Inservice WD - Qualified Roth distribuiton

[Becky Schwing]

participant want to take ISWD of $50,000 from his Roth 401k account.  He is over age 59 1/2 and has me the five year rule on his roth contributions.   My question is - when the money comes out do you have to split between basis and earnings on that amount?  It should all be non-taxable because he met the requirements but so is there any reason we need to determine the amount of the earnings attributable to the amount being taken out of the plan?

[Luke Bailey]

You have to check your plan document (or your plan document plus a policy adopted by the employer as plan administrator, if your plan document says this is to be determined by a policy) to determine if the participant in fact has the right to choose to take all of the $50,000 (which appears to be a non-hardship in-service distribution from a non-rollover account) from his/her designated Roth account. Of course, your plan document also has to permit ad hoc in-service distributions at age 59-1/2, which not all plans do. Some institutional trustees default to prorata unless both the plan document and the request from the participant dictate that it's all from the Roth, in which case they will report only a portion coming from the Roth and will report on two different 1099-R's. If, in fact, it all comes from the Roth account, then if he has met the Roth holding period for a qualified distribution, there is no federal income tax on distributions from that account.

[JAS76]

I think the OP's question relates to how, for a qualified Roth distribution, the earnings and basis are allocated.

It was easy for me to find references indicating that a non-qualified distribution from Roth includes both earnings and basis, pro-rata. But I was unable to find anything that says the same for qualified distributions.

The question is relevant because the money left behind could end up in an IRA down the road that can't make a qualified distribution.

[Luke Bailey]

I'm still struggling to find relevance, although it's possible I'm missing something obvious (or not obvious), and always welcome enlightenment. But granted, a rollover IRA can't make a qualified distribution until it separately satisfies the 5-year holding period, but the entire amount rolled over to it (Roth contributions and post-contributions earnings) is treated as basis in the rollover IRA, so the problem of differentiating basis from earnings in the IRA would only be for the post-rollover earnings.

[card]

Generally agree with Luke that there is no practical reason for continuing to account for basis/earnings after an employee reaches age 59 1/2 and satisfies the 5 year holding period. (I'm also assuming there's no state tax reason for doing so.) But IRS guidance may technically require it.

For example, the separate accounting regs, at (f)(3), state:

(3) Separate accounting required. Under the separate accounting requirement of this paragraph (f)(3), contributions and withdrawals of designated Roth contributions must be credited and debited to a designated Roth account maintained for the employee and the plan must maintain a record of the employee's investment in the contract (that is, designated Roth contributions that have not been distributed) with respect to the employee's designated Roth account. In addition, gains, losses, and other credits or charges must be separately allocated on a reasonable and consistent basis to the designated Roth account and other accounts under the plan. However, forfeitures may not be allocated to the designated Roth account and no contributions other than designated Roth contributions and rollover contributions described in section 402A(c)(3)(B) may be allocated to such account. The separate accounting requirement applies at the time the designated Roth contribution is contributed to the plan and must continue to apply until the designated Roth account is completely distributed. A-13 of § 1.402A-1 for additional requirements for separate accounting.

And the regs also contain this Q&A:

Q-7. After a qualified distribution from a designated Roth account has been made, how is the remaining investment in the contract of the designated Roth account determined under section 72?

A-7. (a) The portion of any qualified distribution that is treated as a recovery of investment in the contract is determined in the same manner as if the distribution were not a qualified distribution. (See A-3 of this section) Thus, the remaining investment in the contract in a designated Roth account after a qualified distribution is determined in the same manner after a qualified distribution as it would be determined if the distribution were not a qualified distribution.

However, the example the IRS provides deals with a qualified distribution due to disability, and notes that "This determination of the remaining investment in the contract will be needed if C subsequently is no longer disabled and takes a nonqualified distribution from the designated Roth account."

[Luke Bailey]

So Card, the question wasn't all that precise about the issue that they were asking about, but I was addressing the relevance of the distinction to the distribution and its reporting. I think what the regs are saying is that obviously, since when the Roth funds are originally credited you don't know whether the Roth holding period requirements will be met, you need to keep a record of "basis" and "earnings." And you don't stop after the holding period has been met, although the distinction may no longer be relevant.

[Mike Preston]

But it may be relevant in the context of future legislation. 

[card]

Agreed, original question wasn't very clear. If the question concerns reporting, Box 5 of the 1099R specifically requires reporting the portion of the distribution that's basis, without regard to whether the distribution is  qualified or nonqualified.

Mike- good point.