Mega Backdoor question - from 401(k) to Roth IRA without intermediary traditional IRA?

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m2go
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Joined: Fri Jun 17, 2011 7:05 pm

Mega Backdoor question - from 401(k) to Roth IRA without intermediary traditional IRA?

Post by m2go » Wed Sep 12, 2018 12:49 pm

I have been doing a Mega Backdoor Roth for many years. At some point, I understood that the 401(k) roll over of an in-service distribution of the after-tax 401k portion to a traditional IRA was no longer necessary? Instead, I could just deposit the proceeds of the in-service withdrawal directly into a Roth IRA without the intermediate step of depositing into a traditional IRA and then converting said traditional IRA to a Roth. Is that correct, or did I screw up?

I now received a tax notice to pay 10% early distribution penalty on the taxable amount of amounts I directly moved from a 401k to a Roth IRA. HR Block never computed an early distribution penalty, because it lined up with amounts that had been deposited into a Roth IRA after the in-service withdrawal of the after-tax contributions to our 401k accounts.

retiredjg
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Re: Mega Backdoor question - from 401(k) to Roth IRA without intermediary traditional IRA?

Post by retiredjg » Wed Sep 12, 2018 1:23 pm

m2go wrote:
Wed Sep 12, 2018 12:49 pm
I have been doing a Mega Backdoor Roth for many years. At some point, I understood that the 401(k) roll over of an in-service distribution of the after-tax 401k portion to a traditional IRA was no longer necessary? Instead, I could just deposit the proceeds of the in-service withdrawal directly into a Roth IRA without the intermediate step of depositing into a traditional IRA and then converting said traditional IRA to a Roth. Is that correct, or did I screw up?
I don't know the entire history, but to my knowledge the rollover has never been required to go through tIRA.
I now received a tax notice to pay 10% early distribution penalty on the taxable amount of amounts I directly moved from a 401k to a Roth IRA. HR Block never computed an early distribution penalty, because it lined up with amounts that had been deposited into a Roth IRA after the in-service withdrawal of the after-tax contributions to our 401k accounts.
Sounds like a mistake?

I wonder if this is one of those things that requires you to include an explanatory comment on your tax form?

Alan S.
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Re: Mega Backdoor question - from 401(k) to Roth IRA without intermediary traditional IRA?

Post by Alan S. » Wed Sep 12, 2018 1:34 pm

m2go wrote:
Wed Sep 12, 2018 12:49 pm
I have been doing a Mega Backdoor Roth for many years. At some point, I understood that the 401(k) roll over of an in-service distribution of the after-tax 401k portion to a traditional IRA was no longer necessary? Instead, I could just deposit the proceeds of the in-service withdrawal directly into a Roth IRA without the intermediate step of depositing into a traditional IRA and then converting said traditional IRA to a Roth. Is that correct, or did I screw up?

I now received a tax notice to pay 10% early distribution penalty on the taxable amount of amounts I directly moved from a 401k to a Roth IRA. HR Block never computed an early distribution penalty, because it lined up with amounts that had been deposited into a Roth IRA after the in-service withdrawal of the after-tax contributions to our 401k accounts.

Did you report the direct rollover correctly on Form 1040? The total amount rolled over should have gone on line 16a and only the taxable amount on 16b. While amounts on 16b would usually be subject to penalty, the code G in Box 7 tells the IRS that a direct rollover was done of the full amount and there is never a penalty with a direct rollover. You do not owe the penalty. Send the IRS a copy of the 1099R with code G circled and also a copy of Form 5498 that you received in May showing a rollover of the same amount as shown on the 1099R to your Roth IRA. That should take care of this.


Another reason for this confusion from the IRS is that they are used to looking for Form 8606 for Roth conversions. But when you go direct from your 401k Form 8606 does not apply. So this is an IRS error, not your error. It would probably have been a very costly mistake if you had rolled this money into a TIRA first, since that would have triggered the pro rata rules of Form 8606 when you converted from the TIRA.

m2go
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Re: Mega Backdoor question - from 401(k) to Roth IRA without intermediary traditional IRA?

Post by m2go » Wed Sep 12, 2018 2:22 pm

Alan S. wrote:
Wed Sep 12, 2018 1:34 pm
m2go wrote:
Wed Sep 12, 2018 12:49 pm
I have been doing a Mega Backdoor Roth for many years. At some point, I understood that the 401(k) roll over of an in-service distribution of the after-tax 401k portion to a traditional IRA was no longer necessary? Instead, I could just deposit the proceeds of the in-service withdrawal directly into a Roth IRA without the intermediate step of depositing into a traditional IRA and then converting said traditional IRA to a Roth. Is that correct, or did I screw up?

I now received a tax notice to pay 10% early distribution penalty on the taxable amount of amounts I directly moved from a 401k to a Roth IRA. HR Block never computed an early distribution penalty, because it lined up with amounts that had been deposited into a Roth IRA after the in-service withdrawal of the after-tax contributions to our 401k accounts.

