roll pre-tax IRA into 401k then Roth conv on post-tax?
Hi,
If you have a pre-tax Traditional IRA (let’s say $100k), can you roll that into your 401k (assuming plan allows), and then make a non-deductible Traditional IRA contribution and immediately convert to roth in the same tax year (while keeping the full basis of the non-deductible IRA and therefore not paying any tax)? Any issues?
Also, does the order matter? In other words, can you make the non-deductible IRA contribution now, then roll the pre-tax IRA into the qualified plan (401k), then do roth conversion of non-deductible IRA, keeping the full basis of the non-deductible IRA?
I’m wondering if you would need to roll the assets into the 401k and then wait until the next tax year to do this optimally.
Thanks for any advice!
Permalink Submitted by Alan Spross on Fri, 2010-04-09 18:45
Yes, you can make non deductible TIRA contributions and then immediately convert them to a Roth IRA tax free if you have no other TIRA, SEP or SIMPLE IRA accounts. You must report the non deductible contributions on Form 8606 and you also use the same 8606 to report your conversion.
You can also roll over pre tax IRA dollars to your current employer plan IF the plan will accept such rollovers. Some plans may accept rollover IRA accounts but not accounts that you contributed to. But any amount the employer will accept will reduce the taxable portion of any conversion you do for that year regardless of the order in which you do them. But it is better to do the rollover to the employer plan first, so you will have a better idea of how much to convert based on the amount of the conversion that will be taxable. You do not have to wait until the next year to do the conversion.
Right now you could make a non deductible TIRA contribution for both 2009 and 2010. You would report the 2009 contribution on Form 8606 with your 2009 return. Then for your 2010 return you would report your 2010 non deductible contribution and also your conversion in 2010. If there is very little or no taxable amount for your conversion, you would probably opt out of the two year deferral of the conversion income for simplicity. No point in splitting a very small amount over two years, when the tax rate may actually be higher in 2011 and 2012 than it is now.
You can make your regular contributions any time you are eligible. After that the best order is:
1) Discuss with HR or plan administrator if your current plan will accept IRA rollovers including contributary IRAs.
2) If so, complete the direct rollover for the full pre tax balance in your TIRAs or as much as the plan will accept. Remember to add the basis for recent non deductible contributions so you know your exact amount of basis.
3) After this is done, convert ASAP to prevent earnings or losses from accumulating. If you have earnings, they will be taxable upon conversion. If you have losses, you may qualify for a small itemized deduction, but it will probably be erased by the 2% of AGI limit.
Permalink Submitted by David Briegs on Sat, 2010-04-10 16:09
Thanks! Can I ask you to clarify to be sure I understand correctly?
Can I make the 2009 and 2010 non-deductible IRA contributions BEFORE rolling my pre-tax rollover conduit IRA into my current employers 401k plan? And THEN do roth conversion of TIRA to Roth without any tax (assuming no earnings) once the rollover to the 401k is complete? Or does the TIRA rollover to the 401k need to be completed BEFORE making the non-deductible IRA contributions to have the Roth conversion be tax-free?
Thanks again. Just want to be certain I understand what you are saying.
Permalink Submitted by Alan Spross on Sun, 2010-04-11 00:20
You can make the 2009 and 2010 regular non deductible contributions before OR after the rollover of the pre tax amount to the employer plan. You just need to be sure you know the exact total basis in your IRA when you roll over the rest of the IRA balance so that you roll over the correct amount. Neither you NOR the plan wants to roll any basis over to the plan in error.
After the pre tax amount is rolled over to the employer plan, then do your Roth conversion. It will still be OK if you do the conversion first, but if the plan does not take your entire pre tax balance, then you will run into unexpected taxes on your conversion and probably have to recharacterize part of it. The reason to do the rollover to the plan before the conversion is due to the fact that the IRA rollover to the plan is the tough and most unpredictable part of this strategy, so it works better to get that out of the way before the conversion.
