Roth 4o1k Distribution / Rollover

Submitted by MIKE KRUCHTEN on Wed, 2016-09-14 00:16

My client started Roth 401k contributions in 2010 which met 5 year rule. He retired this year at age 58. His Roth Balance was $101,907 and total contributions were $79,454. He requested $80,000 from Roth as a distribution to himself. The 401k plan stated his basis on the $80,000 distribution was of $62,373 which is tax free and was taxed on the $17,627. The remainder Roth balance was rolled over($21,907) to a new Roth IRA for client. With these facts, I assume the age 55 401k exemption must not apply to Roth 401k distributions and to be qualified thou the 5 year rule was met the client must be age 59.5. Since client had no Roth IRA prior I believe he has to restart his 5 year clock for Roth IRA earnings to be tax free. Also, should the client need to remove $10,000 from the Roth IRA in 1 year how would the distribution taxation look and how will new IRA custodian know since no break out was delivered. I believe of the $21,907 rolled over to Roth IRA, $17,087 is basis which I assume would be first to be distributed from new Roth IRA when redemptions are first requested. After the $21,907 was removed the earnings if not held for 5 years would then be taxed but if held for 5 would not. Again, I don’t know how IRS would ever know the 5 year time frame was met.



Submitted by Alan - IRA critic on Wed, 2016-09-14 01:02

Was the direct rollover and the distribution to him requested at the same time? Note that the 1099R for the Roth 401k distribution lists the year of the first designated Roth contribution. For the Roth IRA to become qualified, the 5 year clock must start over and will start 1/1/2016. The question above affects how much of the Roth balance is treated as contributions and how much is treated as earnings, and that in turn will determine how much can be distributed from the Roth IRA tax free before the Roth IRA becomes qualified in 2021.

Submitted by MIKE KRUCHTEN on Wed, 2016-09-14 01:54

Yes, both occurred at same time. If 80k distribution was requested on a Monday and difference as a Roth rollover a week later what would be impact. Always thought pro rata regardless of distribution to client or rollover. Also it seems the 59.5 requirement needs to be met even thou client pulled from plan at age 58

Submitted by Alan - IRA critic on Wed, 2016-09-14 03:26

  • Recently released TD 9769 clarifies that this transaction is treated as a single distribution, not as separate distributions even though the distribution went to different destinations.   https://www.irs.gov/irb/2016-23_IRB/ar05.html
  • Further, when a direct rollover is included the pre tax portion of the distribution is applied first to the direct rollover. So let’s look at how the designated Roth is dissected. The pre tax portion (earnings) amounts to 21,907 which was also the amount of the direct rollover to the Roth IRA. Therefore, the Roth IRA added earnings and the 80,000 difference that was distributed to the client is the basis from contributions to the designated Roth. As such, the 80,000 is non taxable. The 1099R reporting this portion of the distribution should show 0 in Box 2a and 80,000 in Box 5.
  • The direct rollover will be on a different 1099R for 21,907. While pre tax, this is not currently taxable because it is a rollover of Roth to Roth. Since there was no prior Roth IRA, the Roth IRA now holds all earnings. This means that until the Roth IRA separately meet the 5 year holding period, any Roth IRA distribution will be taxable. Further, if such distribution occurs prior to 59.5, there will be a 10% early withdrawal penalty.
  • There is chance that this recent Notice has not been considered by the plan. Therefore, before the 1099R forms are issued in January, it would be beneficial to ask the plan administrator to issue those 1099R forms per the instructions in TD 9769 attached.
  • As for the Roth IRA distribution, the custodian does not track Roth basis or earnings and is not interested in this breakdown. The client is responsible for providing his own breakdown on Form 8606 which would show 0 Roth IRA basis from contributions. If the distribution of 10k can wait until 59.5, the 10% penalty will be avoided.

