Correcting Transfer Directly from 401k to Roth

[Guest Lyric]

I believe you could have simply "recharacterized" your Roth IRA as a traditional IRA. I don't think you needed to "roll" it back again, so the 62 days would not have been an issue. You can recharacterize your IRA anytime before filing date, including any extensions to which you are entitled. Lots of people will be recharacterizing their Roths if it turns out they earned too much in 1998 to be eligible for a Roth, or contributed more than $2,000.

Speak to an accountant or tax specialist about what steps you need to take and what penalties you might have incurred inadvertently. There may be a way out of this. The IRA's custodian may know too, but his/her concern is with investments, not tax issues per se.

If the retirement account is recharacterized as a traditional IRA, there should be no tax liability whether paid as a lump sum or spread over four years, because your IRA remains a deductible tax-deferred account as the 401(k) was. That's why one can't roll a 401(k) directly to a Roth, which is tax-free (taxes having been paid upfront on the original earnings). And the four year tax break was only good till December 31, 1998 anyway. Henceforth the taxes due on conversions to a Roth have to be paid as a lump sum.

Talk to a professional.

[Guest Richard Carson]

I mistakenly rolled-over a 401(k) from a previous employer directly to a Roth, rather than first to a traditional IRA. Upon discovering the error, I had my trustee move it to a rollover IRA. Unfortunately, 62 days passed from the date the Roth received the funds until the funds were moved to the rollover IRA.

What can I do to avoid penalties for excess contributions and early distribution, and avail myself of the four-year tax payout?

[Guest Lyric]

Richard,

Here's something from the IRS website which may answer your question about correcting an erroneous rollover:

"Recharacterizations

You may be able to treat a contribution made to one type of IRA as having been made to a different type of IRA. This is called recharacterizing the contribution. More detailed information is in Publication 590.

To recharacterize a contribution, you generally must have the contribution

transferred from the first IRA (the one to which it was made) to the second IRA in a trustee-to-trustee transfer. However, if the same trustee maintains both IRAs, you can have the trustee transfer the contribution from the first IRA to the second IRA. If the transfer is made by the due date (including extensions) for your tax return for the year during which the contribution to the first IRA was made, you can elect to treat the contribution as having been made to the second IRA instead of to the first IRA. It will be treated as having been made to the second IRA on the same date that it was actually made to the first IRA.

No deduction is allowed for the contribution to the first IRA and any net earnings transferred with the recharacterized contribution are treated as earned in the second IRA.

Effect of previous tax-free transfers. If an IRA has been moved from one IRA

to another in a tax-free transfer, such as a rollover, the contribution to the second IRA generally cannot be recharacterized.

How do I recharacterize a contribution? To recharacterize a contribution, you

must notify both the trustee of the first IRA (the one to which the contribution was initially made) and the trustee of the second IRA (the one to which the contribution is transferred) that you have elected to treat, for federal tax purposes, the contribution as having been made to the second IRA rather than the first. You must make the notifications by the date of the transfer. Only one notification is required if both IRAs are maintained by the same trustee.

Reporting a recharacterization. If you elect to recharacterize a contribution to one IRA as a contribution to another IRA, you must report the recharacterization on your tax return as directed by the tax form and its instructions. You must treat the contribution as having been made to the second IRA."

Hope this helps.

[Guest Cronin]

I beleive that the recharacterization rules do not apply to rollovers from qualified plans (401k's etc.) Is their another way to fix this?

[Guest Janey]

I'm fairly young (20's) and have been hearing all the great things about ROTH IRAs. I recently left a job and would like to ultimately start a ROTH with the money I currently have in the 401K. I'm going back to school and won't have another 401 to roll the money over to, so i need to do something with it. Can anyone clue me in on if this is possible..I know it can't be as simple as a "rollover" into an account because of the taxes I havn't paid on the 401K money.

[John G]

First, find out from your current employer what options they provide. You might be able to keep the $ in their system. If you worked for Intel, Cisco Systems or some other growing concern, that might be an attractive option. Alternatively, you could role the $ into an IRA, either cashing out before you make the rollover or taking the stock with you. Next, you have the Roth option. It is probably safe to assume that as a student you will qualify for a Roth conversion. Depending upon the amount involved, you might be able to convert it at a very low tax rate. Normally, you want to have suficient funds outside your IRA to pay the taxes.

I suggest that you first talk with your employer. Then before you do anything, talk to atleast two potential custodians (after the IRA/tax season). If big $$ are involved, you probably want to get an hour of CPA/accountant advice. Good luck with your investments and your education.