Direct Rollover for 401k- Question for Alan Oranis

Hi Alan,

My question is as follows:

For a client doing a direct rollover of a 401k plan on a trustee to trustee basis, assume the paperwork was completed correctly in order for the rollover to be made directly from one institution to the other.

However, the employer who is terminating its Plan had checks sent to the Plan participants. The check for our client read the custodian’s name “FBO XXXXXX YYYYYYY”, so it wasn’t made out just to the client’s name. No tax withholding was made either.

Should we assume that, although we requested a direct rollover on a trustee to trustee basis, because the check was made out as stated above, that there will be no tax withholding if the client deposits the check within 60 days? If there is a potential problem, what can they do considering they provided the employer with the requisite information and the employer’s own tax notice says they can do a direct rollover on a trustee to trustee basis – – and now 2 months later, a check was sent. Thanks for your timely reply!



David,
This should not present a problem, although the two month processing time seems excessive. The format being used here is considered a direct rollover in all respects, and most employer plans prefer to mail the check to the employee for delivery to the IRA custodian. Having no withholding is further evidence that the plan considers this a direct rollover. The 1099R they will issue will be coded with a “G” for a direct rollover.



Question for Alan Oniras:

Hi Allan,

Thanks for your replies. A few follow-up questions on the Roth IRA Conversion:

1. Suppose an individual will be converting his Simple IRA into a Roth IRA. The individual’s MAGI is >$100,000.

a. Can this individual transfer the Simple IRA directly into a newly created Roth IRA? If not, must it first go into a Traditional IRA and then to the Roth Conversion IRA?

b. Must this individual wait until January 1, 2010 before converting this Simple IRA? If so, can paperwork be created now, in 2009, even though the assets are not actually transferred until 2010?

2. Must an individual with a 401k Plan or other qualified retirement plan take this into account when doing the conversion in computing the pro-rata basis for taxable/tax-free conversion income? I was under the impression it was only applicable to IRAs. So, for example, an individual with a few IRA’s totaling $50k and a 401k Plan of $50k would ignore the 401k Plan of $50k in computing the tax consequences of the conversion (whether the individual is still an active employee or not). Please confirm.

3. For an individual with an existing Roth IRA, how should they title the newly created Roth Conversion IRA? Is it preferrable to call it something else to differentiate it from the pre-existing Roth IRA?

I appreciate your assistance. Thank you.

David



1) The SImple IRA can be converted directly to a Roth IRA, but with MAGI over 100,000 the conversion will have to wait until 2010. The paperwork can be prepared now, but I would be wary about someone making an error and processing it before year end. Unless there is a way to make it crystal clear not to distribute the funds until January, I would hold up the paperwork.

2. That is correct. The balance in the 401k is totally separate from IRA balances in determining the pro rate rules for after tax and pre tax amounts. IRAs are aggregated with each other, but each 401k plan is kept separate from all other plans no matter what they are.

3. I would try to have it titled “Roth Conversion” if the conversion came from a non rollover IRA, and have it titled “Rollover Roth Conversion” if it came from a qualified plan directly or from a Rollover IRA that had it’s source from a qualified plan. This is mainly for creditor protection purposes, and may not matter if your state fully protects IRA accounts. Some custodians may limit flexibility in the titling of accounts.



Hi Alan,

Thanks for the reply.

With respect to your last answer (#3), suppose a Roth IRA Conversion is being made from both non-rollover and rollover IRAs. In this instance, how should the Roth Conversion be titled? Alternatively, would you create 2 Roth Conversion IRAs – one titled Roth Conversion (the non-Rollover IRA) and the other titled Rollover Roth Conversion (the Rollover IRA)?

In general, however, I assume the name is not that critical as long as one can document/substantiate what monies are included in the Roth Conversion Account (the source of the funds).

Appreciate your assistance.

