Roth 401K RMD Processing

[cheung325]

I reached 72 in year 2022 and had 401K and Roth 401K with my former employer. As I was not aware of Roth 401K RMD requirement, I did not do any rollover prior to age 72. Therefore, my former employer processed my RMD in 2022. Just wish I was born 1 year later, so I don't have to deal with this nightmare with the just signed Secure Act 2.0

Please enlighten me how the RMD on 401K and Roth 401K should be processed.

Below were what my former employer did on my first RMD on 2022:

1. My former employer calculated the combined RMD from  both Roth 401K and 401K and made it one RMD. The funding source for the only RMD cheque was from Roth 401K  with IRS distribution code "B".  I think this means I don't have to pay tax on this RMD.  No record with IRS distribution code"7" for the taxable 401K distribution portion.
2. The remaining balance from Roth 401K after the RMD amount for both Roth 401K and 401K was taken, they sent me a direct rollover cheque for deposit into Roth IRA.
3. The total balance of my 401K was directly rolled over to my external IRA account. No RMD was taken from 401K, although it was included in the combined single RMD cheque(funding source was Roth 401K)
4. The Company has completely ignored my formal written request for explanation of this process on 12/9/2022. I had not received any response so far.

My questions:
1.  Are above steps the correct way to process the RMDs for both Roth 401K and 401K? So I don't have to pay tax for my 401K RMD(no record with IRS distribution code "7"

2. There is no tax on qualified Roth 401K distribution. They took money out as RMD.  I will lose future tax free growth from this excessive withdrawal for 401K RMD.  What can I do to correct this?
3. What can I do to fix the taxable 401K RMD portion with no IRS distribution code "7" problem?

Thank you for your help.

Sara

[dmertz · Accepted solution]

1.  The tax code and regulations permit the combined RMD to be taken in any combination from either of the accounts, but perhaps the plan agreement specifies how the RMDs will be satisfied, particularly in the absence of any explicit instruction by the participant.

2.  If your intent was to have the entire RMD satisfied by taking funds from the traditional account, you can  somewhat recover by doing a partial Roth conversion in 2023 from the traditional IRA to the Roth IRA.  The difference is that you'll have a larger traditional IRA year-end balance on which your 2023 RMD will be calculated compared to what the balance would have been had the entire RMD been paid from the traditional 401(k) account.  Also, you would be realizing taxable in come in 2023 that would otherwise have been realized in 2022.  You'll need to complete your 2023 RMD for the traditional IRA before doing any Roth conversions.

Had you done this Roth conversion in 2022 after the RMD distribution, there would not have been these differences.  By taking all of the RMD from the Roth 401(k) the plan gave you the the opportunity to recover your intent by doing a Roth conversion before year end, but you did not do that.

3.  There is no problem.  The RMD for the traditional 401(k) account has been satisfied by the distribution from the Roth 401(k) account.  You should have three 2022 Forms 1099-R:  one with code B for the distribution satisfying the total RMD, one with code H for the direct rollover of the Roth 401(k) to the Roth IRA and one with code G for the direct rollover from the traditional 401(k) to the traditional IRA.  You must enter all of these.

[AbrahamT]

He's not counting the distribution from a Roth 401k toward the rmd from a traditional 401k. He simpled combined to two 401k distributions and took the total amount from the Roth 401k money making the whole distribution nontaxable when in essence a part of this distribution should have indeed been taxable; namely the rmd portion from the regular 401K amount.

[dmertz]

@AbrahamT , I believe that you misunderstand the that tax code and regulations.  They permit the RMD for the participant's traditional 401(k) account to be satisfied by a nontaxable distribution from the participant's designated Roth account in that same plan, which appears to be what happened here.

[Opus 17 · Accepted solution]

My thoughts.

1. I believe you must take an RMD from the 401k before the balance is rolled over to the private IRA.

2.  An RMD is required from a Roth 401k for tax year 2022.  Therefore, your plan correctly calculated the RMD amount.

3. The RMD could have been taken from either account; since it was taken from the Roth 401k account, it is non-taxable.  There's no taxable portion of the withdrawal because the required amount was all taken from the Roth side.

4. Then, you did a rollover of the Roth 401k to a Roth IRA, and the pre-tax 401k to a traditional IRA.  This is standard and not complicated or problematic.

Your questions:

1. This was one of the correct ways to take the RMD.  It could also have been taken exclusively from the pre-tax account, or split between the accounts. 

2. There is no way to put the money back into the Roth IRA and re-take the RMD from the pre-tax IRA.  Potentially, you could have reversed things if you were still enrolled in the 401k and you completed the reversal before December 31.  I have no idea if the plan can be held liable for performing the RMD and the rollovers in a way that had fewer tax advantages for you.

Remember that if you had taken the RMD entirely from the pre-tax IRA, you would be losing future growth in the pre-tax account, so the overall impact of taking the RMD from the after-tax account may not be as large as it seems.

If you want to have future tax-free withdrawals, you can do a conversion from the IRA to the Roth IRA.  However, you can't convert your RMD.  You need to take the RMD from the IRA, and then withdraw additional funds to convert.

Lastly, remember that withdrawals from the Roth IRA will not be qualified until 2026.  Unless you have a previous Roth IRA, and withdrawals from the Roth IRA before 2026 could be subject to income tax if you withdraw earnings.  

