In-Service Distribution

Submitted by IRAQuestion5 on Wed, 2020-09-09 19:30

Hello-

Client (age 29) is currently working. He has made both pre-tax and after-tax contributions to his 401k. His plan allows for in-service distributions of after-tax money but not pre-tax money. The plan calculates what earnings are attributable to pre-tax and what earnings are attributable to after-tax.

Can he distribute his after-tax contributions and earnings only and do a direct rollover to a Roth IRA? Or does the amount come out pro-rata between pre-tax and after-tax?

The custodian seems to suggest that it is not pro-rata between pre-tax and after-tax. I did read somewhere that if they separately accounted for the buckets than it wouldn’t have to be pro-rata but everywhere else seems to indicate it is pro-rata between after-tax and pre-tax.

Any thoughts?

Thank you so much! This forum is extremely helpful!



Submitted by Alan - IRA critic on Wed, 2020-09-09 23:07

If the after tax contributions and their earnings are distributable as is the case for most plans, a direct rollover to a Roth IRA can be done of the after tax sub account money, and only the earnings would be taxable. The pre tax plan balance is disregarded. This assumes the after tax sub account is treated as a separate account under the plan per Sec 72(d)(2) as is the usual situation, but it is possible in rare cases that a plan opts to treat these contributions differently. This question should be verified with other plan senior staff, since in most cases what the custodian is indicating is incorrect. 

Submitted by IRAQuestion5 on Thu, 2020-09-10 13:55

Thank you! I seem to read that other places as well. When I look at the IRS website though it seems to indicate the opposite though: Can I roll over just the after-tax amounts in my retirement plan to a Roth IRA and leave the remainder in the plan?No, you can’t take a distribution of only the after-tax amounts and leave the rest in the plan. Any partial distribution from the plan must include some of the pretax amounts. Notice 2014-54 doesn’t change the requirement that each plan distribution must include a proportional share of the pretax and after-tax amounts in the account. To roll over all of your after-tax contributions to a Roth IRA, you could take a full distribution (all pretax and after-tax amounts), and directly roll over:

  • pretax amounts to a traditional IRA or another eligible retirement plan, and
  • after-tax amounts to a Roth IRA.  

Is the distinction that the after-tax and pre-tax are really separate plans if accounted for separately? 

Submitted by Alan - IRA critic on Thu, 2020-09-10 14:51

  • This IRS statement issue has been pointed out several times in the last few years as a deficiency in the IRS website, yet it goes uncorrected for some reason. The IRS has completely disregarded the separate account provisions of Sec 72(d)(2), or if they intended to refer only to the after tax account itself when the earnings in that sub account must be distributed along with contributions, they they should have been more specific and not referred to “the plan”.  Fortunately, this misstatement has not affected the 1099R forms issued by distributing plans or caused issues in practice.  It should also be noted that whenever certain portions of a plan are distributable, the portions not distributable (eg pre tax deferrals before 59.5) are never pro rated with the distributable balances since that would disable plan accounting going forward.
  • Note that the IRS webpage started with a hypothetical distribution larger than the after tax sub account balance. If the taxpayer wishes to distribute only the after tax sub account, they must be specific with their request. Without a specific request, they could end up with pre tax dollars rolled into their Roth IRA or Roth 401k.

Submitted by IRAQuestion5 on Thu, 2020-09-10 16:45

Thank you so much!

Submitted by IRAQuestion5 on Thu, 2020-09-10 17:30

Also, the after-tax contributions and earnings attributable to after-tax contributions can go directly from the 401k to the Roth correct? We don’t have to split the earnings to the IRA if we want them in the Roth as well? I understand the earnings portion will be taxable.

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