David



Yes, this issue reflects the 2005 federal bankruptcy Act that protects IRAs in states that do not protect IRAs on their own. This law has not been effectively tested in many areas, and it is unknown what flexibility will exist in reconstructing the source of commingled IRA funds. It is possible that a commingled account will have part fall within the unlimited protection limit and the part arising from regular contributions will fall within the 1,000,000 overall creditor protection limit. Since we do not know for sure it is best not to commingle larger accounts if there is a decent chance that the IRA owner will ever exceed the 1,000,000 limit. That limit will also adjust for inflation over the years.

If owners relocate from a state that accords full protection to one that does not, this issue becomes critical. CA for example only provides protection to the extent of basic living needs of the IRA owner, so the protection limit there is subjective to legal argument.

IRA custodians also have different titling guidelines and have generally been sloppy in determining the proper title on combined accounts. They do not think in terms of creditor protection at all.



Hi Alan,

Thanks so much for the reply once again.

One last thing I can think of for now. If an IRA owner is married, must he file as married filing jointly in order to do the Roth IRA conversion? Or is the taxfiling status irrelevant for a married individual.

Separately, assume an individual is converting in January, 2010 and will be getting married later in 2010 (e.g. June). When this individual files his 2010 return in 2011 he will be married. Is the answer to the previous question the same as with this question?

Thank you.

David



No conversion is allowed this year for married filing separate, but starting in 2010, marital filing status makes no difference. But just for general info, the filing status options are determined based on the marital status as of the last day of the tax year.



Hi Alan,

Thanks for the response.

If an individual will be converting a Simple IRA into a Roth IRA, since the Simple IRA is not part of a qualified plan (like a 401k), is it not necessary to segregate these monies from a Traditional (Non-Deductible) IRA also being converted into a Roth IRA.

I agree with your assessment of creating different Roth accounts for both non-rollover and rollover IRA conversions. In the case of the above, can the Simple IRA be commingled with the Non-Deductible IRA since they are both non-qualified plans – or would you segregate them as well?

Thank you.

David



For bankruptcy Act IRA protection purposes, a SIMPLE or SEP IRA are not subject to the 1,000,000 limit and therefore in order to preserve the unlimited protection for the SIMPLE IRA, it should be converted to a separate Roth IRA and not combined with a Roth account holding traditional IRA assets that were not rollover IRA assets.

There is no difference for tax purposes, but if the unlimited bankruptcy provision is important, then keep the SIMPLE and the SIMPLE conversion separate from other Roth accounts.



Hi Alan,

Thanks for the previous reply.

With respect to the conversion of a Simple IRA – assume this individual does a 100% conversion [it really shouldn’t matter for purposes of this question if it’s a partial conversion either, but we’ll assume it’s a 100% conversion anyway] from a Simple IRA (maintained in individual mutual funds at a mutual fund company) to a Roth IRA (maintained in a wrap program sponsored by an RIA). Assume the Simple IRA has a $0 balance on January 15, 2010 (date of conversion when assets are transferred out) and then maxes out contributions into the Simple IRA for 2009 and 2010.

In 2010, the individual wishes to do a recharacterization of the Roth IRA funded by the Simple IRA back to the Simple IRA. Is there any issue because the Simple IRA now has contributions plus earnings/losses for 2009 and 2010? Would the fund family be expected to account for the $ type in the Simple IRA as employee salary deferrals, employer matching contributions, rollover contributions (in this case a re-rollover back from the converted Roth IRA), etc? I assume a second Simple IRA would not be necessary to contain the reconverted amounts.

2.



No special issues. It is somewhat surprising that the recharacterization back to the same SIMPLE or a different SIMPLE IRA is allowed given the portability restrictions on transfers into a SIMPLE IRA, but this can be done (p 30 Pub 590). From an accounting standpoint the converted amounts are treated no differently than they were prior to the conversion, ie. as if they had never been converted. Since the amount actually moving back to the SIMPLE IRA will be different than the converted amount as expected, there will be an earnings gain or loss reflected in any overall summary statement issued by the fund company. The amount of deferrals and matching still held in the SIMPLE would have to be restored to provide an accurate statement, but none of this has any bearing relative to taxes or current deferral limits.



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