Verification of steps with nonspouse inherited 401K

Submitted by Jason Scott on Fri, 2016-08-12 14:44

I inherited a Traditional 401K plan this year as a non-spouse. I was considering taking advantage of a partial conversion to an inherited Roth with the remainder going to the inherited traditional IRA.

The plan is telling me I must first convert to the inherited Traditional IRA and then do the conversion of the amount I wish to the inherited Roth. Everything I have read seems to point to it must be done during the initial conversion and once it is in an inherited traditional it can’t be converted at all to an inherited Roth. Am I mistaken or are they?

If they are mistaken, is there something I can refer them to which supports this?



Submitted by David Mertz on Fri, 2016-08-12 15:43

  • The plan is giving you bad information.  Any amount from the inherited traditional 401(k) that is to end up in an inherited Roth IRA MUST be moved to the inherited Roth IRA by direct rollover from the inherited traditional 401(k) to the inherited Roth IRA.  Any portion of the inherited traditional 401(k) first rolled over to a inherited traditional IRA CANNOT later be converted to an inherited Roth IRA.
  • See 2015 IRS Pub 590-A, page 45, regarding the rollover of an inherited traditional 401(k) by a non-spouse beneficiary:  Rollover by nonspouse beneficiary. If you are a designated beneficiary (other than a surviving spouse) of a deceased employee, you can roll over all or part of an eligible rollover distribution from one of the types of plans listed above into a Roth IRA. You must make the rollover by a direct trustee-to-trustee transfer into an inherited Roth IRA.
  • A direct rollover from an inherited traditional IRA to an inherited Roth 401(k) is reported by the plan on Form 1099-R with codes 4 and G in box 7 and the taxable amount in box 2a.  (The taxable amount is the entire box 1 amount unless the traditional 401(k) has some basis in after-tax contributions.)

Submitted by Jason Scott on Fri, 2016-08-12 16:20

I appreciate it. I thought they were, but since it isn’t that common found little to go off of or that I could refer them to review. Even one of the companies I spoke to with regards to opening an inherited IRA account were unaware of the option.As far as I know the Traditional 401K has no after-tax contributions, so I would be liable for any taxes due from the conversion. I am considering using the RMD to cover the taxes owed since I need to take this year based off the original participant’s timeline since one wasn’t taken yet for 2016. 

Submitted by Ben Meyer on Fri, 2016-08-12 16:28

In the event that the decedents 401(k) contains basis from after-tax contributions, is the beneficiary permitted to utilize the benefits of Notice 2014-54?  The beneficiary would then be able to transfer the after-tax basis to an inherited Roth IRA, and transfer the pre-tax balance to an inherited traditional IRA.  The result would be tax-free to the beneficiary.  (The RMDs received from the inherited traditional IRA would still be taxable to the beneficiary.)

Submitted by David Mertz on Fri, 2016-08-12 17:29

  • Notice 2014-54 indicates that it applies to “a disbursement of benefits from a plan to a participant, beneficiary, or alternate payee,” so yes, a beneficiary can make simultaneous direct rollovers with the pre-tax portion going to an inherited traditional IRA and the after-tax portion going to an inherited Roth IRA, resulting in no tax due as a result of these rollovers.
  • Regarding the 2016 RMD, the plan must distribute to the beneficiary any unsatisfied portion of the deceased’s year-of-death RMD before performing any direct rollovers to traditional or Roth IRAs of the remainder of the plan balance.
  • (Technically, a direct rollover from a traditional 401(k) to a Roth IRA is not a “conversion” as the term is used in the Internal Revenue Code.  In the IRC, the term “conversion” is reserved for an amount moved from a traditional IRA to a Roth IRA.  In the case of moving an amount from a traditional 401(k) to a Roth IRA, it’s simply a direct rollover of which the pre-tax portion rolled over is taxable.)

Submitted by Jason Scott on Fri, 2016-08-12 18:15

Thanks for the additional clarification. I figured I needed to take the RMD before I did the rollover, but wasn’t positive it was required. There are actually two, non-spouse beneficiaries. Would we need to take the RMD prior to splittng the 401K or does it matter as long as we satisfy the RMD prior to the direct rollover? 

Submitted by Alan - IRA critic on Fri, 2016-08-12 18:40

If the plan requires a citation regarding beneficiary direct rollovers, here is Q 7 from Notice 2008-30:

Q-7. Can beneficiaries make qualified rollover contributions to Roth IRAs?A-7. Yes. In the case of a distribution from an eligible retirement plan other than a Roth IRA, the MAGI and filing status of the beneficiary are used to determine eligibility to make a qualified rollover contribution to a Roth IRA. Pursuant to § 402(c)(11), a plan may but is not required to permit rollovers by nonspouse beneficiaries and a rollover by a nonspouse beneficiary must be made by a direct trustee-to-trustee transfer. A nonspouse beneficiary that is ineligible to make a qualified rollover contribution to a Roth IRA may recharacterize the contribution pursuant to § 408A(d)(6). A surviving spouse who makes a rollover to a Roth IRA may elect either to treat the Roth IRA as his or her own or to establish the Roth IRA in the name of the decedent with the surviving spouse as the beneficiary. (See Notice 2007-7, Q&A-13, for a rule on how to title a beneficiary IRA.) A nonspouse beneficiary cannot elect to treat the Roth IRA as his or her own. (See Notice 2007-7, Part V.)  

Note that the provision that the direct rollovers are optional was changed by WRERA in Dec, 2008, therefore the plan MUST offer these direct rollovers today. Also, in the event you change your mind regarding the taxes due on the Roth rollover, you can recharacterize that to an inherited TIRA account subject to the usual deadlines. With respect to your question, the plan will first set up separate accounts for each beneficiary in the plan, but you should then be allowed to split the year of death RMD between the two beneficiaries in any proportion you wish. The last step would be the direct rollovers to inherited IRAs or inherited Roth IRAs.

Submitted by David Mertz on Fri, 2016-08-12 19:28

Also note that MAGI limits for being able to do such a rollover were eliminated for 2010 and beyond, so the statement about that in Q&A-7 no longer applies either.

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