Pub 575

Submitted by charles lore on Fri, 2009-01-09 02:05

Allan,

In prior discussions about distributions from qrp and if pre tax is deemed to come out first ( putting pre 1987 aside) you pointed me to pub 575 as the reference but made a good point that this pub deals with pensions and annuities and as such may not completely relied upon ( my words) .

I am having this debate with an instuctor for a CHFC coarse who also says 575 is the authoritative source. When I pointed out to the caution that this pertains to pensions and annuities he retorted that 575 should be fully relied on since on the latset version on page 26 it says it refers to Qualified Employee Plans ( fisrt bullet)..then goes on to say pretax comes out first . It is very clear .

I’d like to get your comments

Thanks



Submitted by Alan Spross on Fri, 2009-01-09 04:52

Chuck,
On p 26 including the newly released 2008 edition, under “Rollover of Non Taxable Amounts”, it IS clear that the amounts of a distribution that are pre tax are the first ones rolled over.

What is not real clear is how the distribution is split in the first place, since Sec 72 says that there is a pro rata return of basis in a distribution. Therefore, the gray area to me is not what is first rolled over, but what the taxpayer gets out of the QRP regarding the pre tax and post tax split.

It’s all subject to what the QRP shows on their 1099R between pre tax and post tax.

This issue has been raised by the inquiry in how best to get the pre tax balance of a 401k into a TIRA with no after tax amount, and get the full after tax amount into a Roth IRA.

Also, note the chart on p 29 of Pub 575, and it’s reference to “Rollovers to Roth IRAs” also on p 29. The last paragraph says “Any amount rolled over to a Roth IRA (From QRP) is subject to the same rules for converting a TIRA into a Roth IRA”. And we know that this is pro rated on Form 8606.

That’s why I am not real clear on the efficacy of getting all the after tax amounts into a Roth IRA without converting the entire 401k into a Roth. What does the instructor say about that?



Submitted by charles lore on Fri, 2009-01-09 05:43

Allan I have let him know about all these excellent points and in particular page 29. I will let you know when he gets back to me. I am going to Heckerling next week where the focus is on retirement plans. My mission down there will be to get to the bottom of this question. I can assure you that I will let none of the experts get away without me drilling them on this issue.
Natalie included!



Submitted by Bruce Steiner on Fri, 2009-01-09 16:19

IRS Publications are generally pretty good, but they’re not “authoritative.” They’re quite far down the food chain in that regard. They’re well behind the Internal Revenue Code, court decisions (the higher the court, the more authoritative), the regulations, and Revenue Rulings.



Submitted by Martin Helmer on Fri, 2009-01-09 17:43

Under IRC section 72(d)(2) employee (after tax) contributions & income attributable to same may be treated as a separate contract.

Section 72(b) discusses the exclusion ratio in terms of ‘the contract.’ So it looks like some or all of our answer relates to this. The separate accounting of after tax amounts does more than merely give an employee credit for his after tax basis. It creates two contracts, each of which can have its own exclusion ratio.



Submitted by Alan Spross on Fri, 2009-01-09 22:47

Martin,
How common is it that a plan would maintain separate contract reporting in a format that would require separate distributions as well?



Submitted by Martin Helmer on Sat, 2009-01-10 00:38

Alan, I’m not seeing your exact meaning. I’ll venture an opinion on the easier of my two interpretations of your question. It’s likely most plans do make an accounting of participants’ after tax basis. And hopefully the attendant earnings are separately tracked too. There’s no need for an actual physically separate account; it’s just tracked on paper or electronically. I’ve had a few people tell me their plan did not keep such records, but let’s avoid that troubling wrinkle for now.

My understanding is that the mere act of accounting for the after tax basis and its earnings enables an option to use the separate contract treatment. I don’t see where it’s required to use separate contracts, if that’s what you’re asking.

But once distributions do begin using a separate contract approach, without completely distributing a contract, I would think this would oblige the plan to treat the partially distributed contract as separate in the future.



Submitted by Denise Appleby on Sat, 2009-01-10 10:05

[quote=”bsteiner”]IRS Publications are generally pretty good, but they’re not “authoritative.” They’re quite far down the food chain in that regard. They’re well behind the Internal Revenue Code, court decisions (the higher the court, the more authoritative), the regulations, and Revenue Rulings.[/quote]

True, and as much as I hate to say it, they often include errors which is why it is a good idea to never refer someone to any of them unless you have just read the section to which you refer and confirmed that it is accurate.
The plus is that the errors are usually corrected quickly when brought to the attention of the IRS.



Submitted by Denise Appleby on Sat, 2009-01-10 11:06

I really wish that we could still access the old message board. This was discussed ad nauseam there and include all the cites and simplified explanations and would definitely save some time on writing explanations and research.
For the basis recovery rule of pre-86 balances, we might want to look at IRC. § 72(e)( 8 ).
For the rollover treatment of a distribution when the distribution includes pre-tax and post tax amount, we want to look at JCWAA and § 402(c)( 2).
Under § 72(e)(8 ), if a participant has a balance of $100,000 that is made up of $20,000 pre-tax and $80,000 after tax, any distribution from the account will include 1/5 after-tax and 4/5 pre-tax.
For any amount of the distribution that is rolled over, the rollover will be treated as coming from the pre-tax amount first JCWAA and § 402(c)( 2).



Submitted by Alan Spross on Sat, 2009-01-10 19:48

Denise & Martin,

Attached is a copy of the applicable portion of 402(c)(2):

(B) such portion is transferred to an eligible retirement plan described in clause (i) or (ii) of paragraph (8)(B). In the case of a transfer described in subparagraph (A) or (B), the amount transferred shall be treated as consisting first of the portion of such distribution that is includible in gross income (determined without regard to paragraph (1)).

