By Andy Ives, CFP®, AIF®
I recently inherited a traditional IRA from my mother. I mistakenly asked for a lump sum to be paid to me by the custodian. I realized after the fact that I wanted to set up a stretch IRA. I haven’t cashed the check yet. Can I just return it or have them stop payment on the check and change my option to an inherited beneficiary IRA?
Once the distribution is paid to you, you cannot roll it over to an inherited IRA. Since the custodian properly followed your original instructions for a lump-sum payout and the check was already issued, you will probably be locked into the result. There are no rules requiring the custodian to backtrack if someone changes their mind. However, this does not preclude you from seeking additional advice from a CPA or inquiring with the custodian about possible alternatives. Be aware that the ultimate decision is theirs.
I’ve been contributing the maximum for two years to my company’s after-tax sub account of my qualified 401k plan. I diligently convert those after-tax dollars to the in-plan Roth quickly to minimize tax on the earnings. The plan is keeping track of those as “2018 In-Plan Roth Conversions” and “2019 In-Plan Roth Conversions.” I am over 59 ½, so naturally I qualify for the catch-up contribution.
Yesterday I asked a plan customer service rep about the tax implications of the already-converted funds once I roll them over to my Roth IRA (which has been in place more than five years). They answered that the earnings will be taxed if they are rolled over in less than five years from the dates of conversion. I thought my Roth IRA, having already been in place more than five years, would “grandfather” the rollover of the earnings into the Roth IRA without taxation.
I have been reading on IRS.gov and can’t find any proof of my assertion. My concern is that the plan will designate those earnings as taxable when they should not be. I expect to be separated from service in September and wanted to rollover the entire 401k. (Of course, I also have pre-tax money in the plan.) As you know, Roth 401k funds are subject to RMDs, whereas Roth IRAs are not.
Do I have to leave those funds in place for five years for each conversion year to avoid the plan administrator giving me a 1099 indicating that the funds are taxable? Or am I just wrong and must wait five years from the date of each conversion year as they said?
You can roll over any of the funds in your Roth 401(k) to a Roth IRA without any taxation at the time of the rollover.
Since it has been only two years since your first conversion to your Roth 401(k), when funds leave your Roth 401(k), it would be considered a nonqualified distribution. This means that when you roll over funds to your Roth IRA your after-tax converted funds would go into your Roth IRA as basis and your pre-tax earnings on those funds would go into the Roth IRA as earnings.
The good news is that the 5-year holding period for qualified distributions from your Roth IRA would be the 5-year period applicable to the Roth IRA. Because you have had a Roth IRA for more than 5 years and are over 59 ½, any distribution from your Roth IRA would be tax and penalty free, including the rollover dollars that recently entered the account.
To avoid complications and the required 20% withholding, it is recommended that your pre-tax dollars also be moved to your traditional IRA via direct transfer.