Retirement Savings and Benefits
Questions and comments about IRAs, 401k accounts, social security, and other forms of retirement savings and benefits.
Do After-Tax 401k Contributions count as Conversions?
Posted by: AKay, August 8, 2017 12:36AM
A number of years ago my husband made after-tax contributions to his traditional 401k. In 2010, we went through the process of "isolating the basis" & putting the after-tax 401k contributions into his Roth IRA.

We are now getting a divorce. I am trying to figure out the contribution & conversion basis in our respective Roth IRAs.

Do the after-tax 401k contributions transferred to his Roth IRA go in the conversion basis bucket?

This is relevant because he is taking large distributions from his Roth IRAs. Also, some of the money from his Roth IRA was transferred to my Roth as part of the divorce agreement & I want to correctly determine my pro-rata share of his contribution & conversion basis.

Thanks for your help!

Re: Do After-Tax 401k Contributions count as Conversions?
Posted by: Alan S., August 8, 2017 02:46AM
Yes, the 401k rollover from the after tax sub account would be treated as a partially taxable, but likely mostly non taxable conversion. If there was no earnings included in the Roth rollover, then the entire amount is non taxable. Since 5 years have passed all of the rollover could now be distributed free of tax or penalty.

If you are receiving 50% of his Roth IRA, you receive 50% of his regular contributions basis on the date of the transfer incident to divorce. You also receive 50% of his conversion basis including the Roth rollover of 2010. That means you also get 50% of any gains in the Roth IRA.

You are wise to document the basis amounts as of the date of transfer, as you will need those amounts to report any non qualified Roth distributions you take on Form 8606.

If he took out Roth distributions after the decree but prior to the transfer of half the funds to you, I hope that the amount you received was correctly adjusted to MORE THAN HALF the value on the date of transfer.

Note that there is no QDRO penalty exception for an IRA distribution, as would have been the case if had been awarded part of his 401k or other qualified plan.

Re: Do After-Tax 401k Contributions count as Conversions?
Posted by: AKay, August 8, 2017 08:23PM
Thanks for the reply, Alan S.

Do we both need to file Form 8606 in 2017 to state the new basis in our respective TIRAs & Roths? If yes, do the transfers incident to the divorce get listed on the 8606 just like any other type of distribution?

(Prior to the split, both our TIRAs had basis as well as us both having contribution & conversion basis in our respective Roth IRAs.

Per our settlement, we split our collective retirement nest egg in half. However, since his account values were higher this resulted in a transfer of money from his TIRA & Roth to my TIRA & Roth. I'm assuming my share of his basis is pro-rata based on the size of the transfer to my account.)

One more question related to Form 8606 . . . We filed a joint tax return for 2016, the year of his Roth distribution. This included a Form 8606 reflecting his Roth distribution, which came 100% from contribution basis. At the time, I did not know the value of his conversion basis, which Part III of the 8606 asks for, so I just left it blank.

Do you think it's necessary for us to file an amended return for 2016 that includes his conversion basis? OR is it well enough to just file new 8606s in 2017 which will reflect the updated basis amounts post split & leave it at that?

The addition of the conversion basis info to the 8606 does not affect the tax owed since he still has contribution basis left, so I'm tempted to skip it!

Re: Do After-Tax 401k Contributions count as Conversions?
Posted by: Alan S., August 8, 2017 11:45PM
For the joint 2016 return, as long as his regular Roth contribution basis exceeded his distribution amount, the form instructions are to stop and not enter any conversion basis. Therefore, there is probably no need to amend that return. However, you do need to know if the regular contribution basis shown on the 8606 is correct, since that figure reduced by the 2016 distribution is the remaining basis for regular contributions, and you will receive half of that.

For 2017, you do not have to file an 8606 for your Roth IRA to show your increased basis, as this is not needed until you take a distribution. But if you want to document your new regular contribution basis, you could take out $10 and then show your new basis on your 8606 and add an explanatory statement about the divorce transfer. You still would not show conversion basis, but you should document your own records as to what it is. Once you reach 59.5 and 5 years, these figures will no longer be needed since your Roth will then be fully qualified and you will not need an 8606 to report any Roth distributions.

