Can You Put Non-Deductible Funds From a Qualified Plan into a Roth IRA?

By Joe Cicchinelli and Beverly DeVeny, IRA Technical Experts

This week’s Slott Report Mailbag looks at converting non-deductible funds to an IRA and the rules for taking a Roth distribution of contributed and converted funds. As always, we recommend you work with a competent, educated financial advisor to keep your retirement nest egg safe and secure. You can find one in your area here.

1. Can you take non-deductible funds from a qualified plan and put them in the Roth IRA? One practitioner told me she has been doing this for years.

Answer:

The IRS changed their position on this issue in 2009. Both pre-tax and after-tax qualified plan funds can be converted to a Roth IRA. However, generally, most distributions from company plans should be prorated to include a percentage of pre-tax and after-tax funds. So, you generally cannot just convert the after-tax funds tax-free to a Roth IRA when you’re doing a partial rollover. This issue is controversial so you should consult with a knowledgeable tax advisor.

2.

I am 53. I retired at 52. I am currently living off my non-retirement cash savings.  Can I do a Roth conversion on my traditional IRA and also take an equal distribution of the contributions to my Roth IRA in the same tax year, essentially bypassing the early withdrawal penalty on my traditional IRA?  My Roth IRA has been opened for over 5 years and has more than enough contributions to support the withdrawal.

Rick Hollinger

Poway, California

Answer:

Any Roth IRA annual contribution funds can be withdrawn at any time without tax or the 10% penalty. However, conversion funds are subject to a 10% penalty if they are withdrawn before you turn age 59 ½ if the withdrawal is within 5 years from when you converted. Each conversion done in a different year has its own 5 year clock.

3.

My employer is closing out our ESOP plan and transferring to a 401(k). I have elected to receive company stock this year under the NUA provision, planning to sell the stock over the next two years. Will the plan report to me this year the value of the original basis of the stock (30k) or the current market value (80k)?  If the latter, how is this treated on my tax return?

Answer:

The plan is required to give you the fair market value of the stock when you take a distribution, as well as the cost basis. Both those amounts will also be reported to the IRS on Form 1099-R that you’ll receive in January after the year of the distribution. If you don’t roll over the company stock to an IRA, you’ll be taxed on the cost basis only of the company stock and the NUA will be taxed as long term capital gain when you eventually sell the stock. Also, the 10% early distribution penalty will apply to the cost basis of the stock if you are under age 59 ½, unless an exception to the penalty applies.

However, the first question for you to resolve is if you can do NUA in the first place. In order to qualify you must empty all like plans within one tax year. Generally a 401(k) is a like plan to an ESOP and you would have to empty both plans in order to use NUA.