The ERISA consultants at the Columbia Management 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. A recent call with an advisor in Maine is representative of a common inquiry involving conversions of 401(k) plans to Roth IRAs. The advisor asked:
“My client understands that if she converts her 401(k) plan account balance to a Roth IRA she will be required to include the pre-tax portion of the converted amount in her taxable income for the year. Does a 401(k) plan apply federal income tax withholding to a 401(k)-to-Roth IRA conversion?”
Highlights of Discussion
• Generally speaking, whether the 401(k) plan will apply federal income tax withholding will depend on how your client completes the 401(k)-to-Roth IRA conversion.
• If the conversion results from a direct rollover of the 401(k) plan to a Roth IRA, the 401(k) plan will not automatically apply federal income tax withholding, even though the distribution is includible in your client’s taxable income for the year of the conversion. However, your client and the plan administrator may enter into a voluntary withholding agreement with respect to the converted amount. (IRS Notice 2008-30, Q&A 6).
• In contrast, if the conversion results from a 60-day indirect rollover, then the plan administrator is required to withhold 20% of the distribution paid to your client, pursuant to Section 3405(c) of the Internal Revenue Code.
• In either scenario — a direct or indirect rollover/conversion — your client would not be subject to an early withdrawal tax, regardless of her age.
Conclusion
When dealing with tax matters, it is always advisable to suggest to your clients that they ask their tax attorneys or consultants regarding their specific situations.That said, financial advisors who have a general knowledge of the rules regarding conversions can help their clients better identify the right questions to ask.
The Columbia Management Retirement Learning Center Resource Desk is staffed by the Retirement Learning Center, LLC, a third-party industry consultant that is not affiliated with Columbia Management. For informational purposes only. Please consult a tax advisor or attorney for specific tax or legal needs. © 2013 Columbia Management Investment Advisers, LLC. Used with permission.
