Pre-tax 401k Rolled into a ROth IRA

[austin3515]

In this situation, is the plan paying the distribution responsible for coding the distribution as taxable? How in the world would the sponsor know whether or not the rollover account relates to a Roth IRA?

[masteff]

Use code G, just like direct rollover to a traditional IRA. The participant reports the conversion on their personal tax return.

[austin3515]

U'm being told that we need to code a portion of the 1099 as taxable. How would we know to do this, since we don't know if the account listed is a Roth IRA?

[GMK]

We added a line on the Distribution Form that the participant files, asking if this rollover is to a Roth IRA.

If necessary, we can contact the IRA sponsor and ask them to confirm one way or the other.

[masteff]

Ah... I'm w/ you now. Instructions for 1099-R, page 4, says: "For a direct rollover of an eligible rollover distribution to a Roth IRA (other than from a designated Roth account), report the total amount rolled over in box 1, the taxable amount in box 2a, and any basis recovery amount in box 5. (See the instructions for box 5 on page 9.) Use Code G in box 7. If the direct rollover is made on behalf of a nonspouse designated beneficiary, also enter Code 4 in box 7."

I think GMK's hit the nail on the head for the solution.

[Bird]

We added a line on the Distribution Form that the participant files, asking if this rollover is to a Roth IRA.

Right. The distributing plan needs to ask/know if it is a Roth IRA.

[austin3515]

Of course, I thought of the need to update the form after posting the link. Another ambitious effort by the government to make plan administration as prone to error as is humanly possible.

I fear the odds of them checking that box correctly are pretty low, then the 1099 goes out incorrectly, and no one will ever know. Ever.

Then it creates a nice opportunity for tax cheats. If a tax cheat knew not checking that box could save an incredible amount of money in taxes, perhaps they'll opt not to check it and then plead "oh, I had no idea!!" OBviously, verifying that an IRA is Roth or Traditional will not be something that any providers or even the most diligent plan sponsors will be doing.

The real world implications it seems were NOT planned for...

[GMK]

Contacting IRA sponsors is usually pretty quick and easy, but ...

another approach could be to send a form cover letter a) stating that the participant has indicated that the receiving account is a traditional IRA (or is not a Roth IRA or however you wish to word it) and b) requesting confirmation for your records.

Probably better to do this before distributing, but better late than never.

[Bird]

Then it creates a nice opportunity for tax cheats. If a tax cheat knew not checking that box could save an incredible amount of money in taxes, perhaps they'll opt not to check it and then plead "oh, I had no idea!!" OBviously, verifying that an IRA is Roth or Traditional will not be something that any providers or even the most diligent plan sponsors will be doing.

I'm not sure, but I think/hope that the receiving IRA has to indicate the type of rollover on Form 5498...yes, I checked and there is a Roth conversion amount on the form.

[austin3515]

But how in the world would they know it was from a pre-tax account??? Maybe they are required to know, in which case I would feel much better. There just seems to be a huge disconnect.

For those of you saying check with the receiving IRA, do you process distributions? These operations are 100% incompatible with that type of a project. For example, we don't even have a phone number. And if you did have a phone number, why would the person answering the phone give us any information at all??

[GMK]

Our cover letter for the fund transfer states that the funds are pre-tax (if they are).

We process distributions. We ask for the phone number and a contact person on the distribution request form.

The people who answer the phone are good about giving us confirming information. I do not know why. Maybe they are just nice people. Maybe it's because we are going to send them a wad of money. Doesn't really matter.

We also try to be helpful when they call to get information about the transfer.

[masteff]

But how in the world would they know it was from a pre-tax account??? Maybe they are required to know, in which case I would feel much better. There just seems to be a huge disconnect.

Just because the plan doesn't report the taxable amount in 1099-R box 2a, the individual is not off the hook. Don't forget the beast that is the IRS data processing centers. It's amazing the connections they find that people assume won't be caught. With someone's 1099-R, 1040 and 5498 in hand, they can see the trail left behind. They have a good idea from the 1099-R what the taxable amount is, so if it goes into a Roth, they'll be looking to see what was put on the 1040. In fact, the instructions for form 1040 say to subtract box 5 from box 1, they don't even reference box 2a.

[austin3515]

I feel a LOT better knowing the purpose of the 5498, which I had never known before. Obviously, whoever is getting the money will know more about it. For example, we (as I'm sure you all do) routinely review support for the source of incoming rollover to make sure it's eligible to come in. So the receiving organization will know it's pre-tax going to Roth and will issue the right 5498.

All is well in the world again