how are folks handling taxable/nontaxable portions of partial direct rollovers in light of Notice 2009-68?

[msimpson]

In the most recent model 402(f) notice published by the IRS in Notice 2009-68, the IRS took the position that if a participant elects a direct rollover of only a portion of an amount paid from a plan, with the rest paid to the participant, each payment has to include an allocable portion of taxable and nontaxable amounts. This interpretation created quite a stir, as it was different from what many practitioners were doing, and several groups asked the IRS to modify its interpretation on this point.

As best I can tell, the IRS has not addressed these concerns. Have I missed something? If not, have folks changed their rollover procedures to reflect the new IRS position, or are they still permitting participants to designate direct rollover of taxable portions only and/or distribution of nontaxable portions?

[masteff]

So I searched the forum and found the one thread where this was brought up here in December 2009. The topic was settled by the following.

From the top of page 5 here: ftp://ftp.irs.gov/pub/irs-tege/spr10.pdf

"Ordering Rule for Partial Rollovers

"If you receive an IRA or plan distribution that consists of after-tax and pre-tax amounts, you would first use the formulas above to determine the pre-tax amount of the distribution. If you roll over only part of that distribution to a Roth IRA, the first dollars rolled over come from the pre-tax amount of the distribution. After all the pre-tax portion of the distribution has been rolled over, any remaining amount is after-tax, which may also be rolled over to a Roth IRA."

[GMK]

I recall a discussion here about this, but my search skills were inadequate to find it.

My understanding is that for moneys contributed before 1987, the participant can choose which taxable and non-taxable amounts are in which distributions. For post-1986 money, distributions are to be proportioned between the taxable and non-taxable amounts.

[masteff]

GMK, you may be recalling this one: http://benefitslink.com/boards/index.php?/topic/47952-after-tax-rollover/ In it, you linked to an older thread which has the link I posted above.

[Calavera]

In dealing with distributions from a DB plan, it depends how the employee elects to receive his benefits. If it is a full lump sum with partial rollover, non-taxable portion goes first to lump sum amount payable to participant. But if it is annuity with partial rollover, the non-taxable portion is split between annuity amount and rollover amount.

[msimpson]

Thanks to everyone responding! This last post interests me in particular, as my question does relate to a DB plan where a participant may receive a full lump sum with a partial (direct) rollover rather than an annuity.

Calavera, can you provide me with the citation/reason for the difference with a DB plan?

[Calavera]

I don't think it is a DB related (I just work with DB plans). IRC 402©(2) as amended by JCWAA 411(q): "In the case of a transfer described in subparagraph (A) or (B), the amount transferred shall be treated as consisting first of the portion of such distribution that is includible in gross income (determined without regard to paragraph (1))."

I have an old printout from ERISA Outline book by Sal Tripodi that has an example in Chapter 7 Section 3 (Taxation Rules). Not sure what would be the section in the newest book.

So statement above: "non-taxable portion goes first to lump sum amount payable to participant" was not quite correct. The proper statement would be that the taxable portion goes first to the IRA.

[masteff]

Generally, see Code Section 72 for "investment in the contract" rules. See 72(d)(1)(D) for rule saying when a partial lump sum is done with the start of an annuity, the lump sum is treated as not being part of the annuity.

[Lou S.]

I think I have a related question and not sure the answer.

Participant terminates with $100,000 to total balance and is not 59.5

$100,000 total balance broken out as follows

$80,000 pre-tax

$15,000 roth basis (deferrals not conversion)

$5,000 roth earnings

Participant elects the following distributions on termination -

$10,000 cash

balance of pretax account to traditional IRA

balance of roth account to roth IRA

The question is can the $10,000 come all from pretax and roll the full $20,000 roth money to Roth IRA with no reduction in ROTH basis?

Can the $10,000 call come from ROTH with $7,500 non-taxable recovery of basis and $2,500 non-qualified earnings subject to taxes and penalties.

Or does the $10,000 have to split pro-rata between pre-tax and ROTH. making the $1,500 recovery of ROTH basis, $500 taxable roth earnings and $8,000 pretax taxable.

Or something else? That is are ROTH accounts treated any differently that non-ROTH AFTER TAX monies in the plan?

Did I mention I hate the IRS rules sometimes?

[Belgarath]

Lou - here's what I think - with the caveat that I'm going from memory and haven't done any research to confirm or provide citations.

For purposes of taxation under IRC 72, the rules are applied separately to distributions from Designated Roth contribution accounts, and to distributions from non-Roth accounts - they are treated as "separate contracts."

So, the entire Roth portion of $20,000 should be eligible for the direct rollover with no reduction in basis in the example you give, and the rest will be subject to "normal" tax rules for distributions of pre-tax money.

[msimpson]

In a follow up to my original post starting this chain, the IRS plans to issue Notice 2014-54 on October 6, 2014, revising its position on allocating after-tax and pretax portions when a distribution is split between mutiple destinations. It shows up in the BenefitsLink newsletter today (thanks, BenefitsLink!), but not yet on the IRS website.

So they are finally responding to all the requests they'd gotten to change their position. Thanks for the feedback to date.