Rollover of After Tax 401K Contributions
I am over 55 but under 59.5 and left my job last year. Later in the year, I moved my 401k (pre- and post- tax) with a direct transfer. Since a good chunk of the money was after tax, rather than have the money in an IRA, it was transferred to a joint investment account.
The way the transaction occurred, the entire 401k was transferred to my IRA account, with the after tax money then withdrawn in a day or two after the transfer.
As I am working on 2008 tax, I see a 1099-R from my IRA account with an IRA distribution of the after tax dollers listed as an early distribtion from an IRA/SEP/SIMPLE with no known exception. Although the Taxable amount not determined box is checked, the gross disrtribution amount is also listed as the taxable amount.
My question – What is the proper way to report this transaction on my 1040 to avoid paying tax on the reported IRD distribution? Does this qualify as a return of an IRA contribution, an excess IRA contribution due to incorrect rollover information, or some other exception to an early IRA distribution?
Decay
Permalink Submitted by Anonymous (not verified) on Fri, 2009-02-20 19:39
There is no indication in your post about the specifics of any incorrect rollover information, but with the direct Roth conversion becoming available in 2008, perhaps you might have a case if the plan did not provide you with information on that option. It would have been a very tax efficient way to get the after tax amounts into your Roth and avoid the pro rate rules that apply to traditional IRA rollovers of after tax contributions. I will try to look into that situation. Besides that issue, it was a serious mistake to roll the after tax amount to the IRA if you were not going to keep those funds in the IRA. Once in the IRA, they are commingled and subject to pro rate rules.
Disregarding the incorrect rollover information issue, since you did roll the after tax amount to your TIRA, you need to file Form 8606 to report the amount of added basis in your TIRA accounts. The basis you will have subjects TIRA distributions to the pro rate rules, meaning that every distribution from your TIRA will have the taxable amount determined by Form 8606. The 8606 with your 2008 return will list the after tax contribution on line 2, and the distribution below that in Part I.
The gross distribution from the plan will show in line 16a with -0- on 16b and “Rollover” entered next to 16b.
The IRA distribution 1099R is correct, as the IRA custodian has no idea how much is after tax. The gross amount of the IRA distribution goes on line 15a and the pro rated taxable amount per Form 8606 will transfer to 15b. The final bit of bad news is that distributions from an IRA lose the penalty waiver that applies to employer plan separation distributions at age 55, so the taxable part of your IRA distribution will be subject to the early withdrawal penalty.
While there may be some recourse against the plan if they violated the Notice requirements, the IRS will expect your return to be filed per above.
I don’t know the amounts you are dealing with here and the amounts involved would affect where best to go from here. It may be possible to start a 72t plan in 2008 to avoid the penalty, but you would have to back into it, and it would take considerable professional assistance from someone very conversant with 72t plans. This is a long shot and is only practical if all the numbers fall within some very narrow ranges. I could probably figure if this is practical if you want to post some actual numbers here. If so, please advise.
If anyone was giving you advice regarding these rollovers, they unfortuneately did you an immense disservice.
Permalink Submitted by Anonymous (not verified) on Fri, 2009-02-20 20:55
Thanks for the reply.
The amount we are talking about is about $175K, so the tax implications are huge, especially since I did not want to be withdrawing (or paying tax) on any money in my TIRA.
What about treating the distribution as a return of an IRA contribution?
Decay
Permalink Submitted by Anonymous (not verified) on Fri, 2009-02-20 22:01
Using the pro rata method that Alan described is the only way that you can pay tax on less than all of the distribution.
A return of contribution would be limited to the $5,000 or so contribution allowed each year.
I always advise people to take the after tax money directly and roll over the balance because there are many problems that occur including yours.