After Tax 401k Contributions rolled to Roth IRA
Can after tax contributions made pre 1987 within a 401(k) be rolled over to a Roth IRA? It is my understanding since these contributions were grandfathered by the Tax Reform Act of 1986 are able to be withdrawn separately without the earnings. Can these after tax separate contributions go into the Roth IRA since they are able to be withdrawn from the 401k without earnings or tax implications? Can someone review again how the IRS may handle after tax contributions within a 401k (pre1987 and post 1986 contributions) with respect to the IRS for rolling to a Roth IRA in 2010?
Thank you, Walt
Permalink Submitted by Alan Spross on Tue, 2010-03-09 22:55
Yes, the pre 87 after tax contributions can come out separately if the plan accounted for them separately. If they did, the amount should show on the employee’s annual statement of plan assets. The only question would be when the plan allows the distribution to be made. There is no issue here of pro rating with pre tax contributions.
The post 86 after tax contributions are totally different. For them, the pro rate rules apply, and it is difficult to isolate the basis and direct only the after tax amounts to a Roth IRA. There is also considerable debate over various strategies for defeating these rules. One strategy that should work is to have the entire balance paid to the employee and then the employee rolls the pre tax amount first to a TIRA and the after tax amount last to a Roth IRA. The pitfall here is that mandatory 20% withholding on the pre tax amount means that employee must come up with large amounts to complete the rollovers and avoid all taxes and penalties. Another is to use a direct rollover to a TIRA for the entire amount of a former plan, and then transfer the pre tax balance of the IRA into the new employer qualified plan leaving the after tax amount only in the IRA for conversion.
The easier tandem direct rollovers to a TIRA for the pre tax and Roth for the after tax is seriously threatened by the pro rate rules, since the IRS will probably look at those rollovers as separate distributions rather than a single distribution. That would trigger prorating of each direct rollover.
If the safer more difficult procedures are not workable for a client, it could pay to simply wait to see if the IRS relaxes the rules for direct rollovers, but so far they have avoided clarifying all the issues.
Permalink Submitted by Walter Powrozek on Wed, 2010-03-10 04:23
Thanks Alan,
Are you saying if the plan allows me to take the pre “87” after tax contributions separately from the plan I should be able to roll these contributions to a Roth IRA without pro rating or tax. Then I can take the remaining plan balance and have them paid directly to me and have the mandatory 20% withholding on the pre tax amount. Step one, rollover the remaining 80% pretax to the TIRA and make up the 20% withholding with other monies to the TIRA. Step Two, roll all the after-tax dollars to the Roth IRA without prorating or tax, other than the 20% withholding on the pre tax amount.
Permalink Submitted by Alan Spross on Wed, 2010-03-10 04:40
Yes, but if you are eligible for a total distribution of the plan, and can afford to make up the withholding, there is no need to bother separating the pre 87 after tax contributions. You could just have the entire lump sum distributed to you and then do the various rollovers in the right order. Here is an updated article explaining the various strategies, and one of them is the indirect rollover procedure:
http://fairmark.com/rothira/09030801-401k-basis.htm