ROTH conversion process

I have never been a part of a Roth Conversion.  Have a single member plan who has asked if she can do one.  The plan document allows for one and I have done some reading.  Have I got the process correct? Is there a script/outline somewhere that someone can point me to?

• In-plan Roth rollovers/conversions have evolved into being the same.  In the beginning you needed to be eligible for a distribution and now anyone can convert as long as the account is 100% vested.  Right so far?
• A 1099-R will need to be prepared for the conversion.  No actual taxes are withheld yet the participant will need to declare the rollover as income on their personal 1040. No 10% penalty, no 20% Fed withholding. 
• The 1099-R distribution code will be G for rollover (Box 7).  Box 1 and 2a will both be the total amount converted.  None of the money has been taxed so it all needs to be declared and is taxable.
• The rollover needs to be put into a designated Roth account.
• The 5 Year Rule...
  • The 5 year rule starts at the beginning of the first tax year. 
  • Each conversion has it's own 5 year rule.  
  • If a distribution is taken before the 5 years is up and the account holder is less than 59-1/2 then the 10% penalty kicks in and the whole distribution is taxable
  • If a distribution is taken before the 5 years is up and the account holder is older than 59-1/2 then the 10% penalty does  not kick in but the whole distribution is taxable

Do I have it right so far?  One question I can't find the answer to or am just missing it is "if the plan closes before the 5 years is up and the ROTH account is rolled over to a ROTH IRA, no penalty?  All good?  but there is still the remainder of the 5 years to go before distributions can be taken tax free?"

Thanks

21 minutes ago, Basically said:

In-plan Roth rollovers/conversions have evolved into being the same.  In the beginning you needed to be eligible for a distribution and now anyone can convert as long as the account is 100% vested.  Right so far?

A plan can allow in-plan Roth conversions of amounts that are not otherwise distributable, but a participant can only do what the plan allows. So if the plan says that in-plan Roth conversions are only allowed for amounts that are otherwise distributable, then that's what would be available to the participant.

One thing to note about allowing in-plan Roth conversions of amounts not otherwise distributable, is that you have to preserve the distribution restrictions attached to that source. Which means you might end up separately tracking Roth conversions from deferrals, Roth conversions from safe harbor, Roth conversions from profit sharing, Roth conversions from rollovers, etc. etc.

The entire source does not have to be 100% vested, but only the vested portion could be converted.

27 minutes ago, Basically said:

• A 1099-R will need to be prepared for the conversion.  No actual taxes are withheld yet the participant will need to declare the rollover as income on their personal 1040. No 10% penalty, no 20% Fed withholding. 
• The 1099-R distribution code will be G for rollover (Box 7).  Box 1 and 2a will both be the total amount converted.  None of the money has been taxed so it all needs to be declared and is taxable.

Agreed.

28 minutes ago, Basically said:

• The rollover needs to be put into a designated Roth account.

As mentioned earlier, if the amount was not otherwise distributable, you will need separate Roth sub-accounts to track the distribution restrictions attached to the original source(s).

28 minutes ago, Basically said:

• If a distribution is taken before the 5 years is up and the account holder is less than 59-1/2 then the 10% penalty kicks in and the whole distribution is taxable
• If a distribution is taken before the 5 years is up and the account holder is older than 59-1/2 then the 10% penalty does  not kick in but the whole distribution is taxable

Only the earnings are taxable, since the basis was taxed at the time of the conversion. In a qualified Roth distribution, the earnings are tax-free.

The 10% penalty could be waived even if under age 59½ in certain circumstances, for example a distribution on termination of employment after age 55. However that would not on its own make it a qualified Roth distribution and the earnings would still be taxable.

39 minutes ago, Basically said:

One question I can't find the answer to or am just missing it is "if the plan closes before the 5 years is up and the ROTH account is rolled over to a ROTH IRA, no penalty?  All good?  but there is still the remainder of the 5 years to go before distributions can be taken tax free?"

If you roll over a designated Roth account to a Roth IRA, it re-starts the 5 year clock. Here is an article with more info: https://www.napa-net.org/news-info/daily-news/case-week-designated-roth-account-rollovers-and-5-year-rule

Ok thanks for helping.  Two things I want to get clear:

1.  5 year rule - So let's say Sue converts her total employee deferral account to ROTH in the plan.  She converts a total of $45,000 on 11/10/2023.  Her 5 year rule starts 1/1/2023.  On 12/31/2027 she has satisfied her 5 year rule requirement.  Any distribution from her ROTH account is tax free.  
   
   But, if she took a full distribution prior to 12/31/2023, and the total distribution was $60,000 (no additional ROTH deferrals added in) then she would have to pay taxes on the $15,000 earnings.
    
2.  And with regards to rolling her ROTH conversion account over to a ROTH IRA , not taxed because it is a rollover to a IRA BUT if the 5 year requirement was not met in the plan then she needs to start all over with the 5 year rule.
   ->  You aren't saying even if she completed her 5 years in the plan that when she rolls her account out into a ROTH IRA she will have that requirement all again are you?

For the 1099-R - Box 1 and 2a will both be the same number.  They would be different if it was a rollover out and the 5 years wasn't satisfied.  

Thanks for your help!

The 5-year period for a Roth IRA begins at the earlier of either 1) the first Roth IRA contribution, or 2) a rollover contribution from a designated Roth account. So if there was no pre-existing Roth IRA, then the rollover starts the 5-year period.

If the rollover happens in 2029, then the 5-year period for the IRA begins in 2029, regardless of how many years the contributions were in a designated Roth account before that.

Ahh, I get it now.  New ROTH IRAs regardless of where the money comes from have a 5 year rule of their own.  Even if the money is ROTH money coming from a pension plan, if the money is going into a new ROTH IRA then it will have it's own 5 year rule.  

Thank you!

Does it matter if after the conversion the plan participant makes regular Roth deferrals into that conversion account? Would it actually be best to put new future Roth deferrals into the conversion account because that Roth account has started it's 5 year rule clock?

7 hours ago, C. B. Zeller said:

So if there was no pre-existing Roth IRA, then the rollover starts the 5-year period.

The participant can contribute a nominal amount (e.g., $100) to an after-tax IRA, then convert the after-tax to a ROTH, so as to have a rollover Roth running simultaneously with the in-plan Roth account that will be ready for any rollovers.

12 hours ago, Luke Bailey said:

so as to have a rollover Roth running simultaneously with the in-plan Roth account that will be ready for any rollovers.

So many rules!   So is what you are saying is that the in-plan Roth conversion, when it is rolled out of the plan eventually, must be rolled into a "rollover" Roth IRA?

AND, if there is an existing rollover Roth IRA established (with it's own 5 year clock) and the in-plan Roth conversion is rolled into it then there is no new 5 year clock that needs to be started for the rollover portion?  That is a good work around, that is thinking outside the box if that is what you are saying.  Has anyone done this?

The establishment of a nominal Roth IRA in anticipation of rolling over a Roth account later was also done to be able to get the Roth money out of the qualified plan before it got caught up in required distributions. The change in law that allows Roth accounts to be excluded from the required distribution calculation obviated the need for the technique.