After Tax Funds in 401(k)
I have a client that is transferring his funds out of his 401(k) into a Rollover IRA with us. He has a small portion (about $8,000) of after tax assets in the 401(k) which he will be keeping separate from the pre-tax funds that are rolling into the IRA. He is turning 59 in April so my question is, does he need to roll the ($8,000) in after tax 401(k) funds into a separate “After Tax” IRA in order to avoid the 10% early withdrawal penalty? I would imagine that after he reaches age 59 1/2 he’ll be free to take all of the after tax money with no penalty and no income taxes owed, I’m just concerned about the time between now and October when he reaches 59 1/2.
Permalink Submitted by Alan Spross on Mon, 2009-03-09 22:24
The early withdrawal penalty only applies to the taxable amount of a distribution, therefore the after tax amount cannot be subject to that penalty. Although the 1099R showing the 8,000 will be coded for an early distribution, that code is essentially meaningless since none of it is taxable. I assume a direct rollover is being done into your IRA, and the after tax amount is being paid to the client directly.
He can either deposit that after tax amount into a taxable account or he can roll it over to the IRA. The IRS has changed the procedure this year and does not want an 8606 filed to report the after tax basis until there is an IRA distribution (p 18 of Pub 590). Therefore, the client may have to remember to do this for a few years and document his IRA file carefully.
Permalink Submitted by Saleah Harpole on Mon, 2009-03-09 22:31
Thanks Alan! I really appreciate your response, very helpful!