Did you report the direct rollover correctly on Form 1040? The total amount rolled over should have gone on line 16a and only the taxable amount on 16b. While amounts on 16b would usually be subject to penalty, the code G in Box 7 tells the IRS that a direct rollover was done of the full amount and there is never a penalty with a direct rollover. You do not owe the penalty. Send the IRS a copy of the 1099R with code G circled and also a copy of Form 5498 that you received in May showing a rollover of the same amount as shown on the 1099R to your Roth IRA. That should take care of this.
Thanks for the clarification - the rollover was not direct. We can only get a check made payable to us for in-service withdrawals. Thus, I received a check made payable to me (after withholding) which I deposited into my checking account, and then wrote a new check for the full amount (replenishing the withheld tax amount).

Box 7 codes "1", "Early distribution, no known exception" as it has in years past when there was no problem with the IRS claiming an early withdrawal penalty was due.

Spirit Rider
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Re: Mega Backdoor question - from 401(k) to Roth IRA without intermediary traditional IRA?

Post by Spirit Rider » Wed Sep 12, 2018 2:43 pm

retiredjg wrote:
Wed Sep 12, 2018 1:23 pm
I don't know the entire history, but to my knowledge the rollover has never been required to go through tIRA.
The Pension Protection Act of 2006 effective 1/1/2008, first allowed direct rollovers from qualified plans to a traditional Roth IRA. Prior to 1/1/2008, you had to rollover to a traditional IRA and then do a Roth conversion.

Alan S.
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Re: Mega Backdoor question - from 401(k) to Roth IRA without intermediary traditional IRA?

Post by Alan S. » Wed Sep 12, 2018 2:48 pm

m2go wrote:
Wed Sep 12, 2018 2:22 pm
Alan S. wrote:
Wed Sep 12, 2018 1:34 pm
m2go wrote:
Wed Sep 12, 2018 12:49 pm
I have been doing a Mega Backdoor Roth for many years. At some point, I understood that the 401(k) roll over of an in-service distribution of the after-tax 401k portion to a traditional IRA was no longer necessary? Instead, I could just deposit the proceeds of the in-service withdrawal directly into a Roth IRA without the intermediate step of depositing into a traditional IRA and then converting said traditional IRA to a Roth. Is that correct, or did I screw up?

I now received a tax notice to pay 10% early distribution penalty on the taxable amount of amounts I directly moved from a 401k to a Roth IRA. HR Block never computed an early distribution penalty, because it lined up with amounts that had been deposited into a Roth IRA after the in-service withdrawal of the after-tax contributions to our 401k accounts.

Did you report the direct rollover correctly on Form 1040? The total amount rolled over should have gone on line 16a and only the taxable amount on 16b. While amounts on 16b would usually be subject to penalty, the code G in Box 7 tells the IRS that a direct rollover was done of the full amount and there is never a penalty with a direct rollover. You do not owe the penalty. Send the IRS a copy of the 1099R with code G circled and also a copy of Form 5498 that you received in May showing a rollover of the same amount as shown on the 1099R to your Roth IRA. That should take care of this.
Thanks for the clarification - the rollover was not direct. We can only get a check made payable to us for in-service withdrawals. Thus, I received a check made payable to me (after withholding) which I deposited into my checking account, and then wrote a new check for the full amount (replenishing the withheld tax amount).

Box 7 codes "1", "Early distribution, no known exception" as it has in years past when there was no problem with the IRS claiming an early withdrawal penalty was due.
OK - but the tax program would still report the rollover on lines 16a and 16b as indicated above and indicate "rollover" next to 16b.

You would not need to provide the IRS a copy of the 1099R, but should provide a copy of the 5498 showing the rollover of the full amount to your Roth IRA, and that should resolve this. There is never a penalty for rollovers to a Roth account.

Sounds like your return was correct, but the IRS was just looking at the Code 1, not realizing that the rollover went to a Roth IRA.

retiredjg
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Re: Mega Backdoor question - from 401(k) to Roth IRA without intermediary traditional IRA?

Post by retiredjg » Wed Sep 12, 2018 3:29 pm

Spirit Rider wrote:
Wed Sep 12, 2018 2:43 pm
retiredjg wrote:
Wed Sep 12, 2018 1:23 pm
I don't know the entire history, but to my knowledge the rollover has never been required to go through tIRA.
The Pension Protection Act of 2006 effective 1/1/2008, first allowed direct rollovers from qualified plans to a traditional Roth IRA. Prior to 1/1/2008, you had to rollover to a traditional IRA and then do a Roth conversion.
Thanks!

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Earl Lemongrab
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Re: Mega Backdoor question - from 401(k) to Roth IRA without intermediary traditional IRA?

