Withdrawal of After-Tax 401k Contributions
Am I correct to assume per IRS Publications below that after-tax 401k money can be withdrawn tax-free as long as I do not exceed by non-taxable/after-tax basis? How is this tracked? Are after-tax contributions kept in a segregated account? What about profits on after-tax contributions?
According to the Tax Treatment of Distributions section of IRS Publication 560:
“Distributions from a qualified plan minus a prorated part of any cost basis are subject to income tax in the year they are distributed.”
In other words after-tax contributions are not taxed when you withdraw them regardless of whether or not you rollover that money
According to the Rollover section of IRS Publication 575:
“If you roll over only part of a distribution that includes both taxable and nontaxable amounts, the amount you roll over is treated as coming first from the taxable part of the distribution.”
Permalink Submitted by Alan Spross on Mon, 2011-11-21 17:56
After tax contributions may or may not be kept in a separate account, although the employer must keep an accounting of them. Most also keep a separate accounting of pre 1987 after tax contributions, which are allowed to be distributed separately from pre tax amounts. Further, some plans allow in service distributions of after tax contributions and their earnings, but do not allow in service distributions of pre tax deferrals or matching contributions.
Pro rating between pre tax and after tax amounts should be done according to what types of plan balances are eligible for distribution. For limited in service distributions where the pre tax deferrals are not eligible, the plan should not include their balance in the pro rating.
If you receive both pre tax amounts and post tax amounts, only the pre tax amounts are taxed. But if you roll over part of that distribution, as quoted in Pub 575, the pre tax amounts are the first dollars rolled over. This provision is what allows you to take a distribution from an employer plan and do your own rollovers (replacing 20% withholding as necessary), completing the TIRA rollover first (pre tax) and then rolling the after tax amount to a Roth IRA.
There is never a double tax on after tax contributions, but being able to isolate basis is difficult due to IRS Notice 2009-68, if you try to separate by doing direct rollovers. The tax code section giving rise to the Pub 575 quote is dependent on the distribution being made to the employee, and does not cover direct rollovers, although the IRS has some work to do to clarify this, and to also clarify 1099R reporting.
Permalink Submitted by [email protected] on Mon, 2011-11-21 18:40
I’m a little confused. I want to do an in service distribution of post 1987 after-tax contributions only. It sounds like this is doable if the plan allows it? if so, will I get a 1099 showing taxable (profits) and non-taxable amounts? Also, any penalty for taking a distribution of after-tax contributions prior to age 59 1/2? I am not retiring this year but want to use some of the after-tax $ to fully fund my Roth IRA for the year.
Permalink Submitted by Alan Spross on Mon, 2011-11-21 19:02
It certainly does get confusing.
Many plans that offer in service distributions of after tax contributions also require that you take out the earnings on those contributions. If the earnings are small enough, you could just do a direct conversion of the eligible balance and be taxed only on the earnings. If the earnings are significant and you want to avoid all taxes on the distribution, then the safest way is to request the distribution payable to you and do those two rollovers. You will have to replace the 20% withholding on the pre tax portion but you get that back when you file your return or sooner if you cut back on your salary withholding.
The 1099R on a distribution to you will show the taxable amount in Box 2a and the non taxable amount in Box 5. While there is never an early withdrawal penalty on the after tax balance even if you kept the money, but you are converting some of it and there are no penalties on conversions either.
If your plan allows you to take out only the after tax balance, but you are eligible to take out the earnings on them as well, then the plan will pro rate if you only take a portion of the eligible amount out. I would confirm with the plan exactly how this works, because it is dependent on how the plan is structured.