Advanced Underwriting Consultants

Question of the Day – April 7

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question: I have a client with a 401(k) account balance consisting of after-tax contributions, and an untaxed portion consisting of pre-tax contributions, employer contributions and earnings.  Can I roll over just the pre-tax portion to a traditional IRA, and then roll over the after-tax balance to a Roth IRA?

Answer: Probably yes, but it’s not so simple in light of IRS Notice 2009-68.

The rules say that a partial distribution from a 401(k) account comes out pro-rata from the untaxed and taxed portions.  A complete distribution, on the other hand, drains the pre-tax portion first, then the already taxed part.

OK, so if the participant asks the plan administrator for a complete distribution, but also asks the administrator to first send the untaxed part as a direct rollover to a traditional IRA, does that work?  The IRS, in its Notice, said no.  It reasoned that the direct rollover of only the untaxed portion is NOT a complete distribution, and therefore drains the account on a pro-rata basis.

So how can the taxpayer accomplish the split rollover?

The participant should ask for the complete distribution to be paid to her.  After receiving the money, she can roll over the pre-tax portion to a traditional IRA by 60 day rollover.  After that is accomplished, she can roll over the rest to a Roth IRA—again within 60 days of taking a complete distribution.  That technique seems to satisfy the statutory requirements as well as the rules in the Notice.

What’s the downside of using the 60 day rollover technique?  The employer must withhold 20% from the taxable part of the distribution for federal taxes.  If the client wants to perform a complete rollover, the tax withheld must be replaced by other funds from the client.  Not all of our clients have that kind of extra money laying around.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.