401k with some taxable money rollover options

Submitted by Janis Sleeter on Mon, 2019-11-04 22:07

My client who is 44, has about $60,000 in an old company 401k.
There is about $50,000 taxable and $10,000 pre-tax.
He has a pension option (which he is not doing) or needs to move it out.

Told him he could
1) roll all of it over to his traditional IRA, but have to report and keep track of pre-tax for his cost basis
2) roll the pre-tax into a Roth and the rest into his traditional IRA.
He isn’t sure he wants to set-up a Roth just for that since he wouldn’t be able to add to it except by conversion and he is in a high tax bracket.

Wasn’t sure what would happen if he wanted to take the pre-tax as a distribtuion.

Appreciate your advice on this



Submitted by Alan - IRA critic on Mon, 2019-11-04 22:49

  • Your thinking is correct, but you are transposing pre tax and after tax amount. The after tax contributions made to the 401k are those the client already paid taxes on when contributed. This is the balance that should be rolled into a Roth IRA in a tax free rollover. The pre tax dollars contributed to the 401k and all company matching have not been taxed. If these were to be rolled to a Roth IRA, taxes would be due, but if direclty rolled to a TIRA there is no tax due for the rollover, but taxes will be due when TIRA distributions are taken.
  • Client should do a split direct rollover. Make a single request indicating that the after tax amount (also known as basis) be directly rolled to a Roth IRA and the pre tax amount to a TIRA. No taxes due.
  • It would be a mistake to roll the after tax amount to a TIRA, since the TIRA would then have basis and the amount would have to reported on Form 8606 line 2. Then whenever a TIRA Distribution is taken Form 8606 would have to be filed as it calculates the pro rata amount of every distribution which is taxable and non taxable. Client would be stuck with filing this form every year once RMDs begin. If that form is not filed then client will eventually be taxed a second time on the after tax contributions. Double tax is a waste, particularly on amounts like 10,000. 
  • Yes, he could also take the after tax 10,000 as a tax free distribution and not roll it over at all. That is what used to be done prior to 2003 when rollovers of this money was not allowed.

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