is likely do do either. That leaves you in the position of taking some risk by doing the direct rollovers or having to front sometimes large amounts of withholding to safely isolate your basis by using the indirect rollover procedure.
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Permalink Submitted by Cengiz Akgun on Wed, 2012-03-28 17:05
Alan,
I am sorry but I could not follow your answer since the numbers in your post was the answer for someone else’s question. In my case, I am still working and not elligible to receive any pension or 401k or TIRA distribution due to my age. As I mentioned earlier, I do not have any RIRA. Now, I decided to roll over the 401k from my old employer to an IRA account because they started to limit the fund choices.
Now, let us say that my old 401k is $600K. I remember and also reminded by the 401k management company that I have $50K after tax amount in that 401k $600K total amount. Probably, I contributed more than it was allowed in early stages to my 401k then. If I am in no way to be double taxed on the same money as you said, why I cannot roll over $550K to TIRA and $50K to RIRA directly without any tax consequences. I paid taxes on the $50K in the past. I understand that it may be a different tax bracket than I may be in currently (however I doubt that since my salary never jump so high for me to think that I paid less tax on that amount in the past comparing my existing tax bracket based on the current income ). So, why prorate the taxes based on isolating cost basis come into play in this situation. Whatever that after tax amount of $50K produced is still going to go to TIRA. According to records, the $50k is declared as after tax amount. Why splitting the hair like that? I am aware that you are not the IRS and they are the ones who are not clarifying their position. What is the problem in my thinking? I’d appreciate if you can give me a little more information on that.
If the getting $50K as a check and open RIRA in 60-day as an indirect rollover will help (still I am not so sure how safer that would be in IRS’ stand point), I can try that. I am sorry but I am really novice on this issue.
Permalink Submitted by Alan Spross on Wed, 2012-03-28 19:40
You would probably be OK doing just that. ie do a direct rollover of the 550k to a traditional IRA, and asking for a check payable to you for the 50k that is post tax. Then roll the 50k over to a Roth IRA. Taxpayers have been doing this for the last 3 years without a problem, but there is a risk that the IRS will require plans to report these transactions differently than they have been.
The only risk free way to do this is to have the entire amount paid to you and you would then do both rollovers in the correct order. But you would need to replace the 20% of 550k or 110k to complete the rollovers, and you may well not have this amount available. In that case, you should probably take your chances and do the rollovers as indicated above, but as noted there is some degree of risk there.