Rollover of before tax and after tax contributions
Plan participant who has a 401K that has pre-tax contributions and some after-tax contributions. The nontaxable balance is identified in the plan but when it came to rolling out the 401K, the participant can only do a direct rollover of the entire amount (tax and nontax balance) into a IRA, or just the taxable amount, but they won’t separate the nontaxable balance and do a direct rollover to a nonqualified account (after-tax account), and must distribute the nontaxable amount directly to the plan participant. The plan participant wants to do a direct rollover of the nontaxable amount but have no choice in the matter but to receive the nontaxable portion and then write a check directly to the nonqualified annuity account. Is the nontaxable portion going to get an early withdrawal tax penalty even if she is immediately writing a check to the nonqualified account as a rollover? She is currently 53.
Can or should that non-taxable portion that is distributed directly to the plan participant be indirectly rolled over to a Roth IRA, rather than a nonqualifed account (annuity)?
By the way, the employer plan distinctly identifies the after-tax balance along with the growth portion allocated to the nontaxable portion, and it also provides the exact dollar amount that is the after-tax contribution. The amount that is being distributed directly to the plan participant is the after tax contribution amount and any growth that is associated with the nontaxable portion is being rollover directly to an IRA.
Permalink Submitted by Alan Spross on Mon, 2011-01-31 19:38
There are other options, and their usefullness depends on the relative dollar amounts in these various accounts:
1) She could request a distribution of the entire amount to her (no direct rollover). Although she will have to replace the 20% withholding on the pre tax portion, she can then first roll the pre tax amount to a TIRA and lastly roll the after tax amount to a Roth IRA. There are no taxes or penalty for this, and she will get the withholding refunded when she files or sooner if she reduces other tax payments starting ASAP. This method is confirmed in the tax code and not subject to pro rating complications.
2) She could allow the direct rollover to proceed for the pre tax amount, and can take the after tax check and invest wherever she wishes. There is never a penalty on after tax amounts. If she makes a rollover contribution to a Roth IRA (tax free Roth conversion), then she is gambling with the IRS Notices of 2009 regarding pro rating issues. Thousands of taxpayers have probably gotten away with this the last two years because the IRS has not fully clarified their position, but they now have several more months to clarify this prior to the 2011 reporting season.
If she buys a NQ annuity with the after tax funds, that is OK also, and is not considered a rollover. But the gains will eventually be taxable, so this option is not as desirable as a Roth IRA.
Permalink Submitted by Sue Wong on Mon, 2011-01-31 19:55
So there’s no tax penalty for the distributions on nontaxable contributions to a 401K plan if she hasn’t reach 59 1/2?