After Tax 401k to Roth IRA
There was earlier discussion on this topic. One point of clarification needed:
If a plan is a standard 401k without a Roth component, but allows after tax contributions and the rollout of these contributions, is it always allowable to roll this portion (and pay taxes on any gains) directly to a Roth IRA?
Permalink Submitted by Greg Henson on Tue, 2012-05-01 19:40
A lot of times you can simply roll the earnings into a traditional IRA and not pay the taxes.
Permalink Submitted by Robert Taylor on Tue, 2012-05-01 20:29
While that is true, the exciting element appears to be the ability to create an annual Roth conversion via an after tax rollover from the 401k. For many individuals they will not do the conversion if they have significant TIRA’s with taxable elements (coffee and cream issue) due to the expense. But this way the problem is circumvented plus the amount that can rollover yearly may be well over the $5-6k normally allowable to a Roth.
My question was based on a confirmatioin that any after tax funds, if the plan allows them to roll out yearly, can go directly to a TIRA or a Roth. There may be some tax on any gains (unless it’s after tax 401k to TIRA) but I wanted to make sure it can go either way.
Permalink Submitted by Alan Spross on Tue, 2012-05-01 21:18
Yes, as long as the plan allows in service distributions from the after tax account, the employee can either:
1) Do a direct rollover to a Roth IRA, and only the earnings included will be taxable.
2) Take a distribution from the after tax account and 20% of the earnings will be withheld. Client can then first roll the pre tax earnings to a traditional IRA, and then roll the after tax amount to a Roth IRA while replacing the 20% that was withheld. This is isolation of basis to the Roth IRA with pre tax going to the TIRA. There will be no current taxes due.
Doing separate direct rollovers of the post tax and pre tax amounts is risky and there is a chance the IRS could require pro rating to each IRA type. Doing this by indirect rollover per #2 above eliminates that risk. If the earnings are small enough and the client does not mind including a small taxable amount for the Roth rollover, using 1) above is simpler, faster, and easier to report.