IRA Rollovers to Qualified Plans: The Retained Investment Issue

Abstract

A taxpayer generally cannot distribute after-tax investment from his or her IRA, and avoid tax by leaving untaxed earnings in the IRA. Unfortunately, each IRA distribution must contain a proportionate amount of both taxable earnings and nontaxable investment. Nevertheless, a taxpayer may be able to achieve a similar result by rolling over part of an IRA distribution tax-free to a consenting qualified retirement plan. The tax law specifically limits such a tax-free rollover to the earnings portion of the distribution. Thus, the taxpayer may retain the nontaxable investment portion tax-free.

In some circumstances, a taxpayer might want to argue that he or she should be able to roll over earnings from an IRA directly to a qualified plan without distributing any related investment (i.e., by leaving the related investment in the IRA) or rolling it over to a Roth IRA. Congress, after all, has clearly shown that it approves only rollovers of earnings (and not investment) from IRAs to qualified plans. What is the utility then of forcing unwanted distributions of related investment that undermine the general goal of allowing funds contributed to an IRA to accumulate tax-free for retirement? Unfortunately, however, these arguments are unlikely to prevail.

Keywords: IRA, rollover, qualified plan