CONSOLIDATE Roth: CONVERSION + R/O + Roth CONTR A/Cs?

Submitted by DAVID DAMASKA on Wed, 2015-08-19 06:48

1st SPECIFIC client SCENARIO:
Wondering if any compelling reasons NOT to do DIRECT Trustee-to-Trustee ROLLOVER of my client’s [ $80K Roth DEFERRALS only ] from former employer 401K PLAN into his ONLY/EXISTING Roth A/C [ $120K original source from P/Ys Roth CONVERSIONS ] vs ESTABLISHING a 2nd NEW Roth to take receipt of $80K Roth DEFERRALS?
FACTS:
#1 100% of $ in ONLY/EXISTING Roth A/C is PAST RECHARACTERIZATION PERIOD, so NO chance this $ will ever be other than ROTH $.
#2 If we were going to do any FUTURE Roth CONVERSIONS, I would definitely establish a SEPARATE Roth A/C to take receipt of all CONVERSION $, atleast until RECHARACTERIZATION PERIOD had expired.
#3 I am also a CFP/Financial Advisor, as well as, a CPA/Tax Accountant.
From an investment perspective, my client can REDUCE his INVESTMENT MANAGEMENT FEE % in a SEPARATELY MANAGED A/C Platform by CONSOLIDATING his [ $80K Roth DEFERRALS only ] from former employer 401K PLAN into his ONLY/EXISTING Roth A/C [ $120K original source from P/Ys Roth CONVERSIONS ], which = $200K Total A/C Value, vs having 2 SEPARATE A/Cs @ $80K & $120K.
#4 From an ADMIN perspective, just easier not having so many SEPARATE A/Cs, as well as, having to prepare paperwork to establish > # of SERPARATE A/Cs w/NEW Investment COS. This client already has a signifianct # of SEPARATE investment A/Cs as it is [ R/O IRA, VAs, NON-TAX QUALIFIED & Various KID’s A/Cs.

2nd GENERAL/OVERALL client-base SCENARIOs:
I ordinarily do not like to commingle Roth: CONVERSION + R/O + Roth CONTRIBUTORY A/Cs, as well as, CONTIRBUTORY TIRA & R/O IRA A/Cs. I’ve made a practice of KEEPING these various types/source A/Cs SEPARATED up to this point. However, I am going to be moving a substantial % of my client-base to NEW Investment COS, & contemplating this issue of CONSOLIDATING the # of A/Cs for EACH client, UNLESS 1 of following situations exists:
A) Roth RECHARACTERIZATION PERIOD has NOT yet UNEXPIRED.
B) CHANCE client may want/need to ACCESS CONTRIBUTION $ in Roth A/C. In which case I think CONSOLIDATING Roth: CONVERSION A/Cs + Roth CONTRIBUTORY A/Cs may be ill-advised, because I believe there is a 5 YEAR WAIT before you can ACCESS Roth CONVERSION A/C CONTRIBUTION $, which is N/A for what I refer to as Roth CONTRIBUTORY A/Cs.
C) CHANCE client may want to transfer P/Ys R/O $ into an employer’s 401K Plan in FUTURE.

BOTTOM-LINE: WHAT ARE the CONS of CONSOLIDATING A/Cs [ if A) thru C) (above) are N/A ], & do the CONS OUT-WEIGH my client’s benefits [ #3 THRU #4 (above) ], in both
1st SPECIFIC client SCENARIO & 2nd GNERAL client SCENARIOs?
Any thoughts are greatly appreciated!



Submitted by Alan - IRA critic on Wed, 2015-08-19 19:58

  • Since all Roth IRAs are treated as one combined account for tax purposes, there is no reason not to roll the Roth 401k into the existing Roth IRA. Client will need to know the composition of the Roth IRA dollars anyway to report any Roth IRA distributions on Form 8606. The 1099R issued by the Roth 401k plan will not show the contribution amount in Box 5 for a direct rollover, so this info will have to come from the 401k statement. The Roth 401k elective deferral amounts and IRR amounts are added to the Roth IRA regular contribution amount and conversion amounts respectively. If the Roth 401k contained in plan Roth rollovers, this amount is treated as a Roth IRA conversion once it is rolled into a Roth IRA and the 5 year holding period for conversions is continued on. Client needs to track these amounts in the same manner whether he has one Roth IRA or multiple accounts, so there is no reason not to take advantage of any account consolidation benefits.
  • The recharacterization deadline is a related issue. IRA custodians can process recharacterization earnings amounts whether the contribution or conversion is in a separate account or not. But the earnings and therefore the amount transferred to the other IRA type will be affected by the earnings result of the entire account if the contribution is made to an existing account. This will result in the amount transferred being either higher or lower than if a new account was created for a contribution or conversion. A higher earnings amount works against the taxpayer, while a lower earnings amount is beneficial because fewer Roth dollars are moved into a TIRA. Conversely, an account just holding one conversion is exactly equitable because in a recharacterization the entire balance is transferred and no calculation is needed. So there is a transparency benefit for keeping a conversion separate until the recharacterization deadline passes, then transfer the account into the other account or vice versa.
  • There might be Roth creditor protection benefit in a few states that do not fully protect IRAs from creditors if that state has opted in to the federal bankrupctcy Act AND if the client will have over 1.2mm of total IRA assets. In those states accounts created solely from qualified plan rollovers (including Roth 401k) would remain separate to take advantage of no dollar limitations should client file bankruptcy. Again, this benefit probably applies to maybe 10 states.