3. No correction is needed.  Because the entire amount was drawn from the after-tax account, no part is taxable. 

[Opus 17 · Accepted solution]

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@AbrahamT wrote:

He's not counting the distribution from a Roth 401k toward the rmd from a traditional 401k. He simpled combined to two 401k distributions and took the total amount from the Roth 401k money making the whole distribution nontaxable when in essence a part of this distribution should have indeed been taxable; namely the rmd portion from the regular 401K amount.

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The RMD requirement from 401k could have been satisfied by taking the entire amount from the pre-tax account, or taking the entire amount from the post-tax side, or taking a split amount from both sides.  Any of the 3 methods is valid.  The plan took the entire amount from the after-tax side, which minimizes the account holder's current tax, but might not agree with the account holder's long term goals.

[cheung325]

Thank you for your detailed explanation. I wish that my former employer would explain the RMD options as you did on your answer to my question #1.  

[cheung325]

Thank you very much for your quick and concise answer. I would not be stressed out if my former employer would explain it as you did.

Yes, I received 3 forms 1099R which are exactly as you have described.

By the way, my former employer does not provide us a plan agreement specifies how the RMDs will be satisfied, and neither do they allow us to provide any explicit instruction on the RMDs, only asked for the direct over IRA/Roth IRA brokerage firm and account numbers. The Distribution document they sent did not mention these at all, other than lump sum distribution is required with the RMD.

Last December I had looked up the IRS publication on defined plan distribution. It seems to me that the RMD for Designated Roth Account is to be done separately.

Below are the extracts for the designated Roth accounts I found on the IRS publications on Defined Plan distribution. Please correct me if I misinterpret it.

----------Beginning of Extracts---------------------------

• https://www.irs.gov/pub/irs-pdf/p4530.pdf 
• IRS RMD FAQ  

https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-required-minimum-distributions#...

• A designated Roth account is a separate account under a 401(k), 403(b) or governmental 457(b) plan: 

        ‧ to which designated Roth contributions are made, and 

        ‧ for which separate accounting of contributions, gains and losses is maintained. 

• Q. Does my employer need to establish a new account under my 401(k), 403(b) or governmental 457(b) plan to receive my designated Roth contributions?

         A.Yes. Designated Roth contributions must be kept completely separate from previous and current 401(k), 403(b)

             or governmental 457(b) pre-tax elective contributions. Your employer must establish a separate account for

             each participant making designated Roth contributions.

• An advantage of a designated Roth account is that you pay tax on your contributions now, but later, when you receive a qualified distribution from the account, it’s tax-free. Less tax on your plan distributions could mean more money in your pocket during your retirement.

• Defined Contribution Plans

         If you have more than one defined contribution plan, you must calculate and satisfy your RMDs separately for each

         plan and withdraw that amount from that plan.

• How are RMDs taxed?

         The account owner is taxed at his or her income tax rate on the amount of the withdrawn RMD. 

• Similar to a Roth IRA, qualified distributions from a designated Roth account, including all earnings, are tax-free. 

• Required minimum distributions

         Designated Roth accounts are subject to the required minimum distribution rules.

• If an account owner fails to withdraw a RMD, fails to withdraw the full amount of the RMD, or fails to withdraw the RMD by the applicable deadline, the amount not withdrawn is taxed at 50%.

---------End of Extracts-----------------------

Obviously “The tax code and regulations permit the combined RMD to be taken in any combination from either of the accounts” were not on the above IRS publications. Would you direct me to the specific IRS publication that would reference and detail this rule?

In regards to #2 on your reply:

“If your intent was to have the entire RMD satisfied by taking funds from the traditional account, you can somewhat recover by doing a partial Roth conversion in 2023 from the traditional IRA to the Roth IRA.“  This suggestion would make my tax return much easier.

Thank you for your help. 
Sara

[Opus 17]

"

     If you have more than one defined contribution plan, you must calculate and satisfy your RMDs separately for each

         plan and withdraw that amount from that plan."

You only had one plan, it sounds like, with 2 different accounts.  Not 2 different plans.

Right now, I have one plan with my former employer that has two accounts (employer contributions pre-tax and my contributions pre-tax).  When I hit 72, if I do nothing else, that will result in one RMD calculation, even though it has two accounts.  I have 3 accounts with my current employer; employer contributions (pre-tax), my contributions (Roth), and an employer match account (pre-tax) which is separate from the other pre-tax account.  So when I hit 72, that plan will also have one RMD, even though there are 3 accounts. 

[cheung325]

Thank you for the explanation of the plan and the accounts. So, looks like each employer will only have ONE plan for their employees.    I am just wondering what is the rationale for an employer to select a specific funding source for the RMD,  and does not give employees the options to choose which funding source works better for them? Is there any tax benefits for the employer if they take the entire amount from the post-tax side?

[dmertz]

For a 401(k) plan with a former employer, the employer taking the entire RMD provides the individual with the opportunity to to realize the income or not to the employee's best advantage.  The individual can later in the same year do a Roth conversion from the traditional pre-tax 401(k) account to reach the same taxable result as the individual would have had if the former employee had been given the opportunity to select the account from which the distribution was to be taken.  Even if the Roth conversion is done the following year the taxable result is similar except that the taxable income is realized the following year.  I would be much more annoyed if the former employer forced the distribution out of the traditional pre-tax account because in that case there would be no way for the individual to adjust the taxable result after the fact.

The employee can also proactively specify particular distributions needed to satisfy the RMD before the employer forces out the RMD automatically and avoid an automatic distribution altogether.

[Opus 17]

@cheung325 

The real problem here seems to have been a lack of communication about the RMD, which was followed up by the rapid rollover from the 401(k) to the traditional and Roth IRAs, which limited your options in adjusting the tax treatment to something you preferred.