Is it possible to recharacterize a 401K to Roth Rollover of after-tax earnings?

Submitted by Gary Tompkins on Mon, 2018-03-19 20:18

I’m new to this Forum and I have seen numerous discussions around taxation of pre-1987 401K money and recharacterization of 401K rollovers to Roth accounts. My issue touches on both of these. Any feedback/help would be greatly appreciated.

I rolled over both Post-1986 pre tax and Pre-1987 401K money to Traditional and Roth IRAs respectively, thinking they were in-kind rollovers and therefore would have no tax consequences. Turns out, my company says, that what I rolled over into the Roth was after-tax EARNINGS and therefore they have to be taxed when going into a Roth (and causing an $11K swing in my taxes!) I suppose that makes sense since Roth contributions must be taxed. Also, these two plus a third rollover were all lumped into one 1099-R with only the Roth ‘contributions’ showing as ‘Taxable amount’ and the whole amount is coded G, Direct rollover.

I guess since it’s done, it leaves me with two options, the way I see it.

1) Find IRS rules/laws to the contrary (if they exist) and present my findings to my company and try to get them to reissue a corrected 1099-R. (OK, I spoke to an IRS rep in the Tax Law dept and she was helpful, but left scratching her head as to why I only got one 1099-R. Same for my CPA, but then they may not have the full picture… else my company is not interpreting the rollover laws regarding Pre-1987 money correctly.)

2) Try to recharacterize the UNTAXED EARNINGS into a type of pre-tax investment where funds have not yet been taxed, which would be more of an in-kind transfer, I would think. I read on some other forum that rollovers from a 401K to a Roth CANNOT be recharacterized. Can anyone confirm this?
To complicate matters, I JUST moved that money from the initial receiving Trust company into another Roth vehicle with another Trust company. So next question is, if recharacterization was even possible to do it to begin with, is it now NOT possible due to the subsequent move of the funds to another Trust company?

I hope all that makes sense. I look forward to any solid input, preferable with backup sources to support your statements.

Thanks!



Submitted by Alan - IRA critic on Tue, 2018-03-20 02:32

  • You should have done a split rollover per Notice 2014-54. The way to request this is to request that the pre tax amount be directly rolled into a TIRA and the after tax balance into a Roth IRA. Generally, whether the after tax balance is pre 87 or not does not matter. But to better determine what exactly happened here please advise how you requested this rollover, whether you have separated from service, and whether this was a full distribution or a partial distribution. I assume that your reference to pre 87 contributions means exclusively after tax contributions, since the pre 87 balance is only significant with respect to after tax contributions.
  • Any amount rolled into a Roth IRA can be recharacterized up to the extended due date. If you recharacterize all or part, you cannot separate out the taxable portion of the Roth rollover. The amounts would come out pro rated between taxable and non taxable. Such Roth rollovers done in 2018 or later cannot be recharacterized, but yours can because it was done in 2017. While you can still have the Roth rollover recharacterized it will now be more difficult due to the change of custodian because the new custodian does not have access to the balance of the Roth immediately after the conversion. Or the new custodian may want to use the value of the account when they received it as the “opening balance” on which the recharacterization formula is applied.
  • Combining direct rollovers to Roth and TIRA on a single 1099R often causes problems when filing taxes. Please address the questions asked above.

Submitted by Gary Tompkins on Tue, 2018-03-20 20:33

Alan, thanks for your detailed response including reference to Notice 1014-54, which I have now read. Can’t say I understand it, but I read it.I was 62 and employed when I made these rollovers. I retired a couple months later.1)    Per my statement ‘I rolled over both Post-1986 pre-tax and Pre-1987 401K money to Traditional and Roth IRAs respectively’, I would think that is a split, per your description, unless your take on a ‘split’ is more complicated that what I’m thinking. That was the intention anyway. Also, I’d like to think my financial advisor, who has done these rollovers many times, was indeed doing a ‘split’. It looks that way on the surface at least. The gross distribution was split between a TIRA (pre-tax contributions and earnings) and R-IRA (after-tax EARNINGS according to my company). None of the examples hits on all points but I can tell you that my instance seems most like Example 4 in the Examples section, for which I have noted my amounts parenthetically to more closely reflect my situation.  “Example 4. The facts are the same as in Example 1, except that Employee C chooses to make a direct rollover of $80,000 (me $44,000) to a traditional IRA and $20,000 (me $46,000) to a Roth IRA. Employee C is permitted to allocate the $80,000 that consists entirely of pretax amounts to the traditional IRA so that the $20,000 rolled over to the Roth IRA consists entirely of after-tax amounts.” I don’t understand how the last sentence about what Employee C is PERMITTED to do applies to my case, if at all. That is, I don’t understand the gist of that statement.I don’t know if, because my R-IRA amount is higher than the TIRA amount that it changes the example.(?)I don’t see anything about the after-tax EARNINGS on pre-1987 earnings and how that might apply, as my company keeps insisting it does.Can you please clarify why you say ‘whether the after-tax balance is pre 1987 or not does not matter’? Keep in mind, I’m told these are earnings, not contributions. Which by the way, Box 9b shows $0.00.2)    WIth regard to the after-tax earnings from the original pre 1987 after-tax contributions (probably to company stock). I can’t say at this point whether ALL pre 1987 contributions I made were after-tax but I’m quite sure they weren’t. I started contributing in the late 70’s right when 401Ks started. I don’t recall when I changed from after-tax contributions to pre-tax but I’m sure it was before 1987. So, if it matters for the sake of this discussion, there were both pre and after-tax contributions pre 1987. At any rate, I have asked my company for historical documentation of my pre 1987 contributions and subsequent earnings over the years to prove that the Taxable amount on the 1099-R is valid.3)    Good to hear that the new Trust company might still be able to recharacterize the Roth. I guess my next step is to contact them. It took me awhile to understand that it’s really all out of my company’s hands at this point.4)    Can you offer an opinion on whether it seems logical that the rolled over (non-Roth) after-tax earnings never previously taxed should have been taxed? I mean, it does make sense to me because if not, then taxed contributions & earnings from other sources in the Roth would be mixed with these untaxed funds. I think my only hope is to recharacterize.5)    Lastly, I find this statement at end of section III interesting, but not sure if it applies. “If the amount rolled over to an eligible retirement plan exceeds the portion of the pretax amount assigned or allocated to the plan, the excess is an after-tax amount.” The total amount of my gross distribution does exceed the pretax amount ($90,000 vs $44,000). But, I don’t know that it automatically means the remainder/excess ($46,000) is ‘designated’ after-tax or it is already just simply after-tax earnings from my pre-1987 contributions. I’m probably trying to hard here to make things apply that really don’t.It’s amazing really with so much government documentation how hard it is to find something that speaks clearly and effectively to an exact situation. I reckon the permutations of scenarios are nearly incalculable and tax advisors just have to do the best they can to properly reconcile where that is not perfect clarity.

