35 yr old client contributes an extra $35k to his 401k with after tax doilars.
his plan allows for in service withdrawals of after tax dollars regardless of age.
he rolls the amount out of the plan each year into a Roth IRA.
will pro-rata rules apply?
No, because the rollover to the Roth IRA is done directly from the qualified plan. Form 8606 does not apply. However, if the amount is first rolled into a TIRA and then converted it would trigger Form 8606 and pro rating with all non Roth IRA accounts. Note that 35k of after tax contributions is a large contribution to the after tax account if client also maxed out the 18,000 elective deferral limit. Hopefully, client will pass the ACP test for the 401k plan.
The after-tax contributions can be rolled over to a Roth IRA and the pre-tax earnings to a traditional IRA. This must be done in a single distribution, but will incurr no tax liability.
what happens if the plan fails the ACP test AFTER the EE takes this in-service distribution and converts to Roth? Do they “claw” it back? -m
The plan has options to eliminate the testing failure as explained here http://www.relius.net/News/TechnicalUpdateDetails.aspx?T=P&1=1&ID=1049. If the plan still fails the test and If the rollover has already been reported on a 1099R, the forms should be corrected to include an excess contribution distribution along with earnings on the excess. The direct rollover 1099R will be reduced accordingly and the participant 1040 will have to reflect the corrected forms. The corrective distribution amount becomes an excess Roth contribution and most be removed from the Roth IRA with allocated earnings accrued after the date of the direct rollover. All this is probably not costly from a tax standpoint, but will be a mess to get it correctly reported on the tax return and also will take some convincing of the Roth custodian why they are being asked to process an excess contribution correction.
Permalink Submitted by Alan - IRA critic on Mon, 2017-06-26 22:05
Prorating only includes earnings generated in the after tax sub account before the Roth IRA rollover. The rest of the 401k balance is not considered because the after tax sub account can be distributed separately upon request.
Permalink Submitted by Thomas Ferry on Tue, 2017-06-27 14:04
Are exisitng IRAs consisting of pre tax dollars also subject to prorata rules at that time, therefore creating add’l tax?