After tax 401K Conversion to Roth

Submitted by Stephen Cloud on Mon, 2008-12-22 14:44

I have after tax savings in my 401K and can make in service withdrawals of these fund. I make too much money to convert by traditional IRA to a Roth IRA.
Can I withdraw the after tax funds from my 401K and rollover to a Roth IRA now?



Submitted by Alan Spross on Mon, 2008-12-22 19:20

No. The income limits apply to all Roth conversions until 2010.

However, in 2010 when the income limitations are gone, check with your plan to see if you can transfer after tax funds directly to a Roth IRA if they still allow in service distributions. It is also possible that if you have pre 1987 after tax contributions, that you would be limited to transferring only those to the Roth.

By 2010, the IRS should have complete Regs issued dealing with various combinations of direct Roth conversions.



Submitted by charles lore on Tue, 2008-12-23 01:03

Alan putting pre 1987 aside for a moment isnt it deemed that all distributions are first deemed to be pre tax until all pre tax is out leaving post tax? I cant find the irs Document that speaks to this.. is it pub 590?



Submitted by Alan Spross on Tue, 2008-12-23 03:43

There is no real good publication on this. Pub 575 has some of the data, but the code section that applies is Sec 72. Pub 575 is somewhat antiquated as it mostly covers annuities and traditional pensions instead of DC contribution plans.

Distributions from these plans are pro rated between the pre tax and post tax balance in similar fashion to a TIRA distribution under Form 8606. (excepting pre 1987 post tax).

However, the 2001 tax legislation that first allowed rollovers of after tax contributions to IRAs resulted in some changes in the way rollovers are handled. This is what you may be thinking of. If a partial rollover of a plan to an IRA is executed, the amounts are first deemed to be pre tax amounts.

This is explained in the following link:

http://www.mhco.com/Library/Articles/2004/ARoll_Portability_080504.html



Submitted by Stephen Cloud on Tue, 2008-12-23 12:31

The article below is what got me thinking of this. Also, interesting is that if I take a in service withdrawal from my 401K the after tax has to come first. I do have both pre 87 and post 87 after tax contributions.

A Sweet Deal on Roth IRA Conversions
If you earn too much to qualify in 2009, set your sights to convert to a Roth in 2010.
By Mary Beth Franklin, Senior Editor
From Kiplinger’s Personal Finance magazine, January 2009

Employees who make (or who have made) after-tax contributions to their employer’s retirement plan, listen up. You can now take that money and convert it to a Roth IRA tax-free.

To qualify for a Roth conversion, your adjusted gross income may not exceed $100,000, whether you are single or married. But don’t despair if you make too much now; income limits on conversions disappear in 2010. Income limits on new contributions to Roth IRAs, however, will remain in effect. In 2009, individuals who make up to $120,000 and married couples who make up to $176,000 may contribute up to $5,000 to a Roth IRA, and $6,000 if they are 50 or older.

The new rule on after-tax contributions is much more liberal than the one that governs a conversion from a traditional IRA to a Roth IRA. In that case, the tax-free portion of the rollover is determined by the ratio of nondeductible pay-ins to the total amount in all of your IRAs. So if your $60,000 IRA contains $6,000 in nondeductible contributions and you convert that $6,000 to a Roth IRA, just $600, or one-tenth of the converted amount, would escape income tax. The remaining $5,400 would be taxed at your regular income-tax rate. But under the new rules for after-tax money in 401(k)s — and 403(b)s and 457 plans — the full $6,000 would escape taxes. Plus, there is no limit on how much you may convert.

“It’s a sweet deal that lets you move money to a Roth IRA with no tax costs,” says Ed Slott, a CPA and IRA expert in Rockville Centre, N.Y. “You can’t do that from an IRA.”

Not all retirement plans allow after-tax contributions. But if yours is among those that do, this is a great way to keep some of your retirement savings growing tax-free without paying the usual price of admission to convert to a Roth IRA. Normally, you must wait to switch jobs or retire before you can move money out of your employer-based retirement account. But some plans permit in-service distributions, allowing you to roll over some or all of your 401(k) money to an IRA once you reach age 59½.



Submitted by Alan Spross on Tue, 2008-12-23 21:28

Of course, this article glosses over the issue of a partial distribution and/or the order in which a plan distributes the balance. A total lump sum distribution does not seem to present a problem if the pre tax amount is transferred to a TIRA and the post tax amount to a Roth IRA. If the plan does not offer two direct rollovers, then the after tax amount can be distributed to the employee who can indirectly roll it to a Roth IRA.