Permalink Submitted by Alanna Crawford on Thu, 2010-04-15 20:09
A follow-up question on an issue similar to this:
If the individual rolls their pre-tax assets into a 401(k) and then makes a non-deductible traditional IRA contribution and then immediately converts those assets to a Roth IRA, can they turn around and roll-out the assets from the 401(k) back into a traditional IRA without having to deal with the pro-rata issue for the conversion?
For Example, on January 1, 2010, John Doe rolls all of his pre-tax IRA assets into his 401(k) plan. On February 1, 2010 John makes a 2010 non-deductible IRA contribution (the only assets in all/any of his traditional IRA). On February 2, 2010 John converts that amount to a Roth IRA. Then, in July he changes jobs and wants to roll his 401(k) assets into his traditional IRA.
Would those pre-tax assets affect the taxation of the conversion? It seems like it shouldn’t, but when you look at Form 8606, it only asks about the year-end balance and does not take into account what the balance was when the conversion was made.
Permalink Submitted by David Briegs on Thu, 2010-04-15 20:23
This one I know. It DOES affect the taxation of the conversion. The year-end balance in the IRAs is what determines the IRA basis %. The rollover of the 401k would need to be delayed to 2011. Of course, you wouldn’t want to even do that if you plan on doing contributions/conversions every year.
Regards,
Dave
Permalink Submitted by Alanna Crawford on Thu, 2010-04-15 20:32
Thanks for the quick reply!!
Permalink Submitted by Anonymous (not verified) on Fri, 2010-04-16 20:29
This is a great discussion. Thanks! A question or two: I have had one ‘IRA specialist’ at a large mutual fund company tell me that I cannot rollover just my pretax money in my traditional IRA to my 401k and leave my aftertax basis behind because when I attempt to rollover just the pretax, it will come out pro-rata. This thread certainly contradicts that but is there something in the IRS code or ERISA documenting that I can separate the money and do this so I can have it for future reference? Thanks again!
Permalink Submitted by Alan Spross on Fri, 2010-04-16 22:31
There is a potential conflict further explained below in a copy of a portion of an article by Kaye Thomas. However, the conventional wisdom and practice so far unquestioned by the IRS allows the pre tax IRA amounts to transfer to an accepting employer plan after which the remaining basis in the IRA can be converted tax free. Perhaps that specialist should not be saying that you “cannot” do this, rather it would be more accurate to say that some potential problems may exist that so far have not surfaced in any fashion:
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Strategy 4: isolating basis in an IRA
Our fourth strategy is actually a way to isolate basis when converting an IRA rather than a 401k account. The method can be used for a 401k account, however, if you first roll that account to an IRA. It isn’t available to everyone, but if you’re lucky enough to have this opportunity you can use it to convert your after-tax dollars without paying tax on the pre-tax dollars – and without the withholding problem we encountered with strategy 3.
Prior to 2002 the rules for rollovers between employer plans and IRAs were different. If you were rolling from an employer plan to an IRA, you could roll only the pre-tax dollars. Assuming you rolled the pre-tax dollars to an IRA, you would receive the after-tax dollars without paying any tax, but these dollars would no longer be held in a retirement plan. Going in the other direction, an employer plan was permitted to accept a rollover from an IRA provided that the IRA consisted only of money received as a result of a rollover from an employer plan, plus any earnings on the rollover money. Note that an employer plan accepting a rollover from an IRA would be accepting only pre-tax money, because it could accept money only from a rollover IRA, and a rollover IRA could not contain any after-tax money.
A law passed in 2001 changed the rollover rules, effective in 2002. A rollover from an employer plan to an IRA can now include after-tax dollars. What’s more, employer plans are now permitted to accept rollovers from IRAs without the previous restriction that they contain only money received in a rollover from an employer plan. However, only pre-tax money can be rolled from the IRA to an employer plan.
