Post-Tax Dollars from 401k to IRA
Hello,
A client wants to rollover after-tax contributions to a 401(k) to their IRA. How are these after-tax dollars tracked for cost basis purposes? Are they reported on an 8606? Thank you!
Hello,
A client wants to rollover after-tax contributions to a 401(k) to their IRA. How are these after-tax dollars tracked for cost basis purposes? Are they reported on an 8606? Thank you!
Permalink Submitted by Alan Spross on Mon, 2012-11-05 17:19
Yes, they are reported on Form 8606. But the 8606 should not be filed for this purpose only. The basis amount should be reported on the next 8606 which is required for another reason.
However, if the after tax amount is more than incidental, the client would benefit from isolating their rollover to a Roth IRA, with only the pre tax amounts going to a traditional IRA. There are some IRS issues affecting how this is most effectively executed.
Permalink Submitted by Michele Meyers on Mon, 2012-11-05 17:38
Thank you for the response. I think I am still confused.
If he never has a reason to file an 8606 in the future, Then this transaction would never be reported, so how are these tracked?
If he did choose to roll these after-tax dollars into his Roth IRA, are the after-tax contributions permitted to be transferred to the Roth IRA without any adverse tax consequences? Can you explain a bit more on what the IRS issues are? Thank you!
Permalink Submitted by Alan Spross on Mon, 2012-11-05 19:04
Whenever he takes his first distribution, the 8606 would be filed to”
1) Report the prior rollover of basis on line 2
2) Calculate the pro rated taxable amount of that distribution.
An 8606 would be required for every year that a distribution including RMDs takes place. Basis would always be a small portion of every distribution until the TIRA is fully distributed. That is why it is much more tax efficient to get those after tax dollars into a Roth IRA. Future 8606 forms would be avoided unless the TIRA contained other basis from prior non deductible contributions.
The challenge with the isolation of basis dates back to IRS Notice 2009-68 where the IRS indicates that basis in an employer plan should be pro rated to each type of IRA, ie a pro rated amount to the TIRA and the Roth IRA. However, the IRS never followed up those rulings with 1099R instructions to employer plans on how to report these. Therefore, thousands of taxpayers have been able to do twin rollovers where the pre tax amount is directly rolled into the TIRA and the after tax dollars to the Roth IRA. The 1099R does not show any taxable amount in Box 2a. For 2012, it is getting too late for the IRS to amend 1099R instructions for this year.
There is a very safe alternative to this uncertainty, but it is only useful for taxpayers who have funds available to replace mandatory withholding. The tax code indicates that when a distribution is made to the employee (not a direct rollover) and the employee rolls over that money, the first dollars are the pre tax dollars. Therefore the employee can first roll the pre tax amount to a TIRA and after that is complete, the after tax amount to a Roth IRA. However, since the plan will withhold a mandatory 20% of the pre tax amount, the employee must have the cash to complete the rollovers and receives the withholding back with his tax refund. Since there will only be a single 1099R in that situation, everything is in the employee’s control. Problem is many employees do not have 20% of the gross pre tax distribution available.
If the employee does not have the money, it may still be worth the risk to do the direct rollovers if the plan will not show any taxable amount on the 1099R.