After Tax 401k Transfer
A 63 year old retired client has $1,100,000 in his 401k account, of which $100,000 are after tax dollars. I get confused with what someone can and can’t do with after tax dollars from a 401k plan (these are not Roth 401k dollars). The client does not need the money right now and would like to avoid as much tax as possible. My question is, what are his options? Does he have to make 2 separate transactions by receiving a check for the $100,000 from the after tax account and then do the 401k Transfer to his IRA, or can he transfer all of it to his TIRA, or can he roll the $100,000 after tax dollars into his Roth IRA and the rest into his TIRA? Will any of the $100,000 be taxable? Would an 8606 need to be filed? Any help in explaining his options and the appropriate actions that need to be taken would be greatly appreciated.
Thank you!
Permalink Submitted by Alan Spross on Mon, 2011-08-22 20:11
If he has the cash to replace the 20% withholding, he should proceed to isolate the after tax basis for Roth conversion purposes. The only “safe” way to do that is to proceed as following, and you will see why he would need cash:
1) Request a total distribution. The plan will withhold 20% of the pre tax amount, which amounts to 200k, which he will have to replace. He receives 900k net. He then adds 100k of his own money to the 900k and rolls 1mm to a TIRA. After this is done, he comes up with another 100k and rolls it to his Roth IRA tax free. All the rollovers must be completed within 60 days of receiving the 900k. He then recovers the 200k of mandatory withholding when he files his return. He can recover it sooner if the 20% withholding allows him to reduce any current withholding or quarterly estimates.
2) If he cannot front the 200k, he could try to do this by direct rollovers, but with the real chance that the IRS would prorate his 100k basis between the Roth and the TIRA. That would make most of his Roth conversion taxable. This has worked for some, but the IRS could start to enforce their pro rating rules at any time.
3) He can roll the entire 1.1mm directly to a TIRA and file an 8606 to report the addition of 100k of basis. Any conversions or other distributions from the TIRA would be pro rated between pre tax and post tax dollars (90.9% taxable if this is his only TIRA)
4) Of course, he could take the 100k in cash without tax or penalty, and directly roll the 1mm to a TIRA.
Before doing anything, he should also determine if there is any highly appreciated employer stock in the account (NUA potential). If so, the after tax dollars could be used to reduce the tax on the NUA cost basis, depending on how much of the 100k the company will allow to be assigned to the employer shares.
Permalink Submitted by Jonathan Sard on Mon, 2011-08-22 20:18
Thank you as usual for your prompt reply! It sounds like option 2) may not be worth the risk if the client is someone risk averse and doesn’t want to take a chance?
Permalink Submitted by Alan Spross on Mon, 2011-08-22 21:07
Option 1 is the risk free option, with the only downside is losing use of 200k of his money for a few months. If he waits until Dec, it would only be a couple months. But this one is fully supported by the tax code and therefore is by far the most reliable.
Option 2 has more risk in NOT working in the first place, but the downside appears not to be too bad, but is also somewhat unpredictable.