401k Distribution error
Client age 54 took a distribution from her 401k for 50K she asked for the entire amount to be after tax, when she received the funds 25k was pre tax with 20% witheld and 25k was after tax. She wants to avoid tax and penalties what are her options at this point? She is in the 60 day period and has done no other rollovers this year. Thanks
Permalink Submitted by Alan Spross on Tue, 2011-07-05 16:32
She can roll the distribution over to an IRA within 60 days of receipt of the funds, but will have to replace the amount that was withheld to complete the rollover. She can reduce other withholding or the remaining quarterly estimates if she is over withheld because of the 20% mandatory withholding. Note that the 401k plan must pro rate the distribution between after tax and pre tax plan balances. The only after tax balances that can come out separately are from pre 1987 after tax contributions if she has any and the plan accounts for them separately. There is no limit on rollovers FROM a qualified plan, only on rollovers FROM IRA accounts.
Also, if client separated from service this year AND will reach 55 before year end, distributions directly from the plan are penalty free due to the age 55 separation exception. Otherwise, if she needs cash flow until 59.5 with the penalty waived, she may want to consider a 72t plan.
Permalink Submitted by Brian Mell on Tue, 2011-07-05 17:16
[i][b]Alan wrote: The only after tax balances that can come out separately are from pre 1987 after tax contributions if she has any and the plan accounts for them separately. [/b][/i]
If the 401k co. sent the amounts as a pro rata distribution. Does she have the option of retaining the after tax amounts and rolling over the pre tax amounts or does it need to be requested when making the distribution to distribute only pre 1987 after tax contribtuions as a lump sum? Thank you in advance…
Permalink Submitted by Alan Spross on Tue, 2011-07-05 18:28
Good point. Yes, if she rolls only part of the distribution over to an IRA, the pre tax amount is considered to be the first dollars rolled over. While the withheld amount will reduce the balance of the remaining after tax amount, the remainder can be kept without a tax liability and no penalty because the penalty only applies to the pre tax amount and that would have been rolled over.
This applies whether the after tax amounts are pre 1987 or not. If she has any pre 1987 contributions still left in the plan, she could ask for those in an additional tax free distribution. She would have to ask the plan administrator how the plan handles pre 1987 amounts if she has any balance there.