Slott Report Mailbag: Does the 2013 Tax Law Authorize Rollover of After-Tax 401(k) to a Roth IRA?

This week’s Slott Report Mailbag (a special Monday edition) includes questions on the new tax law and two popular topics – required minimum distribution (RMD) rules for a beneficiary and Roth IRA contribution rules. As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.

1.

Does the new tax law authorize the rollover of after tax 401(k) accounts to a Roth IRA? If it does, do you have to pay tax on the earnings in the account at the time of transfer to the Roth?

John Persa

Answer:
The rollover of after-tax 401(k) money to a Roth IRA has been available for several years. When rolling over (converting) after-tax 401(k) funds to a Roth IRA, only the principal part of the after-tax money is tax-free, the earnings in the account would be taxable. A word of caution, though. The IRS position on rollovers from employer plans is that they are treated pro-rata for tax purposes. Therefore, generally your rollover to a Roth IRA will not be income tax free.

2.

Mr. Slott,

I understand that IF I were to take my contributions out of my Roth IRA to pay for college expenses, I can do so at any time without tax or penalty. Is that also true if my Roth IRA is in an annuity? I am 40 years old and my IRA is 5 years old in a 5-year surrender annuity.

Juanita McKenna

Answer:
You can withdraw your Roth IRA contributions anytime without federal income tax or an IRS penalty for any reason. This rule applies to all Roth IRAs, including those invested in annuities. However, the insurance company can have a surrender charge for withdrawing the funds too soon, based on the terms of your Roth IRA annuity contract.

3.

My friend was ill in 2012 and failed to take her RMD from her IRA before the end of the year. She has since passed away and did not take the RMD in 2013. It is my understanding that the beneficiaries must take the 2013 RMD, but what happens to the 2012 RMD that was not taken?

Cindy Orlovsky

Answer:
Any RMDs due to the deceased account owner must be taken by the beneficiary(ies) of the IRA. Because she was alive in 2012 and failed to take her RMD, she is subject to a 50% penalty for not taking her RMD. The executor of her estate should file IRS Form 5329 with her 2012 tax return and ask that the 50% penalty be waived because she was ill last year. The beneficiaries should take the 2012 RMD as soon as possible and take the 2013 RMD by the end of the year. Both RMDs will be included in the beneficiary’s 2013 income.