Roth deferrals with a loss at distribution

[K2retire]

There is a debate raging in our office, and I'd appreciate some input from others.

If a participant, who has made Roth deferrals and has a loss on his or her account, elects to take a distribution partially in cash and partially as a rollover, can they choose how to allocate the loss between the cash and rollover?

The Erisa Outline Book says that gains must be prorated, but apparently some of our Compliance people believe that does not apply to losses. I'm struggling to understand why losses would be treated differently than gains, but I do know that logic and IRS rules are sometimes mutually exclusive.

[WDIK]

Don't think of them as losses, think of them as negative gains.

But more seriously, are you saying that the account value is now less than the total deferred because of investment losses?

[K2retire]

Yes, and apparently the participant is wanting to specify that the entire loss goes to either the cash distribution or the rollover part of the distribution. (I've forgotten which.)

[WDIK]

Sorry to be dense on a Monday morning, but if the total account value is below the basis, does the allocation make any difference?

[masteff]

WDIK - the participant probably wants to put the whole loss on the non-rollover money to try to get the full loss now instead of waiting (but see below for why I think he can't).

take a distribution partially in cash and partially as a rollover

I missed that nuiance... if Roth accounts follow the same framework as Roth IRA's, the answer is no, can't take the loss for current tax purposes. Generally have to completely close out all Roth IRAs and then compare all contributions to all distributions to determine if a loss is available. The partial rollover prevents the loss from being recognizable at this time. And then, it's probably reported as a miscellaneous itemized deduction (which must exceed 2% of AGI before it even has an income tax effect).

See page 70 of IRS Pub 590 here: http://www.irs.gov/pub/irs-pdf/p590.pdf

[WDIK]

WDIK - the participant probably wants to put the whole loss on the non-rollover money to try to get the full loss now instead of waiting (but see below for why I think he can't).

Of course that makes perfect sense. I warned you I was dense today.

[K2retire]

So if the partial rollover prevents deducting any loss, does that mean that the entire loss should be part of the rollover? Or do you pro rate it as would be done for a gain and just lose out on the deduction?

[masteff]

I'd say...

Basis is allocated prorata for purposes of gains.

Basis is deferred for purposes of losses. (Meaning you track basis and distributions and, per Pub 590, only recognize a loss when the Roth position is entirely disposed if total distributions are less than total basis.)

But this is premised entirely on gains/losses for 401(k) Roth accounts being treated in the same manner as IRAs and Roth IRAs. And having not traced the Code and Regs for how the Roth account cross-references, I could be entirely off base.