In Service Distributions
I recently tried to take an in service distribution from my 401K of my after tax contributions and have them directly rolled over into my Roth IRA. When I received the check, which was made out to my Roth IRA custodian, the explanation of the total amount was broken into two amounts, my after tax contributions and the earnings on them. I cancelled the transaction not wanting to pay taxes on the ernings which were around 80k. I called my 401K plan administraton and was told that by the rules of the plan any in service withdrawal of after tax contributions has to take the earnings with it. Is it possible to take an in service distribution, have the after tax contributions rolled directly into a Roth IRA and the earnings rolled directly into my regular IRA? I would like to do this to take advantage of other investment options in my IRAs. If not, is there another route I could take? Thank you for your consiceration of this question.
Permalink Submitted by Alan Spross on Thu, 2009-05-21 20:51
If the plan does have this special provision for in service distributions, there appears at this point only one clear way that you could accomplish the end result. That would be to pass on the direct rollovers and ask for an actual distribution. There would be a 20% withholding of $16,000 on the earnings portion. You would have to replace that 16,000 and first roll over the pre tax amount including the 16,000 to a traditional IRA. After that was completed, roll over the after tax amount tax free to a Roth IRA. In addition, the 100,000 modified AGI limit applies this year for eligibility to do the Roth rollover, which is a conversion, albeit tax free. The income limit disappears after 2009. You could cut your withholding in order to recover some of the 16,000 before you filed your 2009 taxes.
The reason that your direct rollovers are not likely to work is that there is a pro rata rule which would cause a pro rated amount of the pre tax to go into your Roth and a pro rated amount of the after tax to go into the TIRA. This is not what you want, and is comparably not tax efficient. But you get around these rules if you take the actual distribution as outlined above, because Sec 402(c)2 indicates that when the distributee (you) does an indirect rollover, the pre tax amount is deemed to be rolled over first. By rolling the full pre tax amount to your TIRA, ALL the pre tax dollars go there. That leaves the after tax dollars available for Roth conversion.
Note that the IRS has not clearly ruled on the tax impact of direct rollovers as you originally suggested, but the tax code in force at this time suggests that the pro rate rules would override your ability to separate the post and pre tax amounts by different IRAs. You could also wait until the IRS clears up the question, which they should be doing within a few months, because this issue is creating some problems and the IRA custodians have no clear directives on how to break out these amounts.
Are you sure you were able to abort the prior direct rollover request?
You may also have some other options if any of your pre tax amounts are pre 1987 after tax contributions as separated on your account statements. Pre 1987 after tax contributions are not subject to the pro rate rules.