401K to IRA Rollover “Tax Implications”

Submitted by James Hannis on Thu, 2017-02-23 19:51

I’m 66 years old, been retired for couple of years and don’t plan or (God willing) need to withdraw any 401K/IRA monies until the RMD kicks in at age 70 1/2.

To reduce fees and to have more investing options, I’d like to rollover an existing 401K account (which includes BOTH before-tax and after-tax contributions) from a former employer to a self-directed IRA account.

When discussing my rollover intention with the 401K “Distribution Consulting Services” department, the topic of after-tax contributions was broached. I do have a detailed “By Contribution” report that includes the cost and current value of “Before-Tax Base/Shift Cont.” and “After-tax Total Pay Cont.” of the 401K account.

So when I pull the trigger on this rollover, I’ll receive a SINGLE check for the total current value amount which then I will have to invest into the IRA fund(s) of my choice within 60 days to avoid any ‘distribution’ tax issues. However, it appears a portion of that single check from the 401K fund (i.e. the “After-tax Total Pay Cont.”) would have to be rolled into an Roth IRA account instead of a typical IRA. Is that correct? Are there any tax liabilities that would result from such a rollover?

FYI – while the majority of the existing 401K is currently invested in mutual funds, a portion is still invested in company “in kind” stock which has performed quite nicely over the lifetime of this account. Do I have the option of taking company stock? If so, what are the pros & cons?

At this point my head is starting to hurt just a little bit.

Can you provide some guidance on the types of tax implications I need to consider and/or point me to some resources? Is this so complicated that the only answer is to ‘consult’ your accountant / tax adviser? Even so, I’d like to do as much research as possible ahead of such a consultation.



Submitted by Alan - IRA critic on Thu, 2017-02-23 23:53

  • It’s not that complicated until you factor NUA potential into the mix. Disregarding NUA for the moment, the usual strategy here would be to utilize Notice 2014-54 and request a split distribution where the after tax contribution balance is rolled directly into a Roth IRA and at the same time the pre tax balance including all gains to a TIRA account. No tax would be due. The after tax basis is therefore isolated to the Roth IRA. Ideally, the plan should issue direct rollover checks to each IRA type to avoid foul ups by the receiving custodian in making the proper IRA contributions. If an error is made, it will take some work to get it corrected. A single check may work if the accompanying instructions are very clear, but separate checks are a better option.
  • With NUA as an additional option, things get complex and can be affected by the plan accounting rules. How much of the after tax contributions have been assigned to the employer shares?  Whatever the amount, this will reduce the taxable cost basis of the shares designated for NUA treatment. The amount applied to reduce the taxable cost basis for NUA purposes (the Box 2a 1099R amount for the stock distribution) cannot also be used for rolling into a Roth IRA tax free. How to use the plan accounting rules to split this up requires some number crunching. Before doing that you need to understand all the requirements and features of NUA and in doing so determine how you will deal with diversification problems caused by holding too much in a single security. Since you do not appear to need to sell shares for living expenses, the NUA cost basis to make it worthwhile would probably be under 30% of the share FMV. You also do not have to use ALL company shares for NUA as you could roll some of the shares over to an IRA instead where they could be sold right away. The plan should be able to provide you with a cost basis quote for NUA purposes, but you would have to adjust that for gains or losses before the lump sum distribution.
  • I have not seen a comprehensive article on slicing your options up since Notice 2014-54. Will be a challenge to find a retirement planner sufficiently conversant with NUA to help with this, but they would certainly have to know the plan accounting rules and component balances in the plan under which the 1099R would be issued because you need to know what the 1099R will look like before pulling the trigger on this.

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