Post 1986 After Tax Dollars in 401k — rollover to Roth IRA

Submitted by David Birkmeier on Tue, 2008-11-11 18:44

I am 40 and have about $40K of post 1986 after tax dollars in my 401K. I want to do an in-service rollover of this aftertax dollars to a Roth IRA.

There used to be gains on this money but current market conditions now have the gains at $.01.

Can I roll the entire $40K into a roth IRA or do I need to do it $5K for this year and each year after till it is gone?

Thanks.



Submitted by Alan Spross on Tue, 2008-11-11 21:34

Your plan is not likely to allow in service rollovers, you will probably have to wait until you separate from service or reach age 59.5 or other age specified in the plan document. A hardship distribution or loan cannot be rolled over while you are employed there.

If you were to separate from service, the best approach would be to see if the plan will offer two direct rollovers. You would first transfer the full post tax amount to a TIRA, as regulations specify that in partial rollovers, the pre tax amount is deemed distributed first. Then the remaining $40k could be transferred directly to a Roth IRA under the new provisions of the Pension Protection Act. There is an income limit for this of 100,000 for 2008 and 2009, but after that the income limit disappears.



Submitted by David Birkmeier on Wed, 2008-11-12 16:43

My plan does allow in service rollovers. Fidelity handles our company 401k but and they said it would be no problem. They have already set up the rollover Roth IRA for the after tax dollars and an rollover IRA for the gains that are attached to these aftertax dollars even though they now seem to be $.01.

I just want to understand why I am limited to $5K for a Roth but in this case I can roll over more than that.

Thanks for your help.



Submitted by mk foss on Wed, 2008-11-12 17:18

The $5K limit applies to Roth contributions. There is no limit on Roth conversions so you can convert as much as you’d like. The MAGI limits on the ability to convert to Roth are not affected by how much you decide to switch over.

Normally you would only convert enough to not put you into a higher tax bracket.

Like Alan, I’m surprised that your plan allows in service distributions for anyone under age 59.5.



Submitted by Alan Spross on Wed, 2008-11-12 17:38

Another item that sounds strange here is that you do not mention pre tax dollars in the plan other than the .01, which is linked to gains on the after tax amount only. A partial rollover from the plan should require pre tax amounts be rolled first. It would be very unique if you had no pre tax amount in the plan.

The answer to your basic question is straight forward, but the stated rollover situation sounds odd. What about the other pre tax money in the plan?



Submitted by David Birkmeier on Wed, 2008-11-12 20:17

Total plan value is around 200K and 40K of that is after tax. I have always had some gain associated with both before and after tax. The plan accounts for a total value then states my aftertax amount. The latest stock market level has taken away all my gains.

Becasue my after tax basis does not change I can rollover a larger percentage of the total 401K to a roth. Then when the stock market does recover a larger percentage of my investments will be in a roth.

Fidelity says I can take it as cash also.. but I really don’t need cash or the headace of triggering any withholding by the IRS. They state that there would be no withholding becase it is after tax money and the gains on that portion would go into a roll over IRA.

My current income level is well below 70K so I don’t think I would trigger any Roth limits.

What IRS publication might I read up on this.



Submitted by Alan Spross on Wed, 2008-11-12 21:07

Originally, I thought that you were attempting to just roll over the after tax amount to a Roth IRA.

But, if the plan allows you to make a full distribution, you would have to roll over the entire pre tax amount of 160,000 to a traditional IRA. On a partial rollover, the amounts are first deemed to come from pre tax amounts as you will see in attached link.

After all the pre tax money has first been transferred, all that remains would be your 40,000 in after tax. If the plan allows two transfers, the second one could be a direct rollover of the after tax amounts to a Roth IRA. Your income appears to make you eligible for this conversion.

There are different rules with respect to any pre 1987 after tax contributions, but at age 40 it is highly unlikely that any of yours are pre 1987. If there were, the plan statement should show them separately.

In the following link, check the final paragraph regarding the rollover of pre tax amounts first. This could also be done simultaneously, but I do not see how you could get the after tax amounts out of the plan before the pre tax amounts.

http://www.mhco.com/Library/Articles/2004/ARoll_Portability_080504.html

There are no IRS publications to date that describe direct Roth rollovers. These are brand new in 2008, and in fact complete IRS Regulations on some of the mechanics are not yet released. My assumption on the rollover order is based on the link attached.



Submitted by David Birkmeier on Thu, 2008-11-13 03:47

Thanks again for all your insight to my questions..

Maybe I was incorrect about a rollover… My plan allows in service withdrawals and the dollar amount is equal to my aftertax dollars. Fidelity says they can do and and will roll it into a Roth IRA and IRA while they are at it to avoid any tax issues. They also estimate taxes if any of the dollars are pre tax gains.

