401(k) after-tax to Roth IRA conversion

Submitted by chris erickson on Wed, 2015-06-17 18:31

Hi,
A client has TWO 401(k)s from previous employers.

401(k) #1 contains $80,000 pre-tax and $20,000 after-tax money.
401(k) #2 contains all pre-tax money.

He would like to do a direct rollover of 401(k) #1 only, with $80,000 going to a Traditional IRA and $20,000 going to a Roth IRA.

I know under the new rules that people can convert all of a 401(k)’s after-tax money to a Roth IRA if the total “account” is distributed i.e. otherwise, if a part of the 401(k) is rolled over, the amount of after-tax money should go into the Roth IRA is a pro-rata portion.

I am wondering if the presence of the second 401(k) muddies the water here i.e. must he roll over BOTH of his 401(k)s to get all of his pre-tax money into a Roth IRA? Or is each 401(k) considered separately?

You might recall that basis is spread across multiple IRAs and comes out pro-rata when distributions are taken from any one IRA. I am wondering if a similar issue applies when converting after-tax money when totally distributing one 401(k) but leaving the other one intact.

Thanks!



Submitted by Alan - IRA critic on Wed, 2015-06-17 18:35

Unlike IRA accounts, each 401k is considered separately. The fully pre tax 401k does not have any affect on client being able to isolate his basis in the other 401k and directing that the 20k be rolled to his Roth IRA while the 80k is rolled to his TIRA.

Submitted by Steven Davis on Thu, 2015-06-18 00:42

I am struggling with the custodian of my clients IRA on this topic.  Client rolled their 401 (k) plan into an existing TRADITIONAL IRA.  There were two checks from the plan admin $100K pre tax, 15K post tax (amount of the roth sleeve in the plan)Rolled over as $115K in December, and now the custodian of the IRA wants only to have a recharactherization done (which it is not)  The balance of all the IRA’s is very large so the 15K post tax will be factored out to near 1% if I follow the custodians direction of preparing form 8606.  The only ohter option the custodian will consider is an overfunding matter, remove the funds sending them back to the original custodian of hte 401(k) plan….. and accepting them back to a Roth account directly.   (I’m not sure the original 401(k) custodian wants to even get involved)  Any other options?

Submitted by Alan - IRA critic on Thu, 2015-06-18 01:21

  • Sounds like a Roth 401k direct rollover ended up in a TIRA account. Does the client have a 1099R coded H in Box 7? How was the rollover done, did client receive separate checks and does client have a copy of the checks. A check for 15k made out to client’s Roth IRA FBO client would provide good evidence that the IRA custodian made the error and should be under pressure to rectify it.
  • If other factors exist, this may take a letter from the 401k plan administrator. An IRA custodian does have the authority to correct errors like this given sufficient evidence and documentation.
  • Form 8606 does not apply here unless there were post tax contributions in the PRE TAX portion of the 401k as well. Treating this as an excess regular IRA contribution is a losing idea as it would be a costly loss of the Roth account.

Submitted by David Mertz on Thu, 2015-06-18 11:45

  • Assuming that this is an improperly completed rollover of a distribution from a Roth 401(k) and the IRA custodian will not make the correction on their own, it seems that it would have to be considered an excess contribution to the traditional IRA because a Roth 401(k) is not eligible to be rolled to a traditional IRA.  In such a case where the custodian will not make the correction, the client could request a return of contribution for the excess and a PLR could be requested for a waiver of the 60-day rollover rule based on the error of the custodian, allowing the contribution to be rolled over to a Roth IRA where it should have ended up in the first place.
  • If the after-tax money in the 401(k) was from the traditional portion of the 401(k) and not from a designated Roth account, again a PLR could be obtained to waive the 60-day rollover rule to allow the after-tax portion of the distribution from the 401(k) to be rolled to a Roth IRA according to IRS Notice 2014-54.  The IRS seems particularly generous in granting such waivers where it is demonstrated that the custodian did not follow the instructions of the taxpayer when originally placing the rollover in an IRA.

Submitted by Steven Davis on Thu, 2015-06-18 13:23

Thank you for TWO great responses.Yes the client got TWO separate checks (we have copies) and the error was allowing BOTH checks to go into an existing TRAD IRA.  The smaller check of $15K was the employee’s roth contributions and the growth on said roth.I will continue to press the TRAD IRA custodian that the orginal rollover was WRONG and the 15K should have been placed in a NEW ROTH IRA.  All the recharacterize talk and excess contributions fit the custodians exit strategies, NOT what had happened and what it should be. As to the Rollover in 2014, I have requested the TWO 1099-R’s    and assume both read $100,000  code G or H      and the second 1099-R $15,000   code  G  or  H   with or without baiss    but my verbal to there without seeing the documents was classifying the entire $115,000 as a roll over. 

Submitted by Alan - IRA critic on Fri, 2015-06-19 00:01

Exactly what is the complete payee on the Roth 401k distribution direct rollover check?  Does it indicate “Roth IRA” as opposed to the corresponding IRA shown in the other check?

Submitted by Steven Davis on Fri, 2015-06-19 15:29

It read pay to the order of New Custodain     FBO John Client          NO IRA, NO roth IRA no nothing but the client name and client address on both checks

Submitted by Alan - IRA critic on Fri, 2015-06-19 15:53

That makes the resolution more challenging, since it diverts some responsibility from the IRA custodian. The checks should have specified the IRA type for the rollover contribution. Notwithstanding this problem, the IRA custodian could have checked before completing the rollovers if client had IRAs of each type opened at the firm.

Submitted by Steven Davis on Fri, 2015-06-19 16:14

All true words that the accepting investment house should have asked for more clarity.  Client actually has two trad IRA, one inherited IRA and one Roth

Submitted by David Mertz on Fri, 2015-06-19 23:30

  • PLR 201242024 granted a waiver of the 60-day rule on the grounds that the plan from which a direct rollover was made failed to properly make the check payable to the taxpayer’s IRA and instead simply made it payable to the receiving financial institution FBO taxpayer, which resulted in the money being allowed to be deposited into an inappropriate (non-IRA) account at the receiving financial institution.  In this case the waiver was granted despite the taxpayer actually explicitly indicating on the plan’s direct-rollover form the account number of the non-IRA account as the desired destination (although the form did indicate that the rollover was to be to an IRA).
  • If obtaining a PLR becomes necessary, I would probably approach both the plan administrator and the receiving financial institution to obtain statements acknowledging their errors:  the failure of the plan administrator to properly identify that the destination for the direct rollover was to be a Roth IRA and the failure of receiving financial institution to properly ascertain the intended destination in the absence of the clear indication from the plan administrator.

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