After-tax distribution from 401(k) - one-check

Submitted by Rob Schmansky on Wed, 2023-06-28 06:14

Hello,

Client is trying to take a distribution of after-tax funds that are at significant gains. I had thought that the custodians may separate this check into the client’s ‘contributions’ and ‘growth’ – as we would like to take the after-tax funds out for liquidity needs, but rollover any growth to a Rollover IRA if possible.

The custodian informed the client that they only send one check that is made up of pro-rata after-tax contributions and the growth on them.

Question: Is the one check normal or is it possible because the client is requesting a distribution and not a direct-transfer to an IRA that the custodian only issues one check?

I’m curious if we made the request to do a rollover if we can separate out the pre-tax and after-tax. I was looking to the after-tax for needed liquidity, but perhaps we can roll this to a Roth IRA if it’s normal that they should send two checks for rollovers.

Client has only has a Roth IRA, no current pre-tax IRAs, although we also are considering an in-service rollover of pre-tax money.

Q#2: Assuming there is no chance of getting them to send two checks for any purpose: Is there a way to achieve a separation of the ‘after-tax’ amount from the ‘pre-tax’ since it is sent in one check? Can we do a distribution and 60-day rollover to an IRA of just the ‘pre-tax’ amount of funds that are sent?

Thank you in advance!

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Permalink Submitted by David Mertz on Wed, 2023-06-28 13:17

It’s not uncommon that a plan will issue only one check associated with a particular distribution.
The tax code stipulates that a rollover of a particular distribution from a qualified retirement plan comes first from the pre-tax funds, so if a single check is received that includes pre-tax funds, within 60 days the client can simply roll an amount equal to the pre-tax portion over to a traditional IRA. The after-tax portion can then be rolled over to a Roth IRA if desired.
If the rollover of the pre-tax portion is not done by direct rollover, there will be a minimum federal tax withholding of 20% of the pre-tax amount. To roll over the entire distribution (to traditional and Roth IRAs), other funds will need to be substituted for the amount withheld and any excess withholding will become part of the client’s tax refund. A direct rollover of the pre-tax portion avoids the complication of mandatory tax withholding, but that requires the plan to allow separate payments to the traditional IRA and to the individual.
If the client is subject to RMDs from the 401(k), the RMD must be satisfied before any other amounts are rolled over.