As part of ThinkAdvisor's Special Report, 23 Days of Tax Planning Advice: 2016, throughout the month of March, we are partnering with our ALM sister service, Tax Facts Online, to take a deeper dive into certain tax planning issues in a convenient Q&A format.
1. What is an eligible retirement plan for purposes of the rollover rules?
The definition of "eligible retirement plan" depends on the plan from which a rollover is made. An eligible retirement plan with respect to a distribution from a qualified plan means an IRA, another qualified plan, a Section 403(a) annuity, a Section 403(b) tax sheltered annuity, and an eligible Section 457 governmental plan (provided it agrees to separately account for funds received from any eligible retirement plan except another eligible Section 457 governmental plan).
Non-Roth IRAs (traditional, SEP, and SIMPLE). An eligible retirement plan with respect to a distribution from a non-Roth IRA (an individual retirement account or an individual retirement annuity) means an IRA, a qualified plan, a Section 403(a) annuity, an eligible Section 457 governmental plan (provided it agrees to separately account for funds received from any eligible retirement plan except another eligible Section 457 governmental plan), and a Section 403(b) tax sheltered annuity. Amounts paid or distributed out of a SIMPLE IRA during the first two years of participation may be rolled over only to another SIMPLE IRA. The only rollover permitted to a SIMPLE IRA is from another SIMPLE IRA.
Roth IRAs. A distribution from a Roth IRA generally can be rolled over only to another Roth IRA. A rollover or conversion from a non-Roth IRA or other retirement plan into a Roth IRA generally is a taxable event.
Section 403(b) annuity. An eligible retirement plan with respect to a distribution from a Section 403(b) tax sheltered annuity includes a non-Roth IRA, a qualified plan, a Section 403(a) annuity, an eligible Section 457 governmental plan (provided it agrees to separately account for funds received from any eligible retirement plan except another eligible Section 457 governmental plan), and another Section 403(b) annuity.
Eligible Section 457 governmental plan. An eligible retirement plan with respect to a distribution from an eligible Section 457 governmental plan includes a non-Roth IRA, a qualified plan, a Section 403(a) annuity, another eligible Section 457 governmental plan and a Section 403(b) annuity.
2. What new rules apply to allow a taxpayer to rollover pre-tax and after-tax contributions in a qualified plan into separate accounts in a single distribution?
The IRS now allows a distribution from an employer-sponsored retirement account to be treated as a single distribution even if it contains both pre-tax and after-tax contributions, and even if those contributions are rolled over into separate accounts, so long as the amounts are scheduled to be distributed at the same time. The new rules allow the taxpayer to allocate pre-tax and after-tax contributions among different types of accounts in order to maximize their future earnings potential—avoiding the pro-rata tax treatment discussed below.
This creates a planning opportunity for higher income taxpayers who have sufficient funds so that they are able to make contributions in excess of the pre-tax limit ($18,000 in 2016). If the specific plan allows for after-tax contributions, these taxpayers can contribute after-tax dollars with the knowledge that those funds can be separated and rolled directly into a Roth upon exiting the employer-sponsored plan, without additional tax liability.
Prior regulations permitted a distribution to be rolled partly into a traditional account and partly into a Roth, but the taxpayer was required to treat the distribution as two separate distributions—meaning that the distribution to each account would be treated as coming partly from pre-tax contributions and partly from after-tax contributions.
So, for example, if the taxpayer's distribution of $100,000 consisted of $80,000 in pre-tax contributions and $20,000 in after-tax contributions, the taxpayer could direct that $80,000 be transferred to a traditional IRA and $20,000 to a Roth. However, the amount transferred to each account would be pro-rated (80%-20%) so that 80 percent of the Roth transfer would be taxed.
3. Must a participant receiving an eligible rollover distribution have the option of making a direct rollover to another qualified plan?
Yes.
All qualified plans, a Section 403(b) tax sheltered annuity, and an eligible Section 457 governmental plan must provide a participant receiving an eligible rollover distribution the option to have the distribution transferred in the form of a direct rollover to another eligible retirement plan. This direct rollover option generally must be provided to any participant receiving a distribution.
A direct rollover is defined as an eligible rollover distribution (see above) that is paid directly to an eligible retirement plan for the benefit of the distributee. A direct rollover may be accomplished by any reasonable means of direct payment, including the use of a wire transfer or a check that is negotiable only by the trustee of the eligible retirement plan. Giving the check to the distributee for delivery to the eligible retirement plan is considered reasonable provided that the check is made payable to the trustee of the eligible retirement plan for the benefit of the distributee. Certain amounts may be rolled over only in the form of a trustee-to-trustee transfer. Plans are not required to accept rollovers, direct or otherwise.
