non deductible 401k to Roth
I have a client who has a 401k funded with both [color=blue][b]pre-tax [/b][/color]and [color=blue][b]non-pre-tax[/b][/color] dollars. ➡ Is there a way to get the non-pre-tax money into a Roth IRA?
For example:
He could withdraw the pre-tax money and transfer it to an IRA. That leaves only non-pre-tax money in the 401k.
Then do a direct transfer from 401k to Roth IRA with the non-pre-tax money left over. Since it is a direct transfer (not in an IRA) he could do the transfer and not have to pro-rate the conversion with the pre-tax IRA funds. Since the direct transfer is being done with non-pre-tax money, there would be little or no tax due at conversion to the Roth.
Can this work? A lot of people are saying no–it has to be pro-rated. But I don’t think they are familiar with the 2008 rule that allow for transfers from 401k to Roth IRA.
Permalink Submitted by Alan Spross on Wed, 2008-04-09 05:15
There are some technical issues yet to be cleared up by the IRS on the direct Roth transfer from an employer plan.
One of those questions is whether pre tax amounts can go to a TIRA and the after tax amounts to a Roth IRA simultaneously. The pro rata rules apply to distributions from these plans with the exception of pre 1987 after tax contributions. Those contributions, if separately accounted for by the plan could go to the Roth whenever the employee qualifies for distributions. The plan would also have to agree to do more than one transfer even if this were allowed. Thus far the IRS has not addressed this issue, and there will be considerable pressure for clarification. I am not inclined to speculate about it at this point.
However, your posted scenario would not work due to the pro rata rules for distributions, with the exception of the pre 1987 after tax contributions.
Permalink Submitted by Kevin McDaniel on Wed, 2008-04-09 18:25
Thanks for your response. I couldn’t help but notice the word simultaneous. What if the transfers are [u]not[/u] simultaneous?
What if we carve out the pre-tax contributions and leave the transfer to the Roth IRA for later (possible the next tax year if that were necessary)?
It seems that if what we have left in the 401k are the non-pre-tax monies (plus earnings) then a direct transfer to Roth IRA would get the job done with the tax payable on the earnings of the non-pre-tax dollars.
Permalink Submitted by Alan Spross on Thu, 2008-04-10 02:42
Reference to simultaneous distribution could result in the pre tax and post tax amounts going to separate IRAs if the IRS rules in favor of this. But there is no way to “carve out” pre tax from post tax in a single distribution because of the pro rata rules that apply to the balance in the plan for each distribution. The exception, as noted above is for pre 1987 after tax contributions which CAN come out separately.
I hope the IRS will clarify this soon. They did issue one bulletin on the Roth transfer, but it did not deal with this critical issue.
Permalink Submitted by mike beaulieu on Mon, 2008-04-28 14:00
Alan, thx for info. While reading Notice 2008-30 in regards to direct rollovers from 401k to ROTH, it mentions, “only the amount that would otherwise have been taxed if directly recieved will be taxed”. with that said, i would presume that POST tax dollars directly rolled to ROTH from 401k would be permitted without be subject pro-rata taxation if the plan admin of 401k was tracking those post tax dollars separately. please reply
Permalink Submitted by Alan Spross on Mon, 2008-04-28 17:39
I do not see Notice 2008-30 as adequate in addressing the question whether a distribution from a pre tax retirement account containing both post and pre tax amounts can be split into two receiving accounts. All it says is that the taxation would be identical to a distribution without a rollover.
If so, only the pre 1987 after tax contributions can be separately distributed. All other post and pre tax amounts in the plan cannot be separately accounted for and must be distributed using pro rated amounts. Only the pre tax amounts would be taxable. The Q&A you cited only contemplates the entire distribution being rolled into a Roth IRA, but part of it to a Roth and the rest to a TIRA or taxable account. That’s why it is not clear to me, and I think the IRS has additional issues that need to be addressed.
When I mentioned previously a simultaneous transfer of portions to both a TIRA and Roth, even if a ruling allowed that transfer to be segmented by post or pre tax status, a plan does not have to offer more than one transfer, and many are likely not to even offer this approach.
Permalink Submitted by Kevin McDaniel on Mon, 2008-04-28 17:54
I received some information that the account can be transferred into an IRA. He can then transfer the deductible portions (only) to a 401k, since non-deductible portions are not eligible to transfer to a 401k. Having separated the two, we now have non-deductible in the IRA, and deductible in a 401k. The IRA can now be converted to a Roth IRA.
Permalink Submitted by Alan Spross on Mon, 2008-04-28 18:10
Yes, but that’s an altogether different solution that involves converting an IRA rather than making a direct transfer from an employer plan into the Roth. There are also many plan administrators that will not accept an incoming IRA rollover, particularly from an IRA account that contain after tax or non deductible contributions for fear of the requirement you cited that they cannot accept any after tax contributions into their plan without incurring compliance problems.
This DOES present a potential solution to the problem if all the pieces fall into place, but still does not answer to question about how the direct plan to Roth IRA conversion can be handled to achieve the same end result in a much more direct and simple process.