After Tax dollars withdrawl from 401k
I am about to take my first RMD from my company 401k after the bye that existed for last year. I’m told that I have after tax dollars in my account that, because this is my first withdrawl, I can take as a lump sum this year that will more than satisfy my RMD. In addition, the after tax dollars have appreciated & I can roll those appreciated dollars over to a new IRA. They say that by doing this I can avoid paying taxes on my RMD this year & that if I do not take the lump sum “after tax dollars” this year they will have to be prorated with future RMD withdrawls. I am also told that an option would be to roll over the “after tax” dollars to a Roth IRA to avoid future taxes but then I would have to take my RMD for this year in addition to the “after tax” & appreciated dollars. I see nothing in the tax code publications that covers this & am reluctant to do these suggested steps if it leads me to tax penalties with the IRS. Can you give me some guidance as to whether the above is true & also point me to the tax code that addresses this.
Permalink Submitted by Joseph Arsenault on Wed, 2010-10-13 21:51
From what I have gathered there are a couple points to make.
– You do have to satisfy your RMD this year and it is ineligible for rollover. The net amount cannot be rolled over to an IRA.
– I would think that the RMD would be fully taxable because distributions come out pre-tax first. 20% will also be withheld. (you may be able to roll over to IRA first then take the RMD out of the IRA without a withholding) maybe someone else can clarify this?
– The appreciation on after-tax dollars is not tax-free unless this is a designated Roth 401k portion.
– Any rollover you make to a traditional IRA will mix the basis, and after that everything will be taxed pro-rata.
– The IRS has said that Direct conversions to a Roth from a 401k are treated pro-rata (although this continues to be fought) because there is some conflicting IRC.
– One loop hole exists which has been discussed on this forum many times, taking the pre-tax money first as a 60-day rollover, making up the 20% and depositing it in a Traditional IRA, then taking the remaining after-tax 401k balance and direct transferring it to a a Roth IRA.
– In your case, it would seem you would take the distribution and satisfy the RMD. You could then try using the 60-day rollover to isolate the after tax basis and convert tax-free to a Roth, or you could wait until December to see if additional guidance becomes available on the basis issue.
Alan does a good job of answering these questions as well on this board, he may expound on some of these points or correct them if they are outdated. Hope those points at least help guide you some what.
Permalink Submitted by A. Duckett on Sat, 2010-10-16 12:44
ja,
Thx. for your response. Obviously this is not as clear cut as I’ve been led to believe. Per your reponse, I would like to hear from Alan since, reading some of his other replies on various subjects, he has a good grasp of these matters. Is there any way to get his input?
Permalink Submitted by Alan Spross on Sat, 2010-10-16 15:06
I suspect that your reference to “lump sum” along with the plan administrator relates to having highly appreciated employer stock shares in your plan. That is a benefit because it opens up the possibility of incorporating NUA (net unrealized appreciation) into the mix along with the rollover and the RMD. If so, you should get professional tax help in putting everything together because working with all these variables along with after tax dollars maxes out on complexity and pitfalls.
If you utilize NUA, you must distribute the entire plan in the same calendar year and putting everything together this year would mean you need to start now because time is short when you need to address all these variables and put together a total planned approach.
With an LSD, the cost basis and the NUA if necessary BOTH count toward your RMD. And if you have after tax dollars in the plan, your taxable cost basis will be less than your NUA cost basis. This means that some of your RMD will be tax free, but the first dollars distributed are deemed to apply to your RMD. Therefore, if you are using NUA, the distribution of employer shares (does not have to be ALL employer shares) must be done first. After that you would select the rollover method that would get the most after tax dollars that remain into your Roth IRA vrs the pre tax dollars that would go into a TIRA. And if you happen to have pre 1987 after tax contributions as well, it gets even more complex.
The first course of action is to eliminate things that cannot apply or are not to your benefit. Accordingly, the first two questions would be whether you have a meaningful balance of pre 1987 after tax contributions. Then confirm if you have highly appreciated employer stock and if so what is the plan cost basis as a % of the current value of those shares?
If you are dealing with all these variables, the references are spread through several areas of the tax code, and in addition we do not even have a solid decision from the IRS on the issue of isolating the basis (after tax amounts) for Roth conversion purposes. So will not try to provide references until we get to some specific point. But it sounds like you will need professional tax guidance to put this all together if you are working with any 6 figure amount. In that context, about all we can do here it to provide you with possibilities to investigate, but the actual number crunching is too detailed for this forum. Where we might help you is giving you enough facts so that you will be better able to locate and vet the qualifications of the professional you use. Frankly, finding one with knowledge encompassing all these areas will be a challenge.
Further questions: Is this a former employer 401k? Or present employer? What year do you turn 70.5?
Permalink Submitted by A. Duckett on Sat, 2010-10-16 17:47
Alan,
Thx. for the quick reply. Answers to your questions are:
– This is a former employer plan & is the company from which I retired.
– I turned 70.5 last year & had the bye for taking my first RMD 2009 until this year.
Permalink Submitted by Alan Spross on Sat, 2010-10-16 18:06
OK – just wanted to be sure of that. If you have not distributed anything from the plan this year to date, your first distribution is considered to apply to your 2010 RMD. As for the highly appreciated employer stock, if you had been accumulating shares as far back as the 70s, and still hold the shares you have a better chance of attaining the amount of appreciation needed to consider using NUA. You may even have spin off shares in another company if there was a sale of a subsidiary and those shares are also eligible. NUA is most viable if your cost basis is 30% or less of the market value, or higher if you need to sell the shares very soon instead of holding them.