Traditional 401k to Roth Direct Rollover under 59 1/2
Hi-
My client wants to roll his Traditional 401k (funded entirely with pre-tax money) to a Roth IRA. His employer does allow this transaction while in service, however they require tax withholding.
How will the tax withholding be treated? I have been told on another forum that the withholding will be treated as a withdrawal and that my client will owe the 10% penalty (he’s under 59 1/2), even though there was no mention of this in the paperwork from the plan.
Is that true?
If so, how would you best accomplish getting these funds into a Roth IRA?
-Joe
Permalink Submitted by Alan - IRA critic on Fri, 2018-11-23 20:44
Per Notice 2008-30 QA 6, withholding on this direct rollover (a qualified rollover contribution to a Roth IRA) is voluntary, not mandatory. The client should refer his plan administrator to the above notice and due to the issues you mentioned client should decline any withholding. However, client will still have to deal with the tax liability resulting from this taxable rollover. Client might pay quarterly estimates or incease withholding from another source. Of course, client could elect withholding and % from the rollover, then replace the withheld amount by completing the rollover with other funds within 60 days. That would result in the full gross distribution going into his Roth, and still have enough taxes paid into the IRS to cover the additional taxable income. There is probably not enough time left in 2018 to pay the taxes through withholding from another source, so actually electing voluntary withholding may be easier. Or if 20% is what he wants withheld just allow the plan to think that withholding is mandatory even though it is not. Does he have other funds to make up for withholding to complete the rollover?
Permalink Submitted by David Mertz on Fri, 2018-11-23 21:21
I’m also concerned that in-service distributions of amounts attributable to elective deferrals are, by law, generally not permitted to be distributed before the employee reaches age 59½. This likely means that only the portion of the 401(k) attributable to employer matching or profit sharing contributions, or perhaps to amounts rolled into the 401(k) from another plan, can be rolled over to an IRA before age 59½ or separation from service.