I believe the IRS requires a person to treat a Roth IRA conversion as consisting of a pro rata share of the individual’s pre- and after-tax retirement assets. When determining the taxable amount of a traditional-to-Roth IRA conversion, does my client include his 401(k) plan balance in the calculation?
ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with a financial advisor in Illinois is representative of a question we commonly receive related to Roth conversions.
Highlights of Discussion
- Your client would not include his 401(k) balance when determining the taxable amount of a traditional IRA-to-Roth IRA conversion. Please see IRS Publication 590-A [1]for further guidance.
- When calculating the taxability of a conversion in this case, your client would include all of his nonRoth IRAs for which he is the direct owner, including traditional IRAs, simplified employee pension (SEP) IRAs, and savings incentive match plan for employees (SIMPLE) IRAs.
- Retirement accounts that are not considered include
- Inherited traditional, SEP or SIMPLE IRAs (unless a spouse beneficiary has elected to treat the inherited IRA as his or her own);
- Defined contribution plans (e.g., 401(k) plans);
- Defined benefit pension plans;
- 403(b) plans;
- 457 plans;
- Nonqualified accounts and plans; and
- Annuities (unless they are individual retirement annuities under Section 408(b) of the Internal Revenue Code).
- The steps for calculating the taxable amount of a traditional IRA-to-Roth IRA conversion are part of the IRS Form 8606 [2], which your client must complete and file to report the conversion.
- Encourage your client to discuss the conversion with his tax advisor.
Conclusion
Because a traditional IRA-to-Roth IRA conversion is (generally) a taxable and (always) a reportable transaction, investors should consult their tax attorneys or professional tax advisors concerning their particular situations.