In-plan conversions of after-tax contributions; does pro-rata rule apply?

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Topic Author
Filife20Forty
Posts: 27
Joined: Tue Feb 20, 2018 7:44 am

In-plan conversions of after-tax contributions; does pro-rata rule apply?

Post by Filife20Forty » Sat Aug 01, 2020 4:05 pm

I have a question on after-tax contributions made in a Company 401(k) plan and our ability to convert these to a Roth 401(k) within my wifes retirement plan. I have been reading the forum and reading the IRS publications and was hoping someone had come across a similar predicament. 

My wife makes both pre-tax and after-tax contributions to her 401(k). She also receives an employer match each year. Her plan balance, and the retirement plan dashboard lists four discrete account types:

Pre-tax 33%
After tax - post 1986- 20% (earnings on after tax contributions is relatively small, less than 10% of total after tax contributions made)
Rollover 33% (pre-tax; rollover from prior employer)
Employer Match 14%[/list]

Her plan states we can make up to 4 conversions per year, each must be at least 90 days apart. We have no non-Roth IRA's.

When we click on the convert button, we can select 100% of the After tax balance and 0% of the other balances. The next screen shows the after-tax contributions we made, and the earnings on these contributions. It indicates we will have a federal and state tax impact based on our tax rate * the earnings on our after tax contributions. We are more than happy to pay the taxes to convert these; however, I have the following questions:

1) Does the pro rata rule apply here?  https://www.irs.gov/retirement-plans/ro ... ment-plans
We are not making a distribution, in that, we are converting a retirement balance within the plan and it is in a 401(k) before and after conversion. The prompt says "which balances do you want to convert to a Roth 401(k)". Not sure if I'm reading the conversion vs. distribution concept incorrectly.

2) If this does not trigger the pro-rate rule, we will go ahead and make this conversion. I assume that the taxable portion (i.e. earnings) will be included on my Form 8606 this year, indicating that I "converted" the earnings amount, which hadn't been taxed before?

3) If this does trigger the pro-rata rule, we will not convert. If this is the case, any strategies you would employ prospectively or be thinking about, if my wife could end up leaving this employer in the future? I.e. continue making after-tax contributions in hopes that upon leaving the Company, we could convert the after-tax contributions and earnings to Roth (IRA)'?

viewtopic.php?t=316616 seems to suggest what we want to do does not trigger pro-rata rule; but was hoping to get clarification (with IRS guidance) that what I'm doing is an in-plan roth rollover (IRR) and not subject to the guidance as a pro-rata distribution.

Thanks in advance for reading.

lakpr
Posts: 5766
Joined: Fri Mar 18, 2011 9:59 am

Re: In-plan conversions of after-tax contributions; does pro-rata rule apply?

Post by lakpr » Sat Aug 01, 2020 4:37 pm

I have a very similar MegaCorp plan, that allows only In-Plan Roth Conversions.

Answer 1: No, no pro-rata rule. If you are converting an after-tax amount of $2200, for example, and $200 of it is earnings, you will owe taxes on $200..

Answer 2: Form-8606 does not apply here, that form is only for conversions from Traditional IRA to Roth IRA, not 401k in-plan conversions. At the end of the year you will get a 1099-R, which will indicate the taxable amount from the conversion ($200 in the above example). This is treated as "additional income" that you will enter on your tax return. Last year for example, I made an MBR contributions of about $9k, with $84 as taxable income.

You can also choose to convert more, if you think there is an advantage in doing so (for example, the March dip) even from the Pre-tax rollover amounts in the plan. What you CANNOT convert is the contributions you made to the plan while you are an employee of the company, and the associated growth. Those conversion amounts also will be listed on the 1099-R you get from the 401k plan administrator

Answer 3: Not applicable.

Alan S.
Posts: 9801
Joined: Mon May 16, 2011 6:07 pm
Location: Prescott, AZ

Re: In-plan conversions of after-tax contributions; does pro-rata rule apply?

Post by Alan S. » Sat Aug 01, 2020 6:41 pm

Filife20Forty wrote:
Sat Aug 01, 2020 4:05 pm
I have a question on after-tax contributions made in a Company 401(k) plan and our ability to convert these to a Roth 401(k) within my wifes retirement plan. I have been reading the forum and reading the IRS publications and was hoping someone had come across a similar predicament. 

