Trad IRA rollover to 401K

My brother's client calls and asks if he should roll his Trad IRA into his 401K, he said his brokerage firm recommended this as a strategy.

His Trad IRA has roughly $60,000 in Non Ded Contributions (Basis) and about $80,000 in earnings and contributions that were deducted in years past.

His brokerage firm (think F word) mentioned that if he converts all of the Trad IRA to a Roth IRA, he will have to pay tax on the portion that represents earnings/deducted contributions. Instead they told him to consider rolling his Trad IRA into his 401K. They said he can take the Basis portion of the IRA and roll it into the Roth 401K bucket (for lack of better term) and then the portion that represents earnings (and before tax contributions) can be rolled into the regular 401K bucket.

Two items are rattling in my mind: I didn't know you could cherry pick the portion of the Trad IRA you could roll into each bucket (Roth and Regular 401K) AND how is the 401K administrator to know that the client made Non Deductible contributions to his IRA?

Is this a mess waiting to happen? BTW, please send an invoice to my brother for your time!

I just saw Neill has a similar post, but maybe others have seen this strategy before. Economic substance codified and what not, I think the IRS may see through this scheme. Just might end up in tax court, but I'd hate for it to happen to one of our clients!

Agree with the F brokerage. This is a standard technique that has been around for many years. I have suggested this approach many times to clients. The downside, is that the rollover funds are subject to the new employers plan rules so maybe locked up for a while. I find the technique most useful when rolling to a solo 401k for the self employed.

Thank you kindly. My main concern is the brokerage firm botching the reporting of the 1099Rs and receiving a probing CP2000 letter. But if the technique has been around, then maybe the IRS is familiar with it.

Thanks again!

I haven't heard of rolling the nondeductible IRA contributions to a Roth 401(k). I'm not sure if that part is allowed or really even necessary.

As WEISSEA mentioned, this is a fairly common technique to avoid the pro rata rule on traditional to Roth IRA conversions.

Here is an article in the Journal of Accountancy explaining the technique: http://www.journalofaccountancy.com/Iss ... 126284.htm

This was also covered in the 2011 University of Illinois Federal Tax Workbook. The chapter archive is available here: http://www2.taxschool.illinois.edu/taxb ... rement.pdf (See Page 38 of the pdf file, or page 184 of the actual book).

An online search for "Backdoor Roth" will turn up countless other blogs posts, articles, and forum discussions on this technique.

I thought that you couldn't rollover any IRA funds into a 401(k) unless the IRA was itself a rollover IRA, funded entirely from a 401(k) or other qualified employer plan. Is my memory shaky? Or does everyone know that, and thus it was unnecessary to mention?

I have seen it done in the other direction, a rollover from an employer plan split into a traditional and Roth IRA, based on taxed and non-taxed contributions into the employer plan.

I missed the ROTH 401k part. Not sure that works as I thought a ROTH 401k needs to be from employee deferrals. Need to do some research as to whether one can roll a ROTH IRA to a ROTH 401k. Can do the reverse for sure. The standard method is to take a traditional IRA with both tax and pretax amounts and roll an amount equal to the pretax to the 401k. Then take the remaining amount equal to the basis and convert to a ROTH IRA.

Here's a rollover chart available on IRS website: http://www.irs.gov/pub/irs-tege/rollover_chart.pdf