If you can roll all the pre-tax money from an IRA to an employer plan, it seems reasonably clear that you are left with only after-tax money, which can be rolled to a Roth IRA without reporting any taxable income. We have no guidance from the IRS on how it works, however, other than a cryptic statement on page 24 of Publication 590 saying that if you rolled money from an IRA to an employer plan you should “attach a statement explaining what you did” when you file your tax return. This is a problem because there appears to be a mismatch between what Congress intended with this rule and the language that appears in the law.
Suppose you have a $25,000 IRA that includes $5,000 of after-tax money. If Congress wants you to be able to move the $20,000 of pre-tax money to an employer plan, it seems logical that you should be able to withdraw $20,000 from your IRA, leaving $5,000 behind, and transfer that $20,000 to the employer plan. The Conference Committee Report accompanying the 2001 tax law indicates this is what was intended: “In the case of a distribution from a traditional IRA that is rolled over into an eligible rollover plan that is not an IRA, the distribution is attributed first to amounts other than after-tax contributions.” This is not what the actual law says, however. In section 408(d)(3)(A)(ii) it says, “the maximum amount which may be paid into such plan may not exceed the portion of the amount received which is [pre-tax money].” Congress didn’t change rule for determining what portion of the amount received is treated as pre-tax money, so if we apply this language literally, only 80% of the distribution from the IRA, or $16,000, is treated as pre-tax money that is eligible to be rolled to an employer plan.
It isn’t clear that the IRS will insist on this literal reading of the law. If you’ve already done something like this, I suspect there’s little chance the IRS will challenge the result. If you’re planning this transaction, however, it appears to be at least somewhat safer to operate within the literal language of the law as follows: (1) withdraw the entire $25,000 from the IRA, then (2) transfer $20,000 to the employer plan, and finally (3) after the transfer to the employer plan is completed, and within 60 days after the distribution from the IRA, roll the remaining $5,000 into a Roth IRA
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Permalink Submitted by Anonymous (not verified) on Sat, 2010-04-17 01:23
Thanks for your input. I am no expert in tax code by any measure but when I look at the paragraph you refer to
‘408(d)(3)(A)(ii) the entire amount received (including money and any other property) is
paid into an eligible retirement plan for the benefit of such individual not later than the
60th day after the date on which the payment or distribution is received, except that the
maximum amount which may be paid into such plan may not exceed the portion of the
amount received which is includible in gross income (determined without regard to this
paragraph).’
does this not imply that if you only withdrew the pretax portion, you can rollover the entire amount as long as it only includes funds which are ‘includable in gross income'(ie, pretax). Sounds like paragraph is addressing case where you have withdrawn both pretax and aftertax and then you obviously cannot rollover an amount that is greater than the ‘includable in gross income’ amount or you would be rolling over aftertax. Or maybe I am missing something here or trying to oversimplify it?? Thanks for your input.
Permalink Submitted by Alan Spross on Sat, 2010-04-17 02:47
The paragraph you cited represents the possibility of a problem in withdrawing ONLY pre tax amounts from the IRA. Since all IRA distributions are pro rated between basis and pre tax amounts, any amount withdrawn would contain a % of both basis and pre tax dollars. There is no question that the amount received and rolled over to the employer plan is made up of pre tax dollars first, but only up to the amount actually distributed. I don’t see this as a problem if you have only one IRA account, but if you have a rollover and a couple other contributary IRAs that the employer plan will NOT accept, you can’t distribute the entire amount of your IRAs for rollover. Example:
1) 8606 basis of 20,000
2) Rollover IRA of 100,000 (only IRA acceptable to the employer plan)
3) Contributary IRAs of 60,000.
You therefore distribute 100,000 for rollover, but the portion of that which is pre tax money is only 7/8 or 87,500. You then have also distributed 12,500 of basis which cannot be rolled over. Therefore your IRAs remaining for conversion are valued at 72,500 of which only 20,000 is basis.
If the plan will accept all your IRAs, it seems simple enough to distribute the entire amount and then 140,000 would be rolled to the QRP and 20,000 left to convert.