My wife makes both pre-tax and after-tax contributions to her 401(k). She also receives an employer match each year. Her plan balance, and the retirement plan dashboard lists four discrete account types:

Pre-tax 33%
After tax - post 1986- 20% (earnings on after tax contributions is relatively small, less than 10% of total after tax contributions made)
Rollover 33% (pre-tax; rollover from prior employer)
Employer Match 14%[/list]

Her plan states we can make up to 4 conversions per year, each must be at least 90 days apart. We have no non-Roth IRA's.

When we click on the convert button, we can select 100% of the After tax balance and 0% of the other balances. The next screen shows the after-tax contributions we made, and the earnings on these contributions. It indicates we will have a federal and state tax impact based on our tax rate * the earnings on our after tax contributions. We are more than happy to pay the taxes to convert these; however, I have the following questions:

1) Does the pro rata rule apply here?  https://www.irs.gov/retirement-plans/ro ... ment-plans
We are not making a distribution, in that, we are converting a retirement balance within the plan and it is in a 401(k) before and after conversion. The prompt says "which balances do you want to convert to a Roth 401(k)". Not sure if I'm reading the conversion vs. distribution concept incorrectly.

2) If this does not trigger the pro-rate rule, we will go ahead and make this conversion. I assume that the taxable portion (i.e. earnings) will be included on my Form 8606 this year, indicating that I "converted" the earnings amount, which hadn't been taxed before?

3) If this does trigger the pro-rata rule, we will not convert. If this is the case, any strategies you would employ prospectively or be thinking about, if my wife could end up leaving this employer in the future? I.e. continue making after-tax contributions in hopes that upon leaving the Company, we could convert the after-tax contributions and earnings to Roth (IRA)'?

viewtopic.php?t=316616 seems to suggest what we want to do does not trigger pro-rata rule; but was hoping to get clarification (with IRS guidance) that what I'm doing is an in-plan roth rollover (IRR) and not subject to the guidance as a pro-rata distribution.

Thanks in advance for reading.
You need to be very clear what sub account will be funding your IRR (in plan Roth rollover). Most participants want to fund the IRR from the after tax sub account. Pro rating does apply in this case, BUT ONLY between the after tax contributions and the earnings on those contributions that remain in the after tax sub account. There is no pro rating with the rest of the plan if you request the IRR correctly. You have been clear that you understand the amount of earnings in the sub account will be taxable when your 100% IRR from the sub account is completed.

There have been cases where web site confusion has resulted in IRRs that have pulled in amounts from the pre tax portion of the account, and those amounts will be 100% taxable. This can be very costly. Since an IRR cannot be recharacterized, you need to be very careful when ordering an IRR to make sure it is clear that only the after tax sub account is to be distributed to the Roth 401k.

If you have any doubts about your entry, call plan administration for help or perhaps have them execute the IRR for you if they will do that.

Topic Author
Filife20Forty
Posts: 27
Joined: Tue Feb 20, 2018 7:44 am

Re: In-plan conversions of after-tax contributions; does pro-rata rule apply?

Post by Filife20Forty » Sat Aug 01, 2020 6:47 pm

lakpr wrote:
Sat Aug 01, 2020 4:37 pm
I have a very similar MegaCorp plan, that allows only In-Plan Roth Conversions.

Answer 1: No, no pro-rata rule. If you are converting an after-tax amount of $2200, for example, and $200 of it is earnings, you will owe taxes on $200..

Answer 2: Form-8606 does not apply here, that form is only for conversions from Traditional IRA to Roth IRA, not 401k in-plan conversions. At the end of the year you will get a 1099-R, which will indicate the taxable amount from the conversion ($200 in the above example). This is treated as "additional income" that you will enter on your tax return. Last year for example, I made an MBR contributions of about $9k, with $84 as taxable income.

You can also choose to convert more, if you think there is an advantage in doing so (for example, the March dip) even from the Pre-tax rollover amounts in the plan. What you CANNOT convert is the contributions you made to the plan while you are an employee of the company, and the associated growth. Those conversion amounts also will be listed on the 1099-R you get from the 401k plan administrator

Answer 3: Not applicable.
Thanks, Lakpr. Appreciate the input.

