Options to convert post-tax 401K monies to IRAs
My 401K plan allows me to roll-over post tax monies even though I am not near retirement age (I am 49). I have $70K in post tax dollars of which roughly 60% consists of after-tax contributions and the other 40% investment gains on those dollars.
The plan provider told me I should consider two options. 1) Roll-over all of the post tax monies directly into a Roth IRA. In this option I would have to pay taxes on the investment gains as regular income, or 2) roll-over the after-tax contribution portion into a Roth IRA and roll-over the investment gain portion into a regular IRA. This option would avoid paying taxes on the investment gains but not provide the future benefits of a Roth IRA to those funds. Since I rolled-over and paid taxes when I converted all of my traditional IRAs to Roth IRAs last year I effectively am starting fresh from a traditional IRA perspective.
The plan provider also cautioned that the second option is subject to interpretation as to whether the IRS will allow. The second option seems ideal as in my tax situation I’ll pay over 25% of the gains as taxes if I choose option one. Do you have any thoughts on whether the second option will pass IRS scrutiny?
Permalink Submitted by Alan Spross on Fri, 2011-05-06 18:20
The second option will pass IRS scrutiny if you do it by indirect rollover and replace the 20% withholding on the pre tax portion. This is protected by Sec 402(c)2 of the tax code, but the employee MUST receive the funds and to the rollovers. The pre tax amount is rolled over first to a TIRA and the after tax amount to the Roth is done second. A direct rollover cannot be used without bringing IRS interpretation into the equation. To do the indirect rollover you must have the cash to be able to replace the 20% withholding (~ 5,600) on the pre tax amount to complete the rollovers, but you will of course recover that when you file or earlier if you adjust other withholding downward.