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But the position that is prevailing at this time ignores the above and assumes whatever amount you take out of your IRA and roll over is deemed to be pre tax. It allows 402(c)2 to override 408(d)(3)a(ii) and so far the IRS has allowed all of these rollovers to be handled in this manner.
There are simply two different code sections that can be interpreted in a manner in which they conflict. This is also true for those who wish to directly convert the after tax contributions in their QRP to a Roth while rolling the pre tax amount to a TIRA. That debate is still raging also and the American Benefits Council appealed to the IRS to clarify matter last October. No response so far, so everyone remains in limbo. The expectation is that it will be too much of a mess to require revised 1099R forms from employers for 2008 and 2009.
Here is the letter from the Benefits Council:
http://www.americanbenefitscouncil.org/documents/402f_notice_abc-cmnts_1…
Permalink Submitted by Anonymous (not verified) on Sat, 2010-04-17 14:57
Thanks again. I believe 401k plan will accept all pretax money regardless of source but I need to confirm. Sounds like I withdraw it all, deposit pretax in present 401k and rollover aftertax basis into Roth and I am good. Thanks.
Permalink Submitted by Alan Spross on Sat, 2010-04-17 19:17
Right. The excess contribution will be taxable along with any allocated earnings in the year distributed. The distribution is not eligible for rollover and you will get a 1099R for it. Other than being additional taxable income, it should not affect your rollover and conversion strategy.
Of course, you would not be rolling that old 401k over to an IRA anyway until after the conversion year is over. You could however transfer it directly to the new employer plan. But beefore any rollover is done it would be best to have the excess contribution distributed. Doing any rollover or transfer of funds that turn out to be excess contributions causes the hassle of dealing with the excess contribution to the account that accepted the rollover.
Permalink Submitted by Anonymous (not verified) on Sat, 2010-04-17 20:31
I was doing fine until the last paragraph. The funds I am referring to that will be distributed this year are from a Deferred Income Plan that is over and above the 401k Plan. This money is in a separate account from the IRA or any 401k account and I am receiving a partial distribution over the next 3-5 years of the account because I am no longer with that employer. My confusion is your reference to this as ‘excess contribution’. Last year I received a partial distribution from the fund and it was treated as ordinary income. I don’t think this money comes into play with what I am doing but just wanted to be sure this distribution did not comprimise or complicate what I want to do with the IRA and my present 401k employer fund. Thanks.
Permalink Submitted by Alan Spross on Sun, 2010-04-18 00:06
Ok, I mistakenly took your description to mean that it was a forced distribution due to an HCE test failure. Now it sounds like this plan may be a non qualified plan, perhaps a SERP which would simply be taxable income to you when distributed according to the plan requirements. It would have no effect on your other IRA and conversion strategy.
Permalink Submitted by Anonymous (not verified) on Sun, 2010-04-18 01:21
Great! I really appreciate your help. Just for information, it is interesting that I got a packet today from my present 401k holder and it addresses some of this same subject. This is a large Large company so I think I can assume they know what they are doing. 😆
But anyway, on the rollover form you must describe where the money you are rolling into the 401k is coming from. Interestingly, it says you can roll over an entire amount from an IRA that contains aftertax money as long as you have other pretax IRA’s out there that will cover the aftertax amount you are rolling in. Obviously they are not concerned with the pro rata aspect of the aggregate of your ira’s and are assuming only the pretax money comes out first when rolling over to their 401k (402(c)2 rules as you said!). I think I am interpreting this right, though I don’t claim to be any kind of expert yet. Again, you have been a great help. Thanks.
Permalink Submitted by Alan Spross on Sun, 2010-04-18 03:08
The reason they OK rolling over the entire amount of an IRA that includes non deductible contributions if there are other IRAs is because the non deductible contributions do not attach to any particular IRA account including the one to which that contribution was made. It may simplify the rollover process if you partition your TIRA accounts into two accounts. One contains the basis from Form 8606 and the other IRA holds the pre tax remainder. That way only one account needs to be rolled over and it can be rolled in total.