401(k) after-tax rollover to
All,
I am having extreme difficulty in obtaining an answer to the following:
Does a 401(k) participant have the ability to faciliate a direct rollover of after-tax dollars only to a Roth IRA?
What about a indirect rollover?
Can the participant request only the basis to be distributed? In effect, this would be a tax-free conversion to a Roth IRA
Does the pro-rata rule apply if there are other IRAs involved?
What happens if the distribution include pre tax dollars? Can the participant request separate checks representing basis and pre-tax values? Roll the basis into the roth and pre-tax amounts into a traditional IRA?
Would the pro-rata rule come into play?
Thank you in advance
Brian
Permalink Submitted by Alan Spross on Mon, 2012-02-27 22:37
The possibilities differ based on whether this is a former participant who has separated from service or is still active. What is the status? An active employee is subject to the rules of the plan while a former participant is not for most purposes.
Permalink Submitted by Brian Dobbis on Tue, 2012-02-28 13:16
Good Question:
The scenario is as follows:
Active participant wants to take an in-service withdrawal (allowed by plan) of after-tax dollars only (not the earnings)
Can the participant cherry-pick his/her after-tax dolllars and roll directly to a roth IRA?
Does it matter if the pre 87 and post 86 accounts are not separately accounted for?
Thank you
Permalink Submitted by Alan Spross on Tue, 2012-02-28 18:17
Most plans that allow in service distribution of after tax contributions require that the earnings on those contribution also be distributed. If the employee requested only a partial distribution, it should be pro rated between the contributions and the earnings on those after tax contributions.
For a plan that accounts for pre 1987 after tax contributions separately, an exception applies. For that balance, the after tax contributions only can be distributed separately.
Either way, doing an indirect rollover of the total after tax amounts and the earnings on them would permit an employee to roll any pre tax amounts to a TIRA and the after tax amount to a Roth IRA tax free. Under 402(c)(2) of the tax code, employee would request a distribution of the entire eligible after tax balance and earnings (if required), then first roll the earnings to a TIRA replacing the 20% withholding as needed, and after a day or two roll the after tax amount to a Roth IRA. If the earnings are small, making up the 20% withheld amount to complete the rollovers should not be a problem.
Trying to do the above using direct rollovers from the plan instead of indirect rollovers is risky because 402(c)(2) specifies that the distribution be PAID TO the employee.
Permalink Submitted by Brian Dobbis on Tue, 2012-02-28 20:39
Allen, thank you for your prompt detailed response.
I would like to confirm that I follow you
Example (indirect rollover):
Participant has a total of $10,000 in after-tax dollars of which $1,000 consists of earnings
Indirect rollover requested: 20% withholding = $200. Total distribution amount= $9,800
1st transaction – deposit $9,000 into a Roth IRA
2nd transaction (different day) – deposit $1,000 (including $200 out of pocket) into a traditional IRA
Please confirm this method would faciliate a tax free transfer to a Roth IRA.
If the above account were all pre-87 dollars the pariticipant could cherry-pick the basis of $9,000 and roll directly to a Roth. Correct?
My confusion continues to arise with a direct rollover. Same situation above. What differs?
I appreciate your assistance
Permalink Submitted by Alan Spross on Tue, 2012-02-28 22:20
You have the rollover order backward. The first rollover should be the pre tax amount to the TIRA, in this case 1,000 to the TIRA. Then a day or so later roll the 9,000 after tax amount to your Roth IRA, making up the $200 withholding to do that. It is vital because Sec 402(c)(2) says that the first dollars rolled over are considered to be the taxable amount. By “taxable amount” it means the amount that you would be taxed on if you did not roll it over. Doing this would result in a tax free rollover in total, both to the TIRA and the Roth IRA.
If the after tax amount was all pre 87, you are correct that the 9,000 could be rolled to the Roth by itself without any earnings. But the company would have to have tracked this amount and it typically shows as a separate amount on your statement.
It would not matter if you had pre 87 after tax contributions if you did a direct rollover to a Roth IRA, because the tax code indicates that this can be done.
But if you have earnings or other pre tax amounts eligible for distribution, note that in my prior post I indicated that 402(c)(2) specifies that the section applies to distributions PAID TO the employee. With a direct rollover the distribution is not paid to the employee, rather to the employee’s IRA or other plan. And Notice 2009-68 indicates that such distributions are taxable in the same fashion as if they were rolled into a TIRA account which was your ONLY TIRA account and then converted to a Roth from there. That triggers pro rating under Form 8606 such that some of the after tax goes to the TIRA and some of the pre tax goes to the Roth. In your example, the 1,000 directly rolled to the TIRA would be $100 pre tax and $900 after tax. And the 9,000 rolled to the Roth would be $900 pre tax and 8,100 after tax. You would be taxed on the $900 pre tax portion of the Roth rollover.
Actually, taxpayers have been able to do direct rollovers the last two years since the IRS has not changed the 1099R reporting guidance to require plans to clearly report the taxable and after tax portions of each rollover. But this guidance could be issued anytime, and if done by around October it could show up on next January’s 1099R forms. So doing direct rollovers is risky.
Permalink Submitted by Brian Dobbis on Wed, 2012-02-29 15:51
Allan –
I appreciate your time in reponding to this topic.
Thank you,
Brian