But the issue of a partial distribution of just the after tax portion appears to present a problem, pending updated IRS Regs on the direct Roth conversion. The article would lead many to conclude that the pre tax balance could be left in place with just the after tax amount transferred to a Roth IRA on a tax free basis.

That does not appear possible according to the link I posted above which clearly states that the first dollars directly rolled over are pre tax dollars. It took another couple years and another tax bill to clarify post 2001 after tax rollover rules. And if the rollover is done indirectly as allowed in Notice 2008-30, then the funds distributed from the plan are pro rated between basis and pre tax dollars per Sec 72 (excepting pre 87 post tax).

Meanwhile, taxpayers need to determine exactly how the plan will show these distributions on their 1099R forms to prevent an unpleasant surprise.



Submitted by Stephen Cloud on Tue, 2008-12-23 23:59

Thanks. Sounds like I need to sit tight for now.

Are the pre 87 after tax contributions treated differently?



Submitted by Alan Spross on Wed, 2008-12-24 00:26

Yes.
If the plan accounts for them separately (usually shown as a separate amount on plan statements), they can be distributed separately from the pro rata rules, ie fully taxfree and without any pre tax funds.

Accordingly, they could also now be converted to a Roth IRA if the plan distributes them to the taxpayer and they are rolled into a Roth within 60 days. The conversion income limits still apply to conversions until 2010.

Some plans may distribute these amounts to in service staff when other parts of the plan are not yet subject to distribution.



Submitted by charles lore on Wed, 2008-12-24 02:20

In the Kiplingers article she is clearly saying there is a “new rule” and that post tax can come out first and rolled to a Roth. And further it says that Ed Sott calls this a sweet deal which implies to me anyway that Ed is blessing this.

What new rule is she talking about? Her example very clearly implies that post tax can come out first …

Also Alan can you clarify what you meant by this? ( done indirectly)

And if the rollover is done indirectly as allowed in Notice 2008-30, then the funds distributed from the plan are pro rated between basis and pre tax dollars per Sec 72 (excepting pre 87 post tax)



Submitted by Alan Spross on Wed, 2008-12-24 04:26

I am not aware of any specific new rule that allows this. The only IRS release on the direct Roth conversion is Notice 2008-30, and it is inconclusive on a few issues.

An indirect rollover is when the check is made payable to the employee who then rolls it over himself. It is subject to withholding, but of course there would be none on after tax amounts.

Doing a direct transfer to a Roth of the after tax amount seems OK in a lump sum distribution or when the pre tax amount has already been rolled over. But doing the Roth direct rollover while the pre tax amount just stays in the plan seem to be in conflict with the “Rollover of Basis” paragraph in this link:

http://www.mhco.com/Library/Articles/2004/ARoll_Portability_080504.html



Submitted by charles lore on Wed, 2008-12-24 05:38

Alan this is from the article you referenced>

A participant rollover, one in which the participant receives the funds and has 60 days to roll the funds over, may not include after tax dollars when the participant is moving their vested account balance to a qualified plan or an IRA

This seems to be saying that an indirect rollover , to use your term, may not include after tax dollars yet your thinking is it comes out pro-rata as per sec 72. Still scratchin my head on this one.



Submitted by Alan Spross on Wed, 2008-12-24 06:09

Other posters have asked about the “or an IRA” at the end of the paragraph you posted. It is a typo and should have read FROM an IRA. The only way to move after tax dollars into a qualified plan is from one QRP that accounts for them directly to another QRP that will continue to account for them.

So sorry to further confuse the issue by posting an article that has this error. I will have to find another one or get them to edit it.

Also, keep in mind that this link was issued in 2004, well prior to the direct Roth conversion, just effective this year.

Back to the distribution FROM the QRP, it does come out pro rate EXCEPT when it is directly rolled over per the article. In that case, the pre tax dollars are the first ones rolled. So if the pre tax amount is directly rolled over first, leaving ONLY after tax dollars in the plan, the after tax dollars can then be either directly rolled or indirectly rolled to the Roth IRA. That gets you around the pro rate rules by timing the transactions to first take care of the pre tax balance.

The real problem is that Notice 2008-30 is incomplete and does not specifically address many of these issues. If you note the answer A-1 in 2008-30 (Sec 824), you can see how I came to conclude that you can get around the pro rate rules by rolling the pre tax amount first to the TIRA and then the post tax amount to the Roth. That is, until the IRS clarifies this further, many of us are coming up with different educated guesses.
http://www.irs.gov/pub/irs-drop/n-08-30.pdf



Add new comment

Log in or register to post comments