Note: This is an updated version of an article previously published in June 2022.

Many investors are unaware of the many potential advantages available when rolling over retirement funds from their Individual Retirement Account (IRA) into their employer-sponsored 401(k) plan. This movement of funds, however, must be carefully reviewed, as there are many variables to consider.

Most individuals correctly view retirement account rollovers as a viable option to move tax-deferred funds from an employer-sponsored plan such as a 401(k) plan into an IRA. But retirement rollovers can be a two-way street. In certain situations, an eligible individual can roll retirement assets from their traditional IRA (including a SEP or a SIMPLE IRA) into an employer-sponsored retirement plan such as a 401(k), 403(b), or governmental 457(b). This movement of retirement funds is commonly known as a “reverse rollover” or “roll in.”

Surprisingly, where 401(k) plans are required to allow participants’ assets to roll the funds out of the plan into an IRA, there is no corresponding rule that plans must allow for rollovers into the plan from an IRA or from a former employer’s 401(k) plan. While most 401(k) plans do allow for a reverse rollover, check your plan’s Summary Plan Description or inquire with your Plan Administrator before initiating the process.

There are both advantages and disadvantages to doing a reverse rollover. Your own individual circumstances and needs should be carefully considered.

Pro-Rata Distribution and How to Separate Pre-Tax and After-Tax Funds

A 401(k) plan is generally permitted to allow incoming rollovers of pre-tax funds only. Notably, Roth IRA or after-tax (nondeductible) IRA funds cannot be rolled over into a 401(k) or other employer-sponsored retirement plan

Do you have an IRA (traditional, SEP, SIMPLE) that contains basis (i.e., after-tax dollars)?  Usually, when any of an individual’s IRAs (excluding Roth IRA) contains both pre-tax (tax-deductible contributions plus earnings) and after-tax money, a withdrawal (e.g., rollover, Roth conversion, required minimum distribution, normal distribution, etc.) is partially taxable (“pro-rata” distribution of funds), making tax liability and reporting onerous.

An individual’s aggregated IRA account balance is determined as of December 31 of the year of distribution; however, the impact or a pro-rata distribution can be lessened or eliminated by reducing the amount of pre-tax IRA dollars by year-end.

If, for example, you’re considering converting an after-tax (nondeductible) IRA contribution to a Roth IRA (called a “backdoor” Roth conversion), a portion of the converted amount may be taxable unless you rid your existing IRAs of all pre-tax funds. This can be accomplished through a reverse rollover.

As mentioned, government rules do not allow for a reverse rollover of IRA basis. IRA funds. Instead, only pre-tax IRA funds qualify for reverse rollover treatment. While this rule, at first glance, may seem unfavorable, it offers the opportunity to “separate” IRA pre-tax and after-tax funds, which in turn offers a potential tax-free Roth IRA conversion!

The pro-rata formula looks at an individual’s IRAs (including SEP and SIMPLE, but not Roth and inherited IRAs) as of December 31 of the year of the distribution. If you have any pre-tax funds as of that date, a portion of the distribution will be subject to taxation. But, if you have rolled over your pre-tax IRA funds to a 401(k) during the year, you’ll be left with only basis as of December 31, and the conversion would likely be tax-free.

Reverse Rollover Example: Ben has a $100,000 traditional IRA which $30,000 consists of basis (after-tax funds), while the remaining $70,000 is pre-tax (deductible contributions plus earnings).

As discussed, a 401(k) plan can, through a reverse rollover, accept only pre-tax funds; basis, however, can’t be rolled over and instead must remain in Ben’s IRA. Ben therefore rolls over $70,000 to his 401(k); what’s left in his IRA ($30,000) is basis, which can now be converted to a Roth IRA without any tax liability!

In addition to doing a reverse rollover, IRA basis can be isolated in the following transactions:

Like a reverse rollover, these transactions can only be accomplished with pre-tax dollars, thus making these strategies exceptions to the pro-rata distribution rule.

Key Takeaways

  • A rollover occurs when an investor rolls over their employer-sponsored retirement plan (i.e., 401(k), 403(b), governmental 457(b), etc.) funds into an IRA. Less well known is a “reverse rollover,” which is the opposite—rolling IRA money into a 401(k) or like plan.
  • Not every plan permits a reverse rollover; check with your employer.
  • IRA basis is reported via IRS Form 8606 “Nondeductible IRAs.”

Individuals interested in a reverse rollover should understand all the ramifications before pursuing this strategy. Pro-rata rules are quite tricky. It is prudent to consult a tax advisor.