mistaken transfer from IRA to Roth IRA

Submitted by Russell Meinen on Tue, 2018-02-27 18:28

Recently met a couple who told me their Roth IRA was $120,000 and traditional IRA was $14,000. Told them the amounts are usually switched. Turns out in 2015 she instructed previous 401k custodian to make out the $98,000 check to new custodian, FBO (her name). She sent an accompanying note with the check to put funds into her current Roth IRA account with them (instead of the Traditional IRA act). This was a mistake. They had no intention of making these funds a Roth. The new custodian didn’t request any additional documentation from previous custodian to confirm tax status of the $98k. The previous custodian coded the 1099-R in Box 7 as G, rollover.

After examining all paperwork I suggested we contact current custodian to acknowledge the mistake to request they move the funds from the Roth act. to Traditional IRA act., i.e. from tax-free to taxable. They have refused to do so. The note from the client that accompanied the $98k check was confusing since both Roth IRA and IRA are mentioned in the same sentence. The account number mentioned in the note was the Roth IRA. It’s my contention they we somewhat culpable in this mistake since there wasn’t enough follow-up for clarification. They don’t agree.
Any ideas?



Submitted by Alan - IRA critic on Tue, 2018-02-27 18:52

  • The usual solution would have been to simply recharacterize the conversion. This could have been done as late as 10/15/2016 which was the deadline. Hasn’t the IRS asked for the conversion income to be reported on their 2016 return on Form 8606? 
  • No custodian will reform a rollover unless it is entirely their fault and they are notified shortly after the transaction, so their refusal is normal. While it probably would not change anything, if the direct rollover check was made payable to client’s IRA (not Roth IRA), the IRA custodian should have deposited it there regardless of confusing notes. The intended destination of a rollover should be specified to the holding custodian so they can make out the direct rollover check to the proper payee and account. However, it is still doubtful that such a case would result in action from the IRA custodian.
  • Of course, the taxes due on the conversion will hurt, but in the long run they may even benefit from this since the Roth will eventually be entirely tax free. Perhaps they also have generated considerable gains on this conversion which will also be tax free. 
  • Unless they have considerable documented evidence of their intent (possibly a copy of the direct rollover check from the 401k plan), it would not be worth spending 15-20k to apply for a PLR from the IRS approving extension of the recharacterization date. This would also take considerable time to file and for the IRS to make their decision. They need to look at the total picture including the gains on this conversion, their expected tax rate in retirement when RMDs start, and the PLR cost before determining their course of action.

Submitted by Russell Meinen on Tue, 2018-02-27 19:59

Thanks Alan,It was never their intent to recharacterize this rollover to a Roth and pay the tax.  Client mistakedly asked the funds be put in the Roth account instead to the IRA account.  No, the client has not heard anything from the IRS. The previous 401k custodian apparently just wanted to know how to make out the check.  We have a copy of the check.  it’s made out to, New Custodian: FBO client name. Only account number on check is the 401k account.  Apparently client told previous custodian it would be rolled over as 1099-R is coded G showing $0 tax due.  Have copy of that as well.It just seems if it was this easy to make taxable funds non-taxable many would be doing it.  Of course, IRA may eventually catch up to that. It was on their own volition to right this wrong, to move this money to taxable account.   This couple are recently retired.  Funds in both the Roth and Traditional IRA are invested exactly the same, low risk bonds funds.If PLR’s cost 15-20k, that would be about the tax cost.  Yes, I understand the porential Roth advantages and appreciate your thoughts.  Any idea how long it would take IRS to discover this situation?

Submitted by Alan - IRA critic on Tue, 2018-02-27 20:29

The IRS enforcement of retirement plan rules is very spotty, and that is being kind. There is no way to predict if or when they will catch up to this or similar errors. They received their copy of the Form 5498 in May, 2016  reporting a Roth rollover. Since they know that many conversions are recharacterized the following year, and 1099R forms for such a recharacterization would not be received until January, 2017, they would not be contacting taxpayers until after that date, despite a mismatch between the original 1099R and the 5498. Accordingly, they are now about a year into their normal response time regarding conflicts between the reporting forms and the taxpayer’s 2015 tax return. Very hard to guess if or when they will catch this, but if they do then the couple might face now only the back tax bill plus interest but possibly also an added penalty for underreporting a substantial amount of income. I think if the non reported income equals 25% or more of the reported income, this penalty comes into play.

Submitted by Russell Meinen on Tue, 2018-02-27 21:42

thanks for the input.  Here’s another question for you to ponder.  What if she requested the current custodian of the Roth IRA cut a check to a new custodian FBO her name, for the $98k plus earnings.  Then she rolled it into a traditional IRA.  Upon distributions of the money from the IRA would it be possibly taxed twice, once when IRS catches up to the 401k to Roth and then again when distributions are received from the IRA account?   Far fetched I know.  How would the IRS see this as gaming the system when she’s just trying to right a mistake?

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