Submitted by David Mertz on Wed, 2016-09-14 08:24

  • If the numbers provided are exact, under Notice 2014–54 in conjunction with TD 9769 the $80,000 distributed to the client would be $79,454 of basis and $546 of earnings.  The Form 1099-R would show only $79,454 in box 5 and the $546 of earnings distributed would be subject to tax but the age 55 exception would apply to eliminate the early-distribution penalty.  The codes in box 7 should be B and 2.
  • From the plan indication that only $62,373 of the $80,000 distributed to the client is basis, it appears that the plan has *not* applied Notice 2014–54 in conjunction with TD 9769, at least in the calculation provided, and need to be instructed to do so in their actual reporting on the Forms 1099-R, as long as the two distributions were requested to be made simultaneously.  If the code B2 Form 1099-R is instead issued showing only $62,373 in box 5, the IRS will see $17,627 as being taxable instead of only $546 being taxable.
  • If the two distributions were not requested to be made simultaneously, Notice 2014–54 in conjunction with TD 9769 would not apply and $17,627 would be taxable.
  • If the plan considered only $62,373 of the distribution to the client to be basis and $17,627 to be taxable, the plan should have withheld a minimum of $3,535 (20%) for taxes.
  • If it has been no more than 60 days since the distribution to the client, the taxable portion of the distribution paid to the client can still be rolled over to the Roth IRA.  Amounts rolled over are deemed to come first from the taxable portion of the distribution.
  • If only $62,373 of basis was distributed to the client, the remaining $17,081 of basis ended up in the Roth IRA as contribution basis.  This would be shown in box 5 of the code H Form 1099-R reporting the direct rollover to the Roth IRA.  Any amount up to the amount of contribution basis can be distributed from the Roth IRA tax and penalty free at any time.  The Form 8606 prepared for the year in which such distribution occurs will need to show the contribution basis (beginning with $17,081 in the year the first year such a distribution occurs) until after the year 2020 when distributions from the Roth IRA will be qualified distributions.

Submitted by MIKE KRUCHTEN on Wed, 2016-09-14 15:42

Both distribution and rollover request was requested same day. Thou no 1099 R has yet to arrive the client did receive a distribution break down of transaction. Distribution confirmation shows of the $80,000 received $17,626 was taxable and $3,525 in Fed taxes was w/ held. After reading your comments and others it appears plan didnt apply recenly released TD 9769 to transaction which occurred in August 2016. I will have particpant pass along info to get corrected.So to be clear in future…. When a client retires and requests a 100% rollover from Roth 401k portion of plan to a Roth IRA 100% of earnings(pre tax amount) will go to Roth IRA first then basis? Then in event a distribution is then requested and lets assume after 59.5 the basis would come out first then earnings? It seems depending how Roth 401k rollover is processed the breakdown of earning and contributions may be affected. Also if the Roth 401k rollover is processed before 59.5 as in my client’s case the custodian will most likely code the rollover as NQ since age 59.5 had not been reached thou his 5 year hold period had? 

Submitted by David Mertz on Wed, 2016-09-14 18:04

  • See Notice 2014-54 for a description of how simultaneously requested distributions can be treated as the portion directly rolled over coming first from the portion that would otherwise be taxable.  TD 9769 describes how a supporting change to CFR 1.408A-1 Q&A-5, now final, permits Notice 2014-54 to be applied to distributions from a Roth 401(k) in addition to distributions from a traditional 401(k) account.
  • Notice 2014-54 treatment of simultaneous distributions is less useful for a distribution from a Roth 401(k) than it is for a distributions from a traditional 401(k) account.  With a Roth 401(k), the same result can be obtained without making simultaneous distributions to different destinations by first directly rolling the entire Roth 401(k) over to a Roth IRA and then distributing the basis from the Roth IRA.  In fact, the latter seems simpler to accomplish, with less potential for error.
  • If still within the 60-day rollover window for the distribution of the $80,000, it would be wise to resolve the reporting issue before the end of the 60-day window.  If the plan refuses to alter the reporting, the problem can be resolved as I described above by rolling over the taxable portion of the $80,000.  Even if the reporting *is* changed, there will still be $546 that is taxable, and that portion could be rolled over to make the entire result nontaxable.

Submitted by MIKE KRUCHTEN on Thu, 2016-09-15 02:55

If the plan refuses to alter the reporting and the regs state the portion rolled over to Roth IRA should have been earnings first. Would the client be better to file return and report only the $546 with an explanation. I don’t know what form the explanation would be placed on. Should he elect to rollover the incorrect reportable amount of $17,627. Does the rollover amount assume earnings are rolled over first vs. a pro rata amount.