For your TIRA basis adjusted for the increased basis, the instructions are not to file an 8606 for yourself until you would otherwise need to due to a distribution, conversion or new Non deductible contribution. The challenge is not to forget about your increased basis down the road.

If you feel more comfortable recording the updated basis for both TIRA and Roth, you could take a small distribution from both or make a small non deductible TIRA contribution for 2017, and use a single 8606 to update both your TIRA and Roth basis along with a single explanatory statement for both regarding the divorce transfer.

Re: Do After-Tax 401k Contributions count as Conversions?
Posted by: AKay, August 9, 2017 07:19PM
Thanks, I'm glad to know I don't have to amend last year's return on account of omitting the conversion basis.

I double checked the Roth contribution basis on line 22 of Form 8606 for my husband. It is the correct basis amount. However, I received way less than half his Roth IRA, so I'm assuming I only get a pro-rata share of his contribution & conversion basis.

The reason I thought I was required to file Form 8606 was because Pub 590 discusses transfers incident to divorce & TIRAs saying:

"If the transfer results in a change in the basis of the traditional IRA of either spouse, both spouses must file Form 8606 and follow the directions in the instructions for that form."

Maybe I'm taking that too literally & it's not necessary to file form 8606 immediately post-divorce?

Your idea about taking small distributions for purposes of updating your 8606 is a good one.

I'm now in the process of trying to wrap my mind around 25 years worth of conversions, after-tax contributions, & rollovers. I'm seeing the light at the end of the tunnel, but what a project!

Thanks so much for your guidance on all this.

Re: Do After-Tax 401k Contributions count as Conversions?
Posted by: Alan S., August 9, 2017 11:28PM
There is enough flexibility and lack of clarity in the instructions such that you can file the 8606 to explain basis change due to divorce even without a distribution, but certainly no later than the next time you would otherwise report IRA basis. Therefore, you would not need to take a distribution to justify reporting your basis if you do not want to, you could just report it with an explanation of the divorce order.

You are correct that the basis you receive is the same % of his basis that the transfer to you amounted to of his IRA value on the date of transfer. This also applies to the Roth IRA transfer relative to the amount of regular contribution basis and conversion basis at the time of transfer. It is helpful if you can coordinate with him, since the basis he reports should be the difference between your basis and the total basis he had prior to the transfer.

Congratulations for addressing this now. Most people would not do this until they had to file their next return, and would then face a research project. By doing this up front, you can will be able to tell at a glance how any distribution you plan is to be taxed.

Re: Do After-Tax 401k Contributions count as Conversions?
Posted by: AKay, August 10, 2017 05:06PM
Thanks for your insight.

I will likely go ahead then & file an 8606 for both of us this tax year & explain that it relates to the divorce. (I plan to offer to prepare his return this year. I think he will be fine with that.)

For his 8606, I suppose I indicate the amounts transferred to me in the appropriate distribution line items (7 & 19), indicate his new adjusted basis in his TIRA & Roths, and then write a statement on the bottom of the form indicating this relates to a divorce transfer?

And on my 8606, I just complete the parts where I state my adjusted basis in my TIRA as well as my new Roth conversion & contribution basis & write a note explaining I was on the receiving end of a divorce transfer?

I usually e-file using Turbo Tax, but I'm not sure there's a way to write the special text that would be needed, so perhaps paper filing will be required for this year?

Re: Do After-Tax 401k Contributions count as Conversions?
Posted by: Alan S., August 11, 2017 01:24AM
No, do not show the required transfer as a distribution, because it must be a non reportable transfer. There should be no 1099R issued.

For both your 8606 forms, lines 7 and 19 should not show an entry unless there was an actual distribution in addition to the divorce transfer.

The corrected amount of basis goes on lines 2,3, and 14 for the TIRA.

For the Roth IRA, there are no instructions on how to handle this. If you wanted to you could enter the revised Roth contribution basis on line 22 and the revised conversion basis on line 24 of each 8606. Attach an explanatory statement explaining the line 2 amount and the 22 and 24 amount for the Roth IRA.

For either party that takes an actual distribution in 2017, that will have to be integrated into the above instructions.

Re: Do After-Tax 401k Contributions count as Conversions?
Posted by: AKay, August 11, 2017 07:07PM
Thanks for the clarification. Extremely helpful! I can't thank you enough for all your guidance on this.

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