September 2013

Can't Directly or Indirectly Rollover a Roth IRA to a 401(k) Plan.

401(k) participants sometimes wonder if they can and should move their Roth IRA funds into their 401(k) plan. Current tax law does not authorize a person to move their Roth IRA funds into their employer’s 401(k) even if the 401(k) plan authorizes Designated Roth contributions. The 401(k) plan does not authorize such a rollover because current law does not authorize this movement as being nontaxable.

Maybe the law will permit this someday, but not at the present time.

There will be a tax mess both for the 401(k) plan and the individual if such a rollover is made. Most likely the IRS would NOT allow the Roth IRA funds to be returned to the Roth IRA if the 60-day period to complete a rollover has expired. The person might try to argue that he or she received poor advice from an advisor, but there is going to come a time when the IRS will not so readily accept this argument. The IRS will make the argument – you withdrew the funds from your Roth IRA and you did not complete a timely rollover; your funds are no longer entitled to be returned to the Roth IRA. Such a distribution may or may not have any current income tax consequences. What is known, such funds will not earn tax-free income as would have been the case had they stayed in the Roth IRA.

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QCD Season and RMDs

Soon it will be August and soon it will be the RMD season. That is, it is the time many of your 70½ and older IRA accountholders are paid their RMD for 2013. Many times the RMD is moved by a pre-authorized transfer from their IRA to a savings or checking account. Or, a check is mailed.

Some of your 70½ IRA accountholders (and also inheriting beneficiaries) may want to make a QCD if they only knew and understood the applicable tax laws.

QCDs are authorized for 2013 as long as made by December 31, 2013. QCDs will apply to 2014 only if there is tax legislation enacted extending such rules to 2014/2015 and possibly subsequent years. Another extension of this law is not a sure thing. If the idea is to collect more tax revenues one does not want to extend the QCD rules.

Your local charities and other non-profits benefit when qualifying individuals make QCDs. The individual benefits also. A QCD is a tax-free distribution and it also counts as an RMD. Qualifying IRA accountholders are those age 70½ and older, including inheriting IRA beneficiaries age 70½ and older.

Your institution can benefit also. Earn some goodwill by informing your qualifying IRA accountholders that your institution is willing to help them make their QCDs.

CWF has a brochure explaining the QCD rules and benefits and also an administrative form which acts much like a transfer form. Remember that one of the critical rules is that the check must name the charity as the payee. There is no requirement by an IRA custodian to use the QCD administrative form. One uses the form for good administrative practices. The administrative form may be sent to the charity. Your institution may decide whether or not you would require the charity to sign it. The charity’s signature is not required.

To order brochures or forms go to: www.pension-specialists.com/orderforms/QCD order form.pdf

Moving Non-deductible Funds from a 401(k) Plan Into a Roth IRA.

This article discusses moving basis within a 401(k) plan or a profit sharing plan into a Roth IRA.

A customer wanting to make a direct rollover or rollover contribution of pension funds containing basis should always be advised to consult with his or her tax advisor as this is complicated tax subject. One reason is – the IRS has not been willing to give definitive written guidance.

Discussion of a hypothetical situation is helpful. Let’s assume Jane Doe has a 401(k) balance of $50,000, it is comprised of two portions – $40,000 (deductible/taxable contributions and earnings) is taxable and $10,000 is nontaxable (i.e. basis).

Is it possible for Jane to directly rollover the $40,000 of taxable money in the 401(k) plan to a traditional IRA and then directly rollover (i.e. convert) the $10,000 of basis into a Roth IRA?

No. When there is a direct rollover or direct rollovers the pro-rata taxation rule will not allow only the basis to go into the Roth IRA. That is, if $10,000 goes into the Roth IRA, $8,000 of it will be taxable and $2,000 will be nontaxable under a direct rollover approach. Jane will include the $8,000 in her income and pay tax on it. This means she will still have $8,000 of basis with the traditional IRA.

This is not the result she wants. She wants to have no basis within the traditional IRA and she wants only basis to go into the Roth IRA so she will not have to pay any income tax.

Is there an approach allowing Jane to pay no tax with respect to the $10,000 she puts into her Roth IRA?

Yes, but she will need to have access to some additional funds ($8,000) as explained below.

Jane will need to instruct the 401(k) administrator that she wishes to have her plan balance of $50,000 paid to her in cash. She cannot do a direct rollover and achieve the desired result. Since she is paid cash, the plan administrator will withhold 20% of the taxable amount of the distribution. The plan will give her a check for $42,000. 20% must be withheld from the $40,000 or $8,000. 0% must be withheld with respect to the basis (i.e. her own nondeductible contributions). Thus, she is paid $42,000 ($32,000 + $10,000).

Jane now has 60 days to rollover this $42,000 distribution. She may do so by making multiple rollover contributions. First, she wants to rollover the $40,000 into her traditional IRA. Later, she wants to rollover the $10,000 into her Roth IRA. Since she only has $2,000 as the other $8,000 was withheld, she will need to add her own $8,000 to make the $10,000 rollover. This $8,000 can come from other personal funds or possibly from a loan.

Why must she do it this way? Code section 402(c)(2) provides that when a person has basis within the 401(k) plan and takes a distribution, that the taxable amount comes out first and the nontaxable amount comes out second. Because of this rule, she may make a roll over contribution of $40,000 to her traditional IRA and then a rollover contribution of $10,000 to her Roth IRA. The $10,000 she contributes to her Roth IRA will be her basis or the nontaxable amount. In this situation, the pro-rata rule is not used. Although asked numerous times, the IRS has not confirmed that this approach works so that all of the $10,000 going into the Roth IRA is basis and nontaxable.