Submitted by Alan - IRA critic on Tue, 2018-03-20 23:25

  • Typically, all after tax contributions have been made into a separate sub account within the 401k. The earnings on those after tax contributions must stay in that sub account, and other than pre 1987 after tax contributions which the plan should also account for, any distribution from the sub account must include the earnings in porportion to the amount of after tax contributions. It is very possible that if you made these after tax contributions 3 decades ago, that the earnings in the sub account now exceed the after tax amount. It is also possible that your particular plan accounting differs from the norm in some manner and is also affected by the fact that your distributions was an in service distribution. Regardless of all this, if this rollover occurred after Sept, 2014, you still could have directed the after tax amount you distributed to your Roth and the pre tax to your TIRA. For some reason it appears that the earnings in your after tax sub account went to your Roth in addition to the after tax contributions, but I can’t tell why. That leaves you will a partially taxable Roth rollover.
  • The relative value of pre tax vrs after tax does not affect the Notice 2014-54 examples. Note that the complex examples in the Notice involve amounts distributed to the participant, and you did not have those.
  • I stated that the after tax split between pre 87 and post does not matter because normally they are both held in the same after tax sub account, and both are usually distributable while you are still employed. The significance of the pre 87 after tax amount without earnings is that this dollar amount can be distributed without earnings in most cases if you specifically request that. But usually there is no need for that with since 2014 because whatever amount comes out of the plan can be sent to the destination account you want, and that normally results in all pre tax amounts (earnings or otherwise) going to the TIRA, with no pre tax amount going to the Roth.
  • Perhaps if you have a plan statement from the end of the year prior to this rollover, it would break out the source of your after tax contributions, amounts of earnings etc. Otherwise, you probably will need to talk to the expert resource in your plan to explain why pre tax dollars were sent to your Roth IRA instead of the TIRA. Of course, that leaves you with a choice of either paying the taxes to in order to keep the non taxable amount of the Roth rollover intact. If you recharacterize either partial or full, an after tax amount will end up commingled in your TIRA after which it cannot be split out if you are retired.
  • Your Q 4 – any pre tax amounts that go into the Roth are taxed at that time. That is why these are usually rolled to a TIRA.
  • Your Q 5 – this addresses a situation where there is a combination of direct and 60 day rollovers. Fortunately, all yours were direct rollovers.
  • Perhaps more could be determined, if you posted the exact amount in the 1099R boxes, and also the amounts that were deposited in your TIRA and Roth IRA.

Submitted by Gary Tompkins on Wed, 2018-03-21 18:01

Thanks again. I think the bottom line is that the the after-tax earnings, not having been taxed and going into a Roth, should have been taxed, as is any money going into a Roth. No, I should not have done that but my Advisor missed or and my company administrator missed it and didn’t specify they were AT EARNINGS and would be taxed. (Unfortunately, and I will beat them about this, they have non-experts doing these transactions and they are playing with 10’s and 100’s of thousands of dollars of other people’s money and mistakes can have dire consequences.) Assuming I can’t undo it with them, I am already in the process of recharacterizing the rollover. I have met no resistance from either the first or second trust companies. The second said I could have the money transfered back to the first if they need it to do the recharacterization (since the movement to the second was a transfer not a rollover). The first just said ‘you need to talk to your tax advisor’. My tax advisor so far thinks it’s certainly possible to move those after-tax earnings into a TIRA and recoup the taxes I’m having to pay at this point.This is so fun, it makes me want to start a 2nd career as a tax specialist…. (or not)

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