Potential direct rollover of pre-tax 401(k) monies to existing Roth IRA
I’m 59 and considering a direct rollover of part of the taxable portion of my 401(k) subaccounts this year to an existing traditional Vanguard IRA and then converting, shortly thereafter, the same monies to an existing Vanguard Roth IRA. I wish to pay the federal taxes associated with such rollover with non-retirement funds and hence the reason for this path in-lieu of requesting a direct rollover to the Roth IRA. According to the 401(k) summary plan documents, a direct rollover to the Roth IRA or the Roth 401(k) subaccount will be taxed, i.e. 20% of the distribution will be withheld, whereas, a direct rollover to the IRA will not have taxes withheld.
Before I proceed, I want to confirm this will not conflict with any IRS restrictions or limitations with: 1) the “backdoor” after-tax contributions ($7K) made in Q1 of this year to the same traditional IRA and then converted shortly thereafter to the Roth IRA, and 2) the upcoming “mega backdoor” after-tax contributions (~$32K), with minimal associated earnings, in Q2 and Q3 of this year, that I contributed to my 401(k) which I will be requesting a direct distribution to the Roth IRA early next month. I don’t want to do anything that may present problems with the “backdoor” and “mega backdoor” processes I’ve been doing the last several years.
Finally, my intent is to repeat all three, i.e. “Roth conversion”, “backdoor Roth IRA” and “mega backdoor Roth IRA, each year going forward if possible to maximize contributions to my Roth IRA.
Permalink Submitted by Alan - IRA critic on Wed, 2021-09-15 20:13
According to tax code Sec 3405(c)(2), direct rollovers are exempt from mandatory 20% withholding even when the rollover is to a Roth IRA. Plans do not deviate on withholding rules, so the summary plan description is likely incorrect. I would present this info to the plan and get their agreement, so you can do the direct rollover.
For your mega back door rollover, does the plan withhold on the small taxable earnings included?
If you were to roll the pre tax 401k to a TIRA and then convert it in the same year as your regular back door Roth conversion, your taxes would not increase in total, but the back door conversion and the conversion of the pre tax rollover will be taxed at the same % that reflects your IRA basis as a % of the total value converted.
A copy of Q 6 from Notice 2008-30 below explain the IRS withholding rule more directly.
“Q-6. What are the withholding requirements for an eligible rollover distribution that is rolled over to a Roth IRA?A-6. An eligible rollover distribution paid to an employee or the employee’s spouse is subject to 20% mandatory withholding under § 3405(c). Pursuant to § 3405(c)(2), an eligible rollover distribution that a distributee elects, under § 401(a)(31)(A), to have paid directly to an eligible retirement plan (including a Roth IRA) is not subject to mandatory withholding, even if the distribution is includible in gross income.”
Permalink Submitted by Bradley Bjerning on Thu, 2021-09-16 14:58
Thank you Alan for the additional information. I contacted via e-mail the plan administrator and they confirmed that there is no mandatory withholding of taxes for a direct rollover to a Roth IRA. The Summary Plan document states: “IRS rules enable you to make a direct rollover of all or part of the taxable portion of your withdrawal (excluding a hardship withdrawal) or an eligible distribution into a traditional IRA or another company’s qualified retirement plan that accepts direct rollovers.”, however it did not mention direct rollovers to a Roth IRA. in addition, the Plan has a Special Tax notice mentioned in the Summary Plan documents that states: “If you roll over a payment from the Plan to a Roth IRA, a special rule applies under which the amount of the payment rolled over (reduced by any after-tax amounts) will be taxed.” The statement “will be taxed” is confusing to me in that to me it implied that a 20% withholding will occur. Regarding your questions above, the Plan did not withhold taxable earnings ($16 in 2020, expected to be $5 in 2021) for the mega back door rollover. Finally, my IRA balance is $0 so there is no basis to consider if I were to roll the pre tax 401k to a TIRA and then convert it in the same year as my regular back door Roth conversion.