Retirement Account Question - Rollover from 401(k) to Roth IRA

[Out of Steam]

My daughter rolled over a small (pretax) 401(k) account from a previous employer, but transferred it to a Roth IRA as it was the only IRA she had, rather than a pretax IRA.

Since the amount was small, she was willing to pay the taxes on it. But the tax program she is working with (Taxslayer) says that this was improper and she has to pay a penalty for early withdrawal as well as the taxes.

I had advised her that this was OK and both she and my wife are rather unhappy with me. My wife is recommending she get a financial advisor.

Is this true? Is there any way to fix it other than paying the penalty?

 

[cathy63]

401(k) to Roth IRA is a legal rollover as long as you include the amount in income. There should not be a penalty.

How exactly was the rollover accomplished? Check made out FBO your daughter, check directly to your daughter, transfer directly to the new custodian? If by check to your daughter, did she complete the rollover within 60 days?

On her 1099-R from the 401(k) provider, what is in box 2a and box 7?

 

[njhowie]

It's not clear to me that any penalty is due, only the taxes on the amount rolled over.

https://www.aarp.org/money/taxes/info-2021/converting-pretax-401k-to-roth-ira.html

 

[Out of Steam]

It's not clear to me that any penalty is due, only the taxes on the amount rolled over.

https://www.aarp.org/money/taxes/info-2021/converting-pretax-401k-to-roth-ira.html

From the AARP article, the problem appears to be that it was done as a single rollover, 401(k) straight to Roth, rather than a double rollover, 401(k) to conventional IRA, to Roth.

 

[Out of Steam]

401(k) to Roth IRA is a legal rollover as long as you include the amount in income. There should not be a penalty.

How exactly was the rollover accomplished? Check made out FBO your daughter, check directly to your daughter, transfer directly to the new custodian? If by check to your daughter, did she complete the rollover within 60 days?

On her 1099-R from the 401(k) provider, what is in box 2a and box 7?

It was a direct transfer to the new custodian. I have not seen the 1099-R.

 

[njhowie]

From the AARP article, the problem appears to be that it was done as a single rollover, 401(k) straight to Roth, rather than a double rollover, 401(k) to conventional IRA, to Roth.

The article just indicates that you can have some amount go from the 401k to one and another amount go to the other.

You are not reading it correctly - it was not 401k to conventional, to Roth. It was one amount from 401k to conventional and another amount 401k to Roth. In your case, the entire amount was 401k to Roth, so taxes are due on the entire amount.

Assuming you are eligible to move the funds out of your 401(k), you should first ask the company if it will allow you to do two separate direct rollovers. One would be from the 401(k) to your traditional IRA. That rollover will be tax-free.

The other direct rollover would be for the remaining funds you want to convert to your Roth IRA. That direct rollover would be a taxable Roth conversion.

 

[cathy63]

It was a direct transfer to the new custodian. I have not seen the 1099-R.

So they withheld 20% for tax when she did the rollover? Did she make up the 20% that was withheld from her personal funds to complete the full rollover? If not, there is a 10% penalty on that 20%. The 10% is not on the full amount of the rollover, only the portion that didn't end up in the Roth.

It's also possible that there's a mistake on the 1099-R and the 401(k) custodian should fix it, but no way to tell without knowing what's on it.

Form 5329 is where the penalty is calculated, so she could look at that and see how TaxSlayer is filling it in.

 

[Out of Steam]

So they withheld 20% for tax when she did the rollover? Did she make up the 20% that was withheld from her personal funds to complete the full rollover? If not, there is a 10% penalty on that 20%. The 10% is not on the full amount of the rollover, only the portion that didn't end up in the Roth.

It's also possible that there's a mistake on the 1099-R and the 401(k) custodian should fix it, but no way to tell without knowing what's on it.

Form 5329 is where the penalty is calculated, so she could look at that and see how TaxSlayer is filling it in.

I've asked her to send me a picture of the 1099. I don't think anything was withheld, but the form will verify.

 

[retire2020]

I have rolled over partial amount from my 401K to Roth directly over the years and never had to pay any penalty. Please verify her 1099-R for any mistakes in distribution code. If it helps, I will share my past 1099-R for you to compare.

You are never a prophet in your own land! I get the same reaction from my daughter and my wife…

 

[Out of Steam]

I have rolled over partial amount from my 401K to Roth directly over the years and never had to pay any penalty. Please verify her 1099-R for any mistakes in distribution code. If it helps, I will share my past 1099-R for you to compare.

You are never a prophet in your own land! I get the same reaction from my daughter and my wife…

Thank you for your offer on the 1099, knowing what the codes that worked were would help!

 

[retire2020]

thank you for your offer on the 1099, knowing what the codes that worked were would help!

 

[Out of Steam]

I just got my daughter's 1099-R.

It was also a distribution code G in Box 7 and had no taxes withheld.

 

[Out of Steam]

Does she simply report it on Form 8606 as a taxable conversion to a Roth?

 

[retire2020]

No 8606. It gets reported in line 4b IRA distribution on 1040 as taxable amount.

 

[Out of Steam]

No 8606. It gets reported in line 4b IRA distribution on 1040 as taxable amount.

I opened a blank return for her in TurboTax and it did exactly that. It appears to be either operator error or an issue with the software she's using.

Thanks, all!