After-tax money in IRA and rolling INTO a 401k and then Roth Conversion?
I believe this strategy works, but please let me know your input:
someone has after-tax and pretax dollars in an IRA. However they are also active in a 401k. The pro-rata rules apply to any roth conversion / distribution from the IRA, but its my understanding that they could roll their IRA back into their 401k. However the after-tax portion is not eligible to be rolled back into the 401k, thus that provides a mechanism for separating the pre-tax and after-tax funds.
then assuming they have no other IRA accounts and now all money in that IRA is after-tax money, they could do a roth conversion on that IRA with zero tax liability correct? After that, they could roll the pre-tax portion of their funds back out of the 401k and into the IRA.
Assuming this is all fine are there any time frames to be observed? ie spread it over 2 tax years, money has to stay in the 401k for 1 year to avoid pro-rata treatment or it doesn’t matter?
thanks.
Permalink Submitted by David Mertz on Sat, 2023-11-04 13:07
All correct provided that the distribution from the 401(k) to roll the funds back to the traditional IRA happens after the end of the year that the Roth conversion is done. If this distribution from the 401(k) is made before the end of the year in which the Roth conversion is done, the resulting nonzero year-end balance in traditional IRAs (even if the rollover of this distribution is not completed until after year-end) would have to be included on line 6 of Form 8606, resulting a pro-rata calculation of the taxable amount of the Roth conversion.
Permalink Submitted by Alan - IRA critic on Sat, 2023-11-04 15:56
DMx – With respect to the definition of “outstanding rollover”, the 8606 Instructions are clear that an IRA to 401k rollover not in either account at year end is not added to line 6. For the reverse transaction (401k to IRA), the 8606 Inst are less than clear, but Worksheet 1-1 in Pub 590 B contains a note stating that an outstanding rollover applies to TIRA distributions so a case could be made that a 401k to IRA rollover should not be included on line 6 as it is not treated as an outstanding rollover for these purposes. ??
Permalink Submitted by William Tuttle on Sat, 2023-11-04 17:35
A reasonable question is, why would someone want to roll the pre-tax balance from the 401k back into IRA in the first place. Unless the 401k expense ratios and/or administrative fees are materially greater that the IRA. The assets may be best left in the 401k.
Permalink Submitted by David Mertz on Sat, 2023-11-04 22:25
Good point with regard to an outstanding rollover. After reviewing IRS Notice 1987-16, I agree that an outstanding rollover can only occur on an IRA-to-IRA rollover, not in a 401(k) to the IRA rollover, so it’s only necessary to make sure that the actual year-end balance in traditional IRAs is zero (and there are no outstanding IRA-to-IRA rollovers) for the year of the conversion.
Permalink Submitted by Alan - IRA critic on Sun, 2023-11-05 01:55
Thanks for the confirmation, although I was only able to access the first portion of Notice 87-16 which dealt with active participation. I think the portion you are referring to is Part III, relating to distributions, but I was not able to access that portion of the Notice.