Post by Earl Lemongrab » Thu Sep 13, 2018 12:34 pm

m2go wrote:
Wed Sep 12, 2018 2:22 pm
Thanks for the clarification - the rollover was not direct. We can only get a check made payable to us for in-service withdrawals. Thus, I received a check made payable to me (after withholding) which I deposited into my checking account, and then wrote a new check for the full amount (replenishing the withheld tax amount).
The law requires the plan to support direct rollovers. The only difference is that the check would be made payable to the new custodian instead of you.
This week's fortune cookie: "Your financial life will be secure and beneficial." So I got that going for me, which is nice.

Spirit Rider
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Re: Mega Backdoor question - from 401(k) to Roth IRA without intermediary traditional IRA?

Post by Spirit Rider » Thu Sep 13, 2018 8:29 pm

Earl Lemongrab wrote:
Thu Sep 13, 2018 12:34 pm
m2go wrote:
Wed Sep 12, 2018 2:22 pm
Thanks for the clarification - the rollover was not direct. We can only get a check made payable to us for in-service withdrawals. Thus, I received a check made payable to me (after withholding) which I deposited into my checking account, and then wrote a new check for the full amount (replenishing the withheld tax amount).
The law requires the plan to support direct rollovers. The only difference is that the check would be made payable to the new custodian instead of you.
@Earl Lemongrab is correct. If the amount is eligible for rollover, the plan must allow a direct rollover.
@m2go, maybe you should educate your plan that they are in direct violation of IRS regulations.

26 CFR 1.401(a)(31)-1 - Requirement to offer direct rollover of eligible rollover distributions; questions and answers.
Q-1: What are the direct rollover requirements under section 401(a)(31)?
A-1: (a) General rule. To satisfy section 401(a)(31), added by UCA, a plan must provide that if the distributee of any eligible rollover distribution elects to have the distribution paid directly to an eligible retirement plan, and specifies the eligible retirement plan to which the distribution is to be paid, then the distribution will be paid to that eligible retirement plan in a direct rollover described in Q&A-3 of this section. Thus, the plan must give the distributee the option of having his or her distribution paid in a direct rollover to an eligible retirement plan specified by the distributee.

Alan S.
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Re: Mega Backdoor question - from 401(k) to Roth IRA without intermediary traditional IRA?

Post by Alan S. » Thu Sep 13, 2018 10:04 pm

It has been reported that several of these plans will not do a direct rollover to a Roth IRA, and instead require that the mega back door Roth rollover be made to the designated Roth account (in plan Roth rollover or IRR).

As indicated by spiritrider and Earl, a distribution made to the participant and declination of a direct rollover to a Roth IRA appears in conflict with Reg. 1.401(a)-31 since the plan obviously considers these amounts to be distributable.

While not the case with the OP, I think that a plan that ONLY offers an IRR as a rollover option would have to amend the plan to make the after tax sub account non distributable while still employed. By making that account non distributable, the plan could restrict IRRs to ONLY non distributable amounts which would block distribution to the participant or to a Roth IRA. But an IRR could still be done as outlined in IRS Notice 2013-74.

Again, in the OPs case a distribution was made to the OP as the only option, apparently in violation of the Reg and the OP might want to challenge the plan if they want a direct rollover done bad enough. The above paragraph does not apply to the OP, but would become an issue when ONLY an IRR was offered. So I don't think a plan can restrict to IRRs only unless they make the after tax sub account NON distributable.

Thoughts?

m2go
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Re: Mega Backdoor question - from 401(k) to Roth IRA without intermediary traditional IRA?

Post by m2go » Fri Sep 14, 2018 12:24 am

Is there anything wrong with doing a deposit followed by a redeposit, other than evidently being more involved, involving the risk of IRS, getting compulsory withholding that one has to replenish, and so forth...?

I actually left that employer, so it is no longer my battle to fight (although I have two more years of tax returns to contend with). Regrettably, my new employer does not offer after-tax accounts, so the Mega Backdoor will be closed for me in the future :-(

Was fun (and profitable) while it lasted!

Spirit Rider
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Re: Mega Backdoor question - from 401(k) to Roth IRA without intermediary traditional IRA?

Post by Spirit Rider » Fri Sep 14, 2018 4:27 pm

I just thought of one thing that might have been relevant to the OP and be relevant to others following this thread

A plan may, but is not required to do the split-rollover of after-tax contributions -> Roth IRA and after-tax earnings -> traditional IRA or other pre-tax accounts.

However, you can partially get around this. They must allow a direct rollover of one and a distribution of the other.

For example, they must allow a direct rollover of the after-tax contributions -> Roth IRA and a distribution of the after-tax earnings. You can then do an indirect rollover of the earning to a traditional IRA, one-participant 401k, etc...

Indirect rollovers between a qualified plan and IRA are not included in the one IRA rollover limit.

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