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I have a situation that involves both my 401k and my IRA. I have approx. 20k pre-tax and 20k after-tax in Traditional IRA’s. I also have approx. 200k in after-tax and 200k earnings (pre-tax) in a 401k. The 401k is with Fidelity and they indicate that I can convert the after-tax portion of the 401k to a Roth IRA, and the pre-tax portion to a Tradiional IRA. (They indicated that the pre & after tax portions had to come out together.)
What I would like to do is to first convert all of my IRA to a Roth (20k gross income) and then convert the 401k. Do you see a problem with the pro-rata rule if I do both of these in the same year? Or can I for example do the 40k IRA conversion, say in Feb. 2010 (20k taxable)and then in March do the 200k Roth, 200k Traditional conversion from my 401k? I’ve asked several sources and haven’t received a satisfactory answer. Thanks.
Hi Dwight,
This is a great question (fact pattern) to evaluate. If you don’t mind, will you post the question at focusgp.wordpress.com ? I would like to post my answer there after you post the question so my clients can view it.
The first area to address is your 401k. Currently the pro-rata rules between QRPs and IRAs are fuzzy, the American Benefits Council has requested clarification and this has not happened yet. So, to get to your questions.
If you can afford to replace the 20% withholding of an indirect rollover, you can have $200k distributed to you via check which you will have to exercise you 60-day rollover on. Sec. 402( c) tells us that the monies coming out in this fashion are pre-tax first.
Once you do this, you will be left with your $200k in after-tax basis in your 401k. You can then rollover that balance directly into a Roth IRA without worrying about the pro-rata rules.
This creates a problem for your current IRAs however. The 8606 you are required to file at the end of the year looks at the ending balances of the basis in figuring the prorated amount taxable from the Traditional IRA to Roth IRA conversion. You will now have a $240k balance with only 20k non-taxable which is only 8.3% non-taxable instead of the prior 50%. This answers your last question, the dates you perform these steps will not change this outcome. You do have an issue there.
One solution would be to keep your funds in the 401k for now, convert your IRA funds this year, which would result in 20k taxable like you mentioned. Then in 2011 you can perform an indirect rollover from your 401k to a Traditional IRA, and rollover the remaining basis to your Roth IRA without paying tax. At the end you will have your 240k in your Roth IRA with 200k in a Traditional IRA, and you would have only included 20k in gross income.
If the IRS issues more clarification on direct conversions than you may not even have to wait until 2011. The American Benefits Council issued this letter to the IRS after some recent IRS Notices.
http://www.americanbenefitscouncil.org/ … 102609.pdf
Please post the question on the link you provided so I may post the answer. If you have any questions about what I have provided let me know.
-Joe
I have a few questions. I am going to convert a 401k with about 80k into a traditional ira (with the intention of converting that into my roth ira account)
If i defer the tax for 2010, does that mean 50% of 80k (40k) is added to my ordinary income for 2011, and the remaining 40k is added to my ordinary income for 2012 for tax purposes? and my tax bracket for say 2011 would be 40k plus income from my job?
also, this question is for my father. he has a 401k with his employer and is not eligible for roth ira bc his income is over the limit. is it possible for him to max out his 401k as well as contribute into a non-deductible ira account and then to convert that into a roth ira account? I also heard that they lifted the income limit for 401k to roth ira conversion for 2010?
Hi Johnny,
If you move 80k from your 401k to a Roth IRA then you will have the option you mentioned. You may either allow your 80k to be deferred over 2011 and 2012, or you can elect to recognize all of that income in 2010. You are correct, the income from the conversion is ordinary income and would be added to your W-2 earnings. Also, you may do a direct conversion (401k to Roth) without having to go to a Traditional IRA in-between.
About your father, he can certainly max out his 401k contributions and then contribute the max to a non-deductible Traditional IRA. He can then turn around and convert that non-deductibel Traditional IRA to a Roth IRA since there are no income limits on Roth Conversions. When you father is over 59 1/2 he may be able to transfer his 401k assets to a Roth IRA as well if the plan allows him to. This is something he would want to inquire about.
The limit on Roth Conversions has been removed permanently, not just for 2010. The election to take income over 2011 and 2012 is a one year deal, however with tax rates at least rising in the top two tax brackets, it may not always be advantageous.
Remember Conversions are great for some, and not for others.
Hope this helps.
-Joe
What should you do if your state has a longer statute of limitations than the federal.
Hi Bernie,
Good question, especially since many states have longer statutes than the Federal statute. Some states may extend the time period when you file an amended return, other states simply add a year to whenever the federal time ends (Colorado is one like that), and some states just have longer statutory periods (Montana’s rules are similar to Federal but 5 years instead of 3).
This underscores the need for taxpayers to be more aware of any state differences when deciding to discard tax records.
The short answer to your question is, the longer of the two.
-Joe