This is the definition given in my plan:

What is an in-service withdrawal?

An in-service withdrawal is a withdrawal that may be made from your retirement plan account while you are still employed by the employer that sponsors that retirement plan. You may be able to request a partial withdrawal up to the maximum available amount specified.

If a fund-specific withdrawal is available to you under your plan rules, you can request one by contacting a Service Representative or your Plan Sponsor. Please review your plan rules for more information regarding In-Service withdrawals that may be available to you.



Submitted by Alan Spross on Thu, 2008-11-13 06:33

OK, now this makes more sense. You need to determine what type of in service withdrawal this is.
1) It might be a loan
2) Or a hardship distribution

Neither of those are eligible for rollover. The plan may specify that you must take a loan before considering a hardship distribution. The plan probably also has a list of what qualifies for hardship consideration.



Submitted by David Birkmeier on Thu, 2008-11-13 13:03

This is more copied from my plan description:

I don’t see where they limit the withdrawal of after tax contributions or link it to my pre tax contributions. If I take out the 40K after tax and calculate the ratio of after tax contributions/Current Value of after tax Contributions + Earnings I don’t see where there is an issue since my earnings are zero since the ratio will equal to one or in some cases greater than one.

Partial Withdrawals and Distributions
Pre-Tax Contributions and Company Matching Contributions. Any partial withdrawal or distribution of Pre-Tax Contributions or Company Matching Contributions assets, including earnings on these assets, is fully taxable as ordinary income and may be subject to the early withdrawal penalty, unless it is rolled over to an eligible tax-qualified Plan or a traditional IRA.

After-Tax Contributions. In general, you can make nontaxable withdrawals from After-Tax Contributions assets up to an amount equal to your After-Tax Contributions made prior to 1987 (pre-1987 contributions) and not used to offset taxable income from prior withdrawals. Any further withdrawal from After-Tax Contributions is treated as partly a nontaxable withdrawal and partly a taxable withdrawal. The nontaxable part of such a withdrawal is determined by multiplying the amount of the withdrawal by the ratio of your post-1986 After-Tax Contributions to your After-Tax Contributions account balance (the sum of post-1986 After-Tax Contributions plus all earnings on After-Tax Contributions, including earnings on pre-1987 After-Tax Contributions). The remaining part of the withdrawal is taxable and may be subject to the 10% early withdrawal penalty.

Your after-tax contributions may be rolled over (through a direct rollover only) to an Individual Retirement Account or annuity, or to a qualified plan described in Code Sections 401(a) or 403(a) that agrees to accept and separately account for amounts transferred.

If your withdrawal or distribution from After-Tax Contributions includes a certificate for Ford common stock and you do not elect to rollover the stock, you may be able to defer tax on the net unrealized appreciation on Ford common stock attributable to After-Tax Contributions.

Early Withdrawal Penalty
If you are not age 59½ at the time of the withdrawal, the taxable amount may be subject to an additional 10% tax for early withdrawal. The additional 10% tax does not apply to a withdrawal received on account of separation from employment during or after the year you reach age 55, or by reason of death or disability, or to a withdrawal rolled over to an eligible tax-qualified plan or a traditional IRA. Note: You are responsible for providing any proof of disability to the IRS when you file taxes to avoid the 10% penalty. See IRS Form 5329, Additional Taxes on Qualified Plans and Other Tax Favored Accounts, for more information on the additional 10% tax.



Submitted by Alan Spross on Fri, 2008-11-14 06:48

You are right. This particular plan has adopted provisions that separate the earnings on after tax contributions from other pre tax amounts. This is not typical, but allowable. The following explains the flexibility plans have in adopting these provisions:

>>>>>>>>>>>>>>
IN-SERVICE CRITERIA BY CONTRIBUTION SOURCE
A plan may be designed so that the source for in-service distributions is across all contribution types or it may be broken down by specific contribution type. Thus, the employer has the flexibility to permit, or not permit, particular contribution types to be available for in-service distribution.

Whatever the employer’s choices, they need to be spelled out in the plan document and communicated to the employees.

>>>>>>>>>>>>>>>

This is a real plus for you now that the direct Roth conversion is newly available. It certainly appears that you could do the Roth conversion and it would be tax free.

When a plan administrator like Fidelity handles these plans, they are set up with the complete plan document which of course contains specific detail that needs to be followed. Conversely, our posts here must deal with more general practices and your plan is unique in this respect. I think you can rely on Fidelity’s interpretation of what you can do. Sorry that we suspected that you were misinterpreting the plan provision or Fidelity’s explanation when it appears correct.



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