Submitted by MIKE KRUCHTEN on Thu, 2016-09-15 03:05

If I am interpreting your response correctly in bullet 2. In hindsight client may have been better off rolling over entire Roth 401k balance to Roth IRA then have taken the $80,000 distribution. His basis was $79,454 and basis would have been removed first from Roth IRA followed by the $546 which would be both taxable and subject to penalty since client is not 59.5. However since he was 58 and retired wondering if the 10% penalty would be waived based on age 55 401k plan exemption. This may be future path of Roth distributions advice if you concur and regs support my interpretation.

Submitted by Alan - IRA critic on Thu, 2016-09-15 03:42

  • If client had rolled over the entire balance to the Roth IRA (declining any withholding), then client would probably have distributed only the 79,454 and not the full 80,000 to avoid tax and penalty on the earnings amount. The age 55 separation exception only applies to distributions directly from a qualified plan, not from an IRA. Therefore, taking a distribution of the 546 of Roth IRA earnings under age 59.5 would result in tax and penalty (unless client qualified for a different penatly exception).
  • With respect to your post at 19:55, the rollover decision for this small an amount should be predicated on an assessment of the one rollover rule. If the one rollover has been used, another one cannot be done. If the one rollover has not yet been used, the question is whether 546 is worth exhausting that rollover for the next 12 months. Most tax programs have sceens to enter an explanatory statement regarding certain items on the return. If the 1099R for the Roth 401k distribution showed 17,677 as taxable because they refused to recognize TD 9769, and a 60 day rollover of that amount to a Roth IRA was completed, pro rating would not apply as amounts rolled over from a Roth 401k distribution are deemed to apply first to taxable amounts. Of course, if client does not find out how the 1099R forms will be issued, it will be too late to do a 60 day rollover by the time the 1099R forms are issued.
  • Sorry for the math error in my original post. I missed that the direct rollover did include all the earnings.

Submitted by David Mertz on Thu, 2016-09-15 04:12

  • To substantiate to the IRS that the reporting of $17,627 of earnings having been distributed is incorrect and that the correct reporting is $546 of earning distributed, one would likely have to provide documentation to support the claim that the two distributions (one to the client and the other as direct rollover) were requested to be made at the same time and that they were to treated as a single distribution under the guidance provided by Notice 2014-54.
  • A rollover of a distribution from a qualified retirement plan is deemed to first come from the otherwise taxable part of the distribution.  Given that the distribution is from a Roth 401(k), this means that earnings are rolled over to the Roth IRA first.
  • In my statement about getting the same result by first rolling over the entire Roth 401(k) to a Roth IRA I assumed that a distribution of $80,000 was requested because it was a conveniently round number only slightly more than the amount of basis in the Roth 401(k), rather than there being an actual desire to distribute more than the basis.  It’s true that if the entire Roth 401(k) was first rolled over to the Roth IRA, and then $80,000 was distributed from the Roth IRA (instead of the exact $79,454 of basis), the $546 in excess of basis would be subject to both tax and 10% early-distribution penalty.  Distributing the $546 from the Roth 401(k) instead avoids the early-distribution penalty.  If it’s truly desired to have $546 of earnings distributed and the reporting shows that $17,627 of earnings were distributed, $17,081 of the earnings could be rolled to the Roth IRA followed by a distribution of the $17,081 of basis that ended up in the Roth IRA.  The age 55 penalty exception would still apply to the $546 of earnings distributed from the Roth 401(k) that would not be rolled over.
  • (You may want to ignore this next part; it’s intended to show that in the case of a Roth 401(k) the same result can be obtained without Notice 2014-54, but it takes a bit of calculation and requires that the plan permit multiple distributions.)  Even without Notice 2014-54, it is possible to obtain an identical result from a Roth 401(k), including the amount of taxes required to be withheld and the avoidance of the early-distribution penalty.  Given the numbers in this case, $99,428.88, consisting of $77,521.88 of basis and $21,907 of earnings could have been directly rolled to the Roth IRA, the $77,521.88 of basis distributed from the Roth IRA, then the remainder of the Roth 401(k), $2,478.12, could have been distributed as an independent distribution, consisting of $1,932.12 of basis and $546 of taxable earnings, with $109.20 required to be withheld for taxes.  The net result would be a total of $79,627 of basis and $546 of earnings not rolled over, and $21,907 of earnings rolled over, identical to the result obtainable by using the guidance in Notice 2014-54.
  • The rollover is of a distribution from a qualified retirement plan, so the one-rollover-per-12-months rule is not involved.

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