Roth IRA

[Small town]

Client rolled over from a designated Roth account into a Roth IRA and also took a distribution from the Roth IRA, receiving two separate 1099-R forms from different companies. The 1099-R for the rollover has an amount in box 5 for employee contributions and also has a year 2010 in box 11. Client is not yet age 59 1/2. Do I manually enter the box 5 amount from the rollover 1099-R into the IRA worksheet to get the correct taxable amount of the 1099-R Roth distribution?

[qbteachmt]

There might not be anything taxable. There are Ordering Rules:

https://www.investopedia.com/terms/o/orderingrules.asp

You need to compare how much they took from the various eligibility factors (various 5-year rules). It isn't clear if that rollover went to an existing Roth, and they had been making contributions there, outside of work. Or, the rollover was the new Roth, and that is the only source of funds, and took the distribution from the Rolled over funds, after it is considered Rolled.

So far, it seems nothing is taxable, but you know details we don't.

[Small town]

Thank you for the link. The rollover was to a new Roth and that is the only source of funds. Client left employment and rolled everything over. I don't know however if the distribution was after the rollover was completed or during the process of the rolling over of investments. Do I need to ask my client for this information? What further information do I need or do I consider the amounts in box 5 of the 1099-R rollovers as the basis of the distribution on the 1099-R with the code J in box 7? I'm not sure if I am describing this clearly?

[qbteachmt]

"I don't know however if the distribution was after the rollover was completed or during the process of the rolling over of investments."

Yes, you do; Look at the issuer names on the 1099-R to see what happened because of who reported it. Was the 1099-R for the distribution out of that "new Roth IRA" or out of that ex-employer's Designated Roth? Or, was the Designated Roth paid out to your taxpayer, who only rolled over some of it to the new Roth account?

"What further information do I need"

All of this matters.

"or do I consider the amounts in box 5 of the 1099-R rollovers"

Wait; now you used Plural for Rollovers? Plural?

"as the basis of the distribution on the 1099-R with the code J in box 7?"

"Basis" is the amount the taxpayer contributed. It is not Earnings. Yet, the amount a leaving employee would be entitled to take or roll would be the entire account balance, including any earnings from the past 11 years.

[Small town]

I spoke to my client to clarify. In an effort to make things less confusing, I only asked about one of my clients roll overs. My client left employment from two jobs where contributions were made to their Roth Designated accounts. One job was from 2010 (was never rolled over even after leaving employment) and the other was 2017 and both were rolled over in 2021. All of the Designated Roth Accounts were rolled over into one new Roth IRA. From the 2017 investment, my client received a check in May, but rolled it over in June, the 2010 investment was a direct roll over. Two distributions from the new Roth IRA were made in 2021, one happened two weeks after the roll over into the Roth IRA and another in August. Are you saying that the new Roth IRA contribution amount is the total of the roll overs, or do I have to track that the roll overs were part from contributions and part from earnings? I have searched IRS code, but I haven't found a clear answer, and I'm unsure if this is a conversion since they are both Roth accounts? 

[qbteachmt · Accepted solution]

"All of the Designated Roth Accounts were rolled over into one new Roth IRA."

Yay! See how things will make sense if you take it one step at a time?

There would be two 1099-R, then. And there will be one Form 5498.

"From the 2017 investment" account...", my client received a check in May, but rolled it over in June,"

For reference, it matters if that check issued is payable to your taxpayer or to their broker, and if that had been from a 401(k) account (or traditional IRA); and, always look for withholding, to be able to tell if the taxpayer rolled over the same Gross or not. A Rollover has a 60-day window. A Roth also has various 5-year rules for "qualification" as well.

"the 2010 investment was a direct roll over."

Okay, let's review that Rollovers (where the funds are available to the client) for Roth are only permitted once in 365 days. That's why Direct is the better option.

"Two distributions from the new Roth IRA were made in 2021," technically, Three. If that check was made out to the taxpayer that got Rolled..."one happened two weeks after the roll over into the Roth IRA and another in August."

Yay! So, now you know there would be 3 1099-R. One from each employer and one from the Roth IRA brokerage. But now we bump against the 5-year rule. If there was no Roth IRA prior to this, your taxpayer fails the 5-year test:

https://www.investopedia.com/articles/retirement/09/roth-401k-rollover.asp

"Are you saying that the new Roth IRA contribution amount is the total of the roll overs,"

Nothing here is a contribution, so far. What you told us about is Rollovers. These are not synonyms. A Contribution is new money for a specific tax year against the earned income for that year and the taxpayer's eligibility. So far, you have been asking about moved money and not new money.

