Non-deductible contributions and rollovers
We have a client who left their employer and rolled over their 401(k) assets into an IRA. The total rolled over was $900,000. A portion, $25,000, consisted of after-tax contributions made to the 401(k).
Once the client realized that both the pre-tax and after-tax contributions were made to his IRA, he said this was not what he wanted and now he wants the $25,000 representing after-tax contributions out of the IRA. What can we do? I have come up with three possibilities:
[b]Option 1:[/b] Have the client distribute the full $900,000 and, within 60-days, only return the $875,000 representing pre-tax contributions.
[b]Option 2: [/b] Have the client roll the full amount back to his previous employer and then have them cut two checks? (not likely that the previous employer will allow this, but worth exploring.)
[b]Option 3: [/b] Have the client roll the entire IRA into his new employer’s plan (assuming the new employer has one, and allows for rollovers, and “at will” distributions of rollover dollars) and then distribute the assets as he wishes, the $875,000 into an IRA and the $25,000 into his pocket.
Ideally, Option 1 would work, but I can’t seem to figure out if, through all the entries on Form 8606, the rollover back into the IRA would have to be on a pro-rata basis.
Any help you could give would be greatly appreciated!
Permalink Submitted by Alan Spross on Fri, 2008-09-05 20:50
Option 1 cannot be done because of the pro rate rules for IRA distributions that are not rolled over to an employer plan.
Option 2 will not work because the employer plan is NOT allowed to accept after tax amounts from an IRA. The plan would face qualification problems and client might lose credit for the after tax basis. In any event, the previous employer would probably not accept any of the funds, not even the pre tax funds since he is no longer employer there.
Option 3 – a version of this could work. If his new employer would accept the pre tax amount as well as all other pre tax amounts in his IRA, he could roll over that amount and leave the 25,000 in the IRA. Once his IRA contains only the 8606 basis, assuming the 8606 gets filed reporting the 25,000 rollover, he can distribute it tax and penalty free. This is the only solution available that would get the 25,000 OUT of the IRA without incurring taxes.
However, this all seems to be an over reaction to the after tax rollover. While dealing with the 8606 presents additional complexity over many years if tax software is not used for preparing the return, that is about the only downside. All future distributions or Roth conversions would be partially tax free as calculated on the 8606, so he will never be paying double taxes on the 25,000. In addition, the 25,000 will be generating tax deferred earnings in the IRA. And if he had any other prior basis in the IRA beside the 25,000, he would already be bound to the 8606 on future distributions.
Permalink Submitted by Alanna Crawford on Mon, 2008-09-08 13:04
Very helpful- thank you!