Before/After Tax 401K contributions transfer to IRA
CPA tells me once after-tax contributions are added to a 401K, upon retirement, then moving the proceeds
to an IRA, the before-tax and after tax portions cannot be separated. Is this true?
Here’s what happened: 401K custodian was instructed to fully close 401K account and transfer (rollover) directly
to assets to an IRA at a big well-known investment house in 2007. The retired employee believed the after-tax amount, a tiny 1% part of the whole amount would be refunded to him but was included in the full transfer. The new investment house, in the effort to refund this after-tax amount, did, and issued a 1099 with distribution code 8. IRS wants now back taxes and interest saying the “refund” was a taxable distribution. This is, in effect, being taxed twice on the $4800.
What can be done? Both the 401K custodian and the investment house want nothing to do with this. IRS wants $1400.
Permalink Submitted by mk foss on Sun, 2009-07-12 03:38
Many 401k plans will only do one distribution so I’m not surprised that they failed to refund the after-tax money before they rolled over the balance. Now once it’s in the IRA, you need to follow the IRA rules for basis recovery. If you enter the after-tax amount on Form 8606 and follow the directions a portion of the “refund” will be a basis recovery. It’s too late to do anything else.
Permalink Submitted by Alan Spross on Sun, 2009-07-12 03:55
I agree, but it also appears that the IRA custodian was misinformed about this rollover because they have coded the distribution as an excess regular contribution, and that is not what happened, since this is NOT an excess contribution. A rollover of after tax funds is entirely proper, and the IRS now indicates that the 8606 should not be filed until a distribution is made from the IRA. The distribution coding should be re issued as either an early or normal distribution, and the 8606 will then result in a very small pro rated portion of the distribution being tax free.
In summary, what the CPA indicated is true. Pro rate rules apply to an IRA once after tax amounts are contributed to the IRA.