Roth 401k Distributed as RMD. Roth Conversion?

Submitted by Michael Quigley on Tue, 2016-04-19 19:48

I have a client who contributed to his ROTH 401k in 2015. Total Contribution – $24,000 (with catchup). He retired at the end of 2015. He turned 70.5 in 2015. 401k just distributed his RMD by April 1st. Part was a return of the entire Roth contribution part was his traditional 401k pre-tax. He did not want the Roth 401k to be distributed. Can he roll that into a ROTH IRA now?



Submitted by Alan - IRA critic on Tue, 2016-04-19 21:40

  • No. The 2015 retirement turned 2015 into a 401k RMD distribution year because he reached 70.5. Both the pre tax and Roth accounts are subject to RMDs based on their balances on 12/31/2014. There is no reason that the Roth 401k RMD should equal his contributions except by coincidence. Since these are RMDs, they are not eligible for rollover.
  • Roth 401k accounts are subject to RMDs and Roth IRAs are not. Therefore, it would be beneficial to do a direct rollover of the Roth 401k to a Roth IRA before the end of this year. Since the 2016 RMD is also due this year, a rollover will not eliminate the 2016 RMD, but it would eliminate Roth RMDs for 2017 and beyond.
  • Note that the two years of Roth 401k RMDs will include taxable amounts if any of these years falls before he met the 5 year holding period. If his first Roth 401k contribution was prior to 2012, then the Roth distribution is qualified and tax free. Otherwise, it would include some earnings pro rated into his contributions values.

Submitted by Ben Meyer on Wed, 2016-04-20 04:39

In the situation reported in this thread the traditional 401(k) and the designated Roth 401(k) were treated as separate accounts, with a separate RMD taken from each.  However, there appears to be an obscure interpretation of the distribution rules that can be applied when RMD is made from a 401(k) plan with both a traditional 401(k) and also a designated Roth 401(k).  Total required distribution can be made solely from the regular 401(k), which can contain both pre-tax and after-tax contributions.  No distribution is taken from the designated Roth 401(k).  It appears that the plan provisions specify an order of depletion of the sub-accounts of the plan that direct the distribution to be made in this manner.  Has anyone heard of this type of distribution?

Submitted by Alan - IRA critic on Wed, 2016-04-20 17:49

Benn, there is no such rule allowing RMD aggregation, but the perception that there is could have come from an “aggregation” clause in Sec 402A (Designated Roth Accounts) with regard to Sec 72. Here is that clause:

(4) Aggregation rules

Section 72 shall be applied separately with respect to distributions and payments from a designated Roth account and other distributions and payments from the plan.

 Plans frequently have distribution ordering rules when the pre tax portion of the plan also contains basis from after tax (non Roth) contributions held in a separate after tax sub account per Sec 72(d)(2). This could allow the plan to draw first from the after tax sub account to satisfy RMDs for the pre tax account, or since the separate after tax sub account can be distributed separately from the pre tax account even after retirement, the participant may have the option to specify if the after tax sub account is to be used to satisfy an RMD. Therefore, there is flexibility within the two pre tax accounts, but not between the designated Roth and the non Roth portions of the plan. The designated Roth is a totally separate account with totally separate accounting maintained by the plan and RMDs cannot be aggregated between the designated Roth and other portions of the plan even though they could be between the pre tax portion and the after tax sub account within the pre tax account.

Submitted by Ben Meyer on Thu, 2016-04-21 02:51

  • The rules for 401(k) plans sometimes seem to be in a world of their own.  Yes, section 402A(d)(4), taken together with section 402A(b)(2) certainly seem to say that the traditional 401(k) and the designated Roth 401(k) should each distribute its own RMD, without aggregation.  However, at least one large U.S. employer does it differently for designated Roth 401(k) accounts that are not yet qualified at the time of the distribution.  This employer makes one distribution from the traditional 401(k) only, to satisfy the total RMD for the traditional 401(k) and the designated Roth 401(k) combined.  The recordkeeper for the plan is one of the major U.S. plan recordkeeper-administrator managers, so it is hard to imagine how these major corporations could get it wrong.  Upon several inquiries, they have insisted that their actions were correct.  No choices or elections were made by the employees involved – the plan simply acted in accordance with its procedures.
  • Credibility is given to this approach in an article in the ASPPA Journal.  The following article states in part:

“Designated Roth 401(k) is subject to RMD rules due to Code Section 401(a)(9). However, in a 401(k) with designated Roth, the RMD may be taken from just non-Roth account assets until the designated Roth is a qualified distribution amount, although the designated Roth must be included in the calculation of the RMD.”

  

Submitted by Alan - IRA critic on Thu, 2016-04-21 03:43

Apparently, Grossman is basing this conclusion on IRS Reg 1.401(a)(9)-8 Q 2. This Reg allows aggregation among the sub accounts in a DC plan, but was written prior to the existence of designated Roths. One of the examples mentions the 72(d)(2) sub account mentioned earlier. Whether this extends to designated Roth accounts as well with their well documented separate accounting rules is not clear from this Reg. The designated Roth Regs do not mention RMD issues. Therefore, this could be a case of extending the original aggregation interpretation to designated Roth accounts, and there is no way to know whether the IRS intended this or not. In addition, if aggregation is indeed allowed, why would it be tied to whether the Roth is qualified or not? Having a portion of a designated Roth RMD taxable due to earnings inclusion certainly carries less of a tax impact than taking the entire RMD from the pre tax account. Therefore, the interpretation is apparently dependent on additional and more recent information than Reg 1.401(a)(9)-8. Too bad the article does not present a cite for this conclusion.

Submitted by [email protected] on Thu, 2016-04-21 13:32

alan, you said “Note that the two years of Roth 401k RMDs will include taxable amounts if any of these years falls before he met the 5 year holding period. If his first Roth 401k contribution was prior to 2012, then the Roth distribution is qualified and tax free. Otherwise, it would include some earnings pro rated into his contributions values.”Do Roth 401k not follow the same ordering rules on distritbutions as Roth IRAs? 

Submitted by Alan - IRA critic on Thu, 2016-04-21 16:17

  • Roth 401k accounts have more restrictive taxation rules than Roth IRA, in addition to their RMDs. There are no ordering rules for Roth 401k distributions resulting in non qualified distributions including a pro rated portion of earnings, so every non qualified distribution will have a taxable amount unless the account has no earnings.
  • What I have not yet seen are any clear regulations regarding the distribution of in plan Roth rollovers. These IRRs are subject to the same 5 year holding period to avoid the 10% recapture tax as Roth IRA conversions are. But since there are no ordering rules in a Roth 401k, there has to be a method of determining how much of a given IRR is included in a distribution, and the taxable portion of that IRR would be subject to the penalty. For example, of the Roth 401k had 15% of value in IRRs less than 5 years old (and participant is under 59.5), then 15% of a distribution would likely be subject to the 10% tax. Seems logical, but have not seen any IRS guidance on this subject and the Regs have not been updated to include the distribution of IRR money.

Add new comment

Log in or register to post comments