Can a reverse rollover reduce your client’s tax bill?

What do you want to know

  • A reverse rollover can allow clients to minimize taxes on a Roth conversion or avoid RMDs once the client reaches the required IRA start date.
  • Clients converting an IRA to a 401(k) may have more limited investment choices and fewer exceptions to penalties.
  • As with any retirement income planning strategy, it is important to consider each client’s unique situation before performing a reverse rollover.

In the typical case, clients want to transfer 401(k) funds into an independent IRA, whether they’re changing employers, retiring, or simply want more control over their retirement funds. However, there may be situations where a client may benefit from a “reverse rollover” strategy, where funds are transferred from an existing IRA to an employer-sponsored 401(k).

Clients looking to execute a Roth conversion in today’s bear market may be particularly attracted to the reverse rollover strategy, as it may allow the client to minimize taxes on the conversion – or even avoid minimum distributions Required (RMD) once the client reaches their required start date for the IRA.

Reverse Rollovers: The Basics

First, the reverse rollover strategy only works if the specific 401(k) plan in question accepts rollover contributions. While all employer-sponsored plans are required to allow participants to transfer funds from the plan to an IRA, the reverse is not true – some 401(k)s may not accept transfers at all. Clients should check with their plan administrator to determine if their 401(k) allows rollovers.

Additionally, the client is only permitted to carry forward pre-tax or deductible IRA contributions in the 401(k). So, if the IRA contains both deductible and non-deductible (after-tax) contributions, only the pre-tax dollars are eligible for transfer to the 401(k). Likewise, Roth IRA funds cannot be transferred into a traditional 401(k).

Clients can carry their entire deductible IRA balance into a 401(k) without limit.

RMD tax advantages and exceptions

There are many different reasons why a client might want to transfer IRA funds into their company-sponsored plan. If the client has reached age 72 and is still working, transferring funds from the IRA into the employer’s plan may allow the client to avoid or minimize RMDs under the exception. still in business” for 401(k) RMDs (client can only take advantage of (still active exception if client owns no more than 5% of business and plan allows deferred RMDs).

A reverse rollover can also help reduce the customer’s tax bill if the customer is interested in performing a Roth conversion. Generally, the pro rata rule requires the client to consider both deductible and non-deductible IRA contributions that exist on December 31 of the year of conversion when funding a backdoor Roth using the conversion strategy.

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