After tax rollover 401k to Roth IRA
Someone mentioned that many corporate 401k plans allow after tax contributions (up to $10,440 annually) to be rolled out to an individual Roth IRA. Is this valid?
If so, I assume the 5 year wait rule applies.
Can someone provide more details on this opportunity to fund a Roth regardless of income level?
Permalink Submitted by Alan Spross on Sat, 2012-04-21 18:16
Some plans allow employees to make after tax contributions in addition to pre tax or Roth deferrals. And then some of those will allow the after tax account to be distributed while employees are still employed. Usually, the after tax account will also contain earnings on the after tax contributions, so the more frequently the employee takes distributions, the more likely the distributions will contain very little earnings in relation to the contributions. But only a small portion of plans allow for all of these features.
Distributions can be direct rollovers to Roth IRAs or the employees can ask for distributions and do the rollovers themselves. The 5 year holding period in the Roth to avoid penalty only applies to the pre tax amount of any such rollovers, so if an employee rolled over a distribution that was 90% after tax contributions and 10% earnings, and they did not hold for the 5 years in the Roth, only 10% of the rollover would be subject to the 10% penalty.
These Roth rollovers are similar to Roth conversions and since 2010 there is no income limit for these rollovers. There is still an income limit for regular Roth IRA contributions.
Permalink Submitted by Robert Taylor on Sat, 2012-04-21 18:33
Good information .
If you rollover after tax that has grown in value and you are under 59-1/2, even if rolled to a Roth, won’t there be tax/penalty on the growth portion or can you roll directly the whole amount including growth without paying taxes?
Is every after tax dollar rolled considered a blend of after tax and growth, if growth occurred?
Permalink Submitted by Alan Spross on Sat, 2012-04-21 19:19
If there are earnings included in the rollover, the earnings would be taxable, but no penalty. Pro rating would apply in partial distributions.
However, if the employee did not want to pay any taxes, they could request a distribution of the entire amount, then roll the pre tax amount to a TIRA and then the after tax amount to a Roth IRA. There would be no taxes at all, but the plan would withhold 20% of the pre tax amount and employee would have to replace that withholding to complete the two rollovers. Withholding would be refunded when taxes filed.
Permalink Submitted by Robert Taylor on Tue, 2012-04-24 11:03
Follow up question:
In the conversion process from the 401k after tax funding to the Roth IRA, does having other TIRA’s with pretax funds or growth have any impact on the tax calculation for the 401k after tax amount? In other words, is the tax calculation for the 401k after tax to Roth solely based on the after tax growth amount and not an aggregation of all IRA’s?
How is the 10,440 maximum after tax allowance calculated?
Permalink Submitted by Alan Spross on Tue, 2012-04-24 20:47
Other TIRA values have no affect on a direct Roth rollover from an employer plan.
The plan probably came up with 10,440 as a limit to avoid making excess annual additions for an employee. The current limit is 50,000 and includes all employer contributions, both pre tax and post tax, employer matching and forfeitures. But only the plan would be able to verify that was the reason.
Permalink Submitted by Carol Novak on Wed, 2012-06-20 20:59
I thought the IRS was questionning this strategy. Is that still the case?
Permalink Submitted by Alan Spross on Wed, 2012-06-20 21:21
The IRS has questioned isolating basis by doing tandem direct rollovers, ie directing the pre tax amount to a TIRA and the post tax amount to a Roth IRA. Notice 2009-68 indicates that the basis should be pro rated equally.
However, this does not apply to distributions made directly to the employee who then does his own indirect rollovers. Sec 402(c)2 of the tax code clearly indicates that if the employee receives a distribution and roll over the proceeds, that the first dollars rolled over are the pre tax dollars. This allows the pre tax amount to be rolled to a TIRA and after that is completed for the after tax amount to be rolled to a Roth IRA. It eliminates the pro rating requirement. The challenge in proceeding this way is that the employee must replace the 20% withholding taken on the pre tax amount in order to complete these rollovers. The employee then recovers the withholding when the tax return is filed, or sooner if there are other withholding sources that can be reduced.