"or do I have to track that the roll overs were part from contributions and part from earnings?"

You should read up on the various Roth 5-year rules. Your taxpayer should have the info, i but it wouldn't have mattered to the tax return, if everything had been qualified. Now, yes, there is going to be penalty and taxable amounts. The age of the taxpayer matters, the amount of time any Roth IRA has existed (not Roth 401(k)), etc. This is why taxpayers need to get better tax guidance before taking these actions.

"I have searched IRS code, but I haven't found a clear answer, and I'm unsure if this is a conversion since they are both Roth accounts?"

The answers are all there, but also use web resources; especially, I like those written towards the consumer, such as that investopedia article I linked (they have a bunch of others), and this one:

https://meetbeagle.com/resources/post/how-many-401k-rollovers-per-year

It's not Conversion, as you note, since it is from similar tax status plan/account to account. For pre-taxed funds, it would matter if the account had Basis (commingled funds). A Roth is entirely post-tax contributions and supposedly tax-free earnings, but there are multiple limitations that are in place to try to keep the taxpayer from using it as a Loan Account, for example.

You should be able to use the 1099-R worksheet, but each 1099-R is its own events.

[Small town]

Thank you for the links, much easier than IRS code to read. The program will calculate the taxable and nontaxable income if you enter through the complete worksheet, which I thought I had, but I had not. Thank you for mentioning that also. Turns out that the entire roll over amounts become the basis for the new Roth IRA. The distribution was not taxable because it was less than the employee contributions into their Roth 401(k). The remaining contributions and earnings become the new Roth IRA basis going forward. The earnings that was rolled over into the new Roth IRA from the Roth 401(k) are included in their gross income for 2021, which makes sense. I had never worked through a Roth roll over like this before, so the research was time consuming, but worth the effort. 

[rbynaker]

Thanks for reporting back.  I haven't had to research this but as time goes on this will become more "normal".  I have a Roth 401(k) and I'm not even sure what the distribution rules are, figured I'd learn that info when I need to. 🙂

Rick

[qbteachmt]

A distribution that is less than their contributions is fine. It seems that otherwise, they violated one or more rules.

"The earnings that was rolled over into the new Roth IRA from the Roth 401(k) are included in their gross income for 2021, which makes sense."

Only if they violated one (or more) of those rules. Otherwise, Roth grows tax-free.

This is exactly why I tell people to open a Roth as soon as possible, even if you only put $500 and then don't put anything else in it for years, so that your "5-year existed" rule is met.

[qbteachmt]

"I have a Roth 401(k) and I'm not even sure what the distribution rules are"

You have RMD; roll it to Roth IRA, and that requirement goes away.

[Small town]

Yes, unfortunately they had to violate the rules. They have not reached the required age, and from what I understand, the 5-year rule starts over with the 'New" Roth IRA. Even though they had contributions longer than 5 years in their Roth 401(k)'s, they didn't have a Roth IRA in place prior to rolling over. If they would have already had a Roth IRA before and rolled over into it, the 5-year rule begins with that Roth IRA. That is good advice to open a Roth IRA now if you plan to eventually roll over from a Roth 401(k). Also, even if you are 59 1/2, you still have to meet the 5-year rule to withdrawal the earnings tax free, from what I understand.

[rbynaker]

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@qbteachmt wrote:

"I have a Roth 401(k) and I'm not even sure what the distribution rules are"

You have RMD; roll it to Roth IRA, and that requirement goes away.

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I have 20+ years before I have to deal with the RMD. 🙂

The new time clock that's running now is that TD Ameritrade is terminating their prototype plans later this year and moving everyone over to Schwab plans.  Normally I wouldn't care but the Schwab plans don't allow Roth contributions.  Yay, more fun with bank mergers!  This was after Capital One acquired my Traditional IRA from ING Direct a few years ago and then, earlier this year, decided to stop doing IRAs.  So I may end up with 4 direct rollovers in 2022.  And I probably need to figure out how to file a 5500-EZ for a terminated plan.