 

Submitted by DAVID DAMASKA on Wed, 2015-08-19 22:42

Alan:Few follow-up items to your reply:

  • Your reference to Roth 401k containing in plan Roth rollovers, being treated as Roth IRA conversion once rolled into a Roth IRA. Seems obvious, but just want to confirm, your NOT saying this would be treated as TAXABLE CONVERSION @ time rolled into Roth IRA, just that [ 1 ] Roth CONTRS will be treated/handled as part of the Taxpayer’s CUMMULATIVE TOTAL Roth CONTRS for future tracking purposes & [ 2 ] that a 5 YR HOLD PERIOD APPLIES? Please confirm EACH prior ACTUAL Roth CONVERSION, & If roll in Plan Roth rollovers INTO SAME Roth IRA A/C, EACH maintains it’s own SEPARATE 5 YR HOLD PERIOD despite COMMINGLING these various xrans into SAME Roth IRA A/C?

Alan, I for one am reassured knowing you’re out there & truly grateful for your willingness to share your vast knowledge w/knuckleheads like me.Thank You! David

Submitted by Alan - IRA critic on Thu, 2015-08-20 03:35

  • You are correct. No part of the Roth 401k rollover is taxable. If the Roth 401k is qualified at the time of rollover, the entire balance is effectively added to the Roth IRA regular contribution balance. If the Roth 401k was not qualified, then the Roth IRA holding period and age of Roth owner will determine when the Roth IRA becomes qualified.
  • I edited my prior post to modify the Box 5 comment because Box 5 is only completed when there is a distribution from the Roth 401k. Box 5 is not completed for a direct rollover to a Roth IRA. This means that the client will have to track the composition of the Roth IRA from Roth 401k statement data since it is not available from the 1099R. Sorry about that.
  • For purposes of Sec 72t (10% penalty), the 5 year holding period runs starting with the IRR year in the Roth 401k continuously with the Roth IRA. This treatment will be the same as for Roth IRA conversions. For example, if client did an IRR in 2013 and a Roth conversion in 2014, the 5 year holding period for the IRR will run through 2017, and a Roth IRA distribution under the ordering rules would have the IRR money coming out before the Roth conversion done one year later. Note that the IRR may have a taxable and non taxable component (this WILL show on the 1099R for the IRR), and only the taxable portion is subject to the 10% penalty if distributed before 5 years.
  • Again, all the above applies equally whether the Roth 401k is rolled into a new Roth IRA account or rolled into an existing Roth IRA because all Roth IRA accounts are combined for tax purposes. Each IRR and each Roth conversion will have it’s own 5 year holding period with or without commingling.
  • As you can see, the accounting for the composition of the Roth IRA will be a challenge whenever an Roth 401k is rolled over. And more challenging if the Roth 401k included an IRR. There is no 1099R documentation in the direct rollover 1099R. This is a 1099R completion flaw and prevents the IRS from knowing the composition of what has been rolled over. If the IRS audits, about all they could ask for is the 401k statement showing what the breakdown was for the Roth 401k. Clients should retain these statements. It is all much simpler if a client can avoid distributions until the Roth IRA is qualified.

Submitted by David Mertz on Thu, 2015-08-20 16:29

Alan, I think your previous Box 5 comment was correct.  The example on page 10 (I had previously said page 5) of the instructions for 2014 Form 1099-R indicate that a code H Form 1099-R for a direct rollover from a Roth 401(k) to a Roth IRA should show the Roth 401(k) contribution basis in box 5.  That’s no guarantee that it will, though.

Submitted by Alan - IRA critic on Thu, 2015-08-20 18:17

  • DMx- which paragraph are you looking at on p 5?  The paragraph that mentions Box 5 also indicates “other than from a designated Roth account”.  I think Box 5 is only filled for taxable distributions including a direct rollover from a pre tax account to a Roth IRA under 408(A)(e).
  • The IRS seems to only want this information for currently taxable distributions, not for the taxpayer’s later use in tracking basis in IRA accounts. Since 2001 this same problem has existed if after tax (not Roth) amounts are directly rolled to a TIRA. There is nothing currently taxable so the IRS instructions omit Boxes 2a and 5. Taxpayer will need the basis info, so I guess that means getting it from a plan statement.
  • It is possible that this same issue was considered when the IRS finally caved on the isolation of basis question and issued Notice 2014-54. Under the 1099R Inst, the IRS would not know the amount of basis being transferred to a TIRA, so they had no way to know what % of total basis was being shown in Box 5 for the rollover to the Roth IRA. Without knowing the total basis being transferred to both IRA types, they could not tell if pro rating was being done or not. The easier solution was just to let the taxpayer isolate basis per 2014-54.

Submitted by David Mertz on Thu, 2015-08-20 19:18

Sorry, I meant page 10.  It’s in the second column under Examples, the second example.  It’s showing a direct rollover $5,000 from a Roth 401(k) to a Roth IRA of which 94%, $4,700, is contribution basis.

Submitted by Alan - IRA critic on Thu, 2015-08-20 20:22

OK – The p 10 example is how I originally thought it should be. But this conflicts with p 5 and also with the specific Box 5 instructions on p 13. With these conflicted instructions, there certainly is not going to any consistency in administrator issued 1099R forms. I guess what we end up with is if the 1099R shows a figure in Box 5, it should include elective deferrals plus any IRRs completed. But if nothing shows, the participant will have to determine the amount of basis added to the Roth IRA from the plan statement. Given all this confusion, if the 1099R shows a Box 5 entry per the p 10 example, the participant should still check that figure against the plan statement.

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