Topic Author
Filife20Forty
Posts: 27
Joined: Tue Feb 20, 2018 7:44 am

Re: In-plan conversions of after-tax contributions; does pro-rata rule apply?

Post by Filife20Forty » Sat Aug 01, 2020 6:57 pm

Alan S. wrote:
Sat Aug 01, 2020 6:41 pm
Filife20Forty wrote:
Sat Aug 01, 2020 4:05 pm
I have a question on after-tax contributions made in a Company 401(k) plan and our ability to convert these to a Roth 401(k) within my wifes retirement plan. I have been reading the forum and reading the IRS publications and was hoping someone had come across a similar predicament. 

My wife makes both pre-tax and after-tax contributions to her 401(k). She also receives an employer match each year. Her plan balance, and the retirement plan dashboard lists four discrete account types:

Pre-tax 33%
After tax - post 1986- 20% (earnings on after tax contributions is relatively small, less than 10% of total after tax contributions made)
Rollover 33% (pre-tax; rollover from prior employer)
Employer Match 14%[/list]

Her plan states we can make up to 4 conversions per year, each must be at least 90 days apart. We have no non-Roth IRA's.

When we click on the convert button, we can select 100% of the After tax balance and 0% of the other balances. The next screen shows the after-tax contributions we made, and the earnings on these contributions. It indicates we will have a federal and state tax impact based on our tax rate * the earnings on our after tax contributions. We are more than happy to pay the taxes to convert these; however, I have the following questions:

1) Does the pro rata rule apply here?  https://www.irs.gov/retirement-plans/ro ... ment-plans
We are not making a distribution, in that, we are converting a retirement balance within the plan and it is in a 401(k) before and after conversion. The prompt says "which balances do you want to convert to a Roth 401(k)". Not sure if I'm reading the conversion vs. distribution concept incorrectly.

2) If this does not trigger the pro-rate rule, we will go ahead and make this conversion. I assume that the taxable portion (i.e. earnings) will be included on my Form 8606 this year, indicating that I "converted" the earnings amount, which hadn't been taxed before?

3) If this does trigger the pro-rata rule, we will not convert. If this is the case, any strategies you would employ prospectively or be thinking about, if my wife could end up leaving this employer in the future? I.e. continue making after-tax contributions in hopes that upon leaving the Company, we could convert the after-tax contributions and earnings to Roth (IRA)'?

viewtopic.php?t=316616 seems to suggest what we want to do does not trigger pro-rata rule; but was hoping to get clarification (with IRS guidance) that what I'm doing is an in-plan roth rollover (IRR) and not subject to the guidance as a pro-rata distribution.

Thanks in advance for reading.
You need to be very clear what sub account will be funding your IRR (in plan Roth rollover). Most participants want to fund the IRR from the after tax sub account. Pro rating does apply in this case, BUT ONLY between the after tax contributions and the earnings on those contributions that remain in the after tax sub account. There is no pro rating with the rest of the plan if you request the IRR correctly. You have been clear that you understand the amount of earnings in the sub account will be taxable when your 100% IRR from the sub account is completed.

There have been cases where web site confusion has resulted in IRRs that have pulled in amounts from the pre tax portion of the account, and those amounts will be 100% taxable. This can be very costly. Since an IRR cannot be recharacterized, you need to be very careful when ordering an IRR to make sure it is clear that only the after tax sub account is to be distributed to the Roth 401k.

If you have any doubts about your entry, call plan administration for help or perhaps have them execute the IRR for you if they will do that.


Thanks, Alan. Good suggestion on calling plan administration to confirm. I did correspond with them; they confirmed the plan allows the in-service and that I can select the individual account(s), but wasn't comfortable with them providing guidance re: pro-rata rule, which you've clarified above.

Will keep that in mind as we look to execute. The website page for conversion is pretty clear in terms of 4 distinct buckets for each account with ability to enter % (0-100) for conversion to Roth. Appreciate you calling out specifically how this can go wrong if it's made in the wrong account. Cheers!

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