[qbteachmt]

"If they would have already had a Roth IRA before and rolled over into it"

You don't have to roll into it. That's the trick. You just need one to have existed at least 5 years earlier time (no, Roth 401(k) doesn't qualify for this provision, since it is an employer plan), even if it is not the one you use, later. Park $500 somewhere, and then roll/contribute to a different one that you use for investments, for instance. It's like the old days where you have a small Savings account + your Checking account.

I can't even count how many times I have had to correct brokers on the provisions, and I am not a retirement advisor by profession. More like, out of self defense  🙂

[Small town]

Yes, aha moment! So many if's and's and but's...Thank you!

[Small town]

You seem knowledgeable in the world of retirement, could I ask you another question? Another client has a form 1099-R showing a code J in box 7, both boxes in 2b are marked, there is no amount on box 2a. I asked them about their contributions, and they told me this account was from a rollover from years ago when leaving employment. They haven't made any contributions since rolling it over. They removed the investment to purchase a rental house for investment. They don't know much more than that and I'm not sure what else I need to ask them. They are not yet 59 1/2, but I think they have had the account for more than 5 years. Since they are not sure and can't give me any proof of contributions, do I just enter it as all taxable? 

[qbteachmt]

Start with the basics, that the issuer only knows what they know. They also interpret what they should be marking, differently.

Remember, all of these terms matter. They mean different things; there are different requirements and provisions. You cannot just use the word Account. Roth Account? Traditional IRA Account? So, you need to know which account type this is. "and they told me this account was from a rollover from years ago when leaving employment" would be moot, now, unless there was Basis, which they would have seen on the initial rollover, if that was also a conversion.

And the issuer has no idea if there was Basis in that account or not; hence, they don't know about taxable amounts. That doesn't make it all taxable, and that doesn't make it partially taxable. It simply means, "Do not ask us. Ask the taxpayer."

"They removed the investment"

Let's restate it: They took a total distribution...

"to purchase a rental house for investment."

There is no known exception to Taxability or Early Distribution Penalty for removing your retirement funds to do this, unless they got guidance to buy the rental house within their self-directed IRA, which is one of those "get rich quick" lessons you can pay to learn about. It's a bit of a dumb idea, but people do it.

"They don't know much more than that"

Then let's assume:

1. They did not do this inside of a self-directed IRA.

2. They should never be running a self-directed IRA. They do not pay attention to enough details to take on that responsibility.

"They are not yet 59 1/2, but I think they have had the account for more than 5 years."

It's only Roth IRA that has any 5-year rules to be met.

"Since they are not sure and can't give me any proof of contributions, do I just enter it as all taxable?"

You have to start with the Account Type.

[Small town]

It is a Roth Account, also there has been federal and state withheld, if that makes any difference?

[qbteachmt]

They should remember when they left that employer and moved the money. It would be in the statement, too, and there would be tax form(s) from that event, as well, and even the broker should be able to answer the question. Even their own tax filing might show something for the event.

There is withholding? That seems like the issuer knows there will be taxes owed. Typically, a Roth distribution would not be taxable, so there is no withholding. Are they sure they meet any/all of the 5-year rules?

No one remembers how much they contributed, which would be found on W2 and paystubs when done through an employer (then their Tax Transcript for that year would include the W2 info), or converted and paid taxes on (which would be on a Tax Transcript and Return, as well), they need to find as much info as possible. For instance, there might have been both 401(k) (employer match) to their own Roth 401(k) amount (post-taxed) and when you leave that employer, the 401(k) would roll to Trad IRA and the Roth 401(k) would roll to Roth. It seems a shame they might be reporting as taxable the money they already put in post-tax.

The IRS has prescribed a distribution hierarchy for Roth IRA assets. Contributions are always taken first; conversions (if any) are second in order by year of contribution, with converted pre-tax assets taken first and converted after-tax assets taken second. Earnings are considered distributed last.

Example:

https://www.investopedia.com/terms/o/orderingrules.asp

Assets are distributed from a Roth IRA in the following order:

1. IRA participant contributions
2. Taxable conversions
3. Non-taxable conversions
4. Earnings

And if they are not at least 59 1/2, then Earnings will include the penalty, even if everything else qualifies for non-taxable and no penalty.

You have a lot of moving parts, my friend. You have to hold the taxpayer responsible for getting most of this info, or giving you authorization to do that. You are going to need an extension for the 1040.

Good luck.