Pre-59-1/2 In-Service Partial 401k Transfer To TIRA?
A 48 y.o. employee has a 401k with only pretax contributions and some minor earnings. He also has 1 nondeductible TIRA whose value is $1,000. less than its cost basis and he has 1 Roth IRA. He does not qualify to make deductible TIRA contributions.
If his 401k plan allows an in-service partial distribution or an in-service partial direct rollover to an IRA at any age, what reason if any is there as to why he must or should wait till age 59-1/2 to do a direct rollover of $1,000. to his TIRA? I believe that a 10% penalty should only apply to a distribution to him or his nonretirement account and not to a direct rollover to his TIRA.
[This question arose from a comment by alan-oniras in the recent topic of “Roth convert now vs wait?” but the above question seemed so remote from the original topic that this new topic seemed appropriate.]
Permalink Submitted by Alan Spross on Thu, 2012-01-05 03:48
There would be no penalty on any rollover. If the plan allows in service distributions prior to 59.5, there is no reason not to rollover over various amounts including an amount sufficient to bring the IRA value up to it’s cost basis.
Permalink Submitted by mk foss on Thu, 2012-01-05 04:19
401(k) plans cannot distribute amount attributable to employee salary reduction deferrals before the emplyee has attained age 59-1/2 unless there is a separation from service (or death or disability). The ability to take a distribution that is transferred to a TIRA is very limited. The plan document or the plan administrator should be consulted before going too far with this plan.
Permalink Submitted by Lee Martinson on Thu, 2012-01-05 14:44
So Mary Kay you are saying that for it to be an in-service withdrawal transfer before age 59 1/2 it should only come from that portion which is from employer contributions?
Lee
Permalink Submitted by mk foss on Thu, 2012-01-05 18:12
It needs to come from employer contributions and earnings on deferrals or employer contributions. The 401(k) rules are very restrictive on access to employee salary deferall; that’s why there are hardship provisions because loans and hardship withdrawals are the only way an employee under age 59.5 can access deferals.
Permalink Submitted by Alan Spross on Thu, 2012-01-05 20:40
Some plans also allow employees to make after tax contributions to the plan, or the plan may recharacterize some pre tax contributions that do not meet the discrimination testing requirements to after tax contributions. These contributions are typically kept in a separate account including the earnings they generate, and employees are often allowed to take in service distributions of these after tax contributions and earnings prior to 59.5.
Some employees contribute large amounts to such plans and periodically do direct Roth conversions from the plan which contain very low amounts of earnings and therefore mimimal taxable conversion income. If these after tax sub accounts generate enough earnings, they could also be rolled to a TIRA where the earnings could absorb the basis in the IRA that exceeds the IRA value. Then the conversion of the IRA can be done with the only taxable amount being the amount that exceeds the basis of the IRA increased by the after tax rollover.