The issue I am concerned with is this:
Assume a plan holds 20,000 in post tax post 1986 basis and 80,000 or pre tax. If employee does a direct rollover to a TIRA of 80,000, it is all pre tax per the above paragraph. The 1099R includes -0- in Box 2a and should consider that the 20,000 that remains to be post tax. That post tax amount could then be distributed to the employee under a separate 1099R and rolled by the employee to a Roth IRA as a conversion.

But what if the employee requests a distribution with the intent to do an indirect rollover? Besides the witholding issue, the 80,000 should be pro rated as 64,000 pre tax and 16,000 post tax, and the 1099R forms should reflect that. If the employee replaces the withheld 16,000 and rolls 80,000 into a TIRA, you get a different result than with a direct rollover, because the plan still holds 20,000 which is a mix of post and pre tax.

The conclusion is that it is not possible to roll the pre tax to a TIRA and the post tax to a Roth IRA unless a direct rollover is first used for the TIRA portion. Then, either a direct or indirect rollover could be used for the post tax amount going to the Roth tax free. Therefore, this must be done in the specified order or some after tax amount ends up in the TIRA and/or pre tax ends up in the Roth, and there will be a tax liability.

In addition, if there are separate contract issues for certain plans, because of the way they account for after tax contributions, and if this results in deviations to the order of distributions, there would appear to be even more complications. That was the essence of my question for Martin, ie how would these separate contracts effect rollover distributions after retirement and the handling of any basis?



Submitted by charles lore on Sat, 2009-01-10 21:01

Alan…Can you just summarize why from your position an Indirect rollover is subject to pro-rata while a Direct roll over is pre tax first . What is the reason for the distinction?[/i]



Submitted by Denise Appleby on Sun, 2009-01-11 20:14

[quote=”[email protected]“]Denise & Martin,

Attached is a copy of the applicable portion of 402(c)(2):

(B) such portion is transferred to an eligible retirement plan described in clause (i) or (ii) of paragraph (8)(B). In the case of a transfer described in subparagraph (A) or (B), the amount transferred shall be treated as consisting first of the portion of such distribution that is includible in gross income (determined without regard to paragraph (1)).

The issue I am concerned with is this:
Assume a plan holds 20,000 in post tax post 1986 basis and 80,000 or pre tax. If employee does a direct rollover to a TIRA of 80,000, it is all pre tax per the above paragraph. The 1099R includes -0- in Box 2a and should consider that the 20,000 that remains to be post tax. That post tax amount could then be distributed to the employee under a separate 1099R and rolled by the employee to a Roth IRA as a conversion.

[color=red][b]But what if the employee requests a distribution with the intent to do an indirect rollover? Besides the witholding issue, the 80,000 should be pro rated as 64,000 pre tax and 16,000 post tax, and the 1099R forms should reflect that. If the employee replaces the withheld 16,000 and rolls 80,000 into a TIRA, you get a different result than with a direct rollover, because the plan still holds 20,000 which is a mix of post and pre tax.

The conclusion is that it is not possible to roll the pre tax to a TIRA and the post tax to a Roth IRA unless a direct rollover is first used for the TIRA portion. Then, either a direct or indirect rollover could be used for the post tax amount going to the Roth tax free. Therefore, this must be done in the specified order or some after tax amount ends up in the TIRA and/or pre tax ends up in the Roth, and there will be a tax liability.[/b][/color]

In addition, if there are separate contract issues for certain plans, because of the way they account for after tax contributions, and if this results in deviations to the order of distributions, there would appear to be even more complications. That was the essence of my question for Martin, ie how would these separate contracts effect rollover distributions after retirement and the handling of any basis?[/quote]

Responding to the [b][color=red]bolded red[/color] [/b]section…I think it is possible and you do get the same result $1 for $1. Your example may appear to produce a different result, because you are now doing a partial withdrawal. Using your example: If the employee withdraws $80,000, which includes $16,000 post-tax, you would get a comparable result to the $100,000 withdrawal only if the employee rolls over $64,000 to the TIRA. This would be entirely pre-tax. Instead of rolling the $16,000 ‘make-up’ to the TIRA, the employee would roll it to the Roth as a conversion, resulting in the tax-free conversion.
Compare this with the $100,000 example. If the plan had paid the amount to the participant, instead of processing it as a direct rollover, the participant would rollover the $80,000 to the TIRA, and the $20,000 could be made-up out of pocket and rolled/converted to the RIRA.

[quote][b]In addition, if there are separate contract issues for certain plans, because of the way they account for after tax contributions, and if this results in deviations to the order of distributions, there would appear to be even more complications. That was the essence of my question for Martin, ie how would these separate contracts effect rollover distributions after retirement and the handling of any basis?[/b][/quote]

From what I recall, the separate accounting merely means keeping track of [i]what is what[/i]- on paper as Martin said earlier. Annuity rules are a little different, which is where this separate contract may be coming from. But since we are talking about non-annuitized distributions from a DC plan, it should be OK to look at all of the participant’s assets under the plan as one account, for which the plan accounts separately for after-tax amounts. It does not matter if the assets are maintained under separate account numbers [i]or not[/i]. I would need to look at the regs for this to see it there is anything different from what I recall…



Submitted by Alan Spross on Tue, 2009-01-13 01:02

Thanks, Denise.
That makes sense. Employee can get to the same net result, although it would take a series of distributions and timed rollovers to get there.



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