Converting from nondeductible 401(k) to Roth 401(k)
My client has total 401(k) of $100k. $20k is nondeductible contribution, and $80k is pre-tax contribution. The account was $120k when he initially made the $20k nondeductible contribution. The account has dropped recently due to market volatility. If he wants to convert his nondeductible contribution to Roth, does he still convert the $20k and prorate 20% (i.e., $20k/$100k) of the conversion as nontaxable conversion and 80% is taxable?
Permalink Submitted by Alan - IRA critic on Thu, 2019-01-10 04:26
After tax contributions to the plan are held in a separate sub account along with earnings on those after tax contributions. Since this is a separate account from the pre tax portion of the plan, if the plan allows in plan Roth rollovers (IRRs), the entire balance in the after tax sub account would normally be rolled into the Roth 401k and only the earnings on the after tax contributions would be subject to tax. Again, there is no pro rating with balances outside the after tax sub account.
Permalink Submitted by John Lau on Thu, 2019-01-10 05:39
Thank you, Permalink for the response. I have a follow-up question: Say the client contributed $20K initially (to nondeductible 401k), and now the separate account is only worth $18K and client wants to convert to Roth. Would the conversion result in a $2K deductible loss?
Permalink Submitted by Alan - IRA critic on Thu, 2019-01-10 15:41
No, for two reasons. First, the misc deduction under which a loss would be reported ended with the recent tax bill. Second, many plans will carry over the unrecovered basis within the plan. For example, if the next contribution of 20k gained 2k to 22k when rolled to the Roth, the 2k of basis not recovered in the first rollover would be applied to the next rollover, and the 2k gain would not be taxable. To determine how this situation is handled by a particular plan, the plan administrator should be asked this question.