After-tax 401k distribution to Roth IRA

Submitted by Jack McManemin on Thu, 2014-02-20 19:16

Has Ed Slott addressed this issue in any monthly newsletters or other writings?
Client is currently permitted to do an in-service distribution of $142k from her 401k plan. $57k of the $142k is after-tax contributions she has made. Fidelity, the administrator of the 401k, told me and the client on a conference call that they can issue two checks (one for the pre-tax $85k; and one for the after-tax $57k) and she can roll the $85k to her IRA and can roll the $57k check into a Roth IRA.
Is the Roth IRA part of this OK, given IRS Notice 2009-68?



Submitted by Alan - IRA critic on Thu, 2014-02-20 20:44

The IRS has never followed up on Notice 2009-68, so for 4 years now people have been doing these tandem rollovers to TIRA and Roth without challenge. However, if the client has the cash to replace the mandatory 20% withholding, there is less risk in having a single check made out to the client. Client would then write his own checks first to the TIRA for 85k, and then adding 17k of other cash to replace the withheld amount, roll the balance to the Roth IRA. This procedure is protected by Sec 402(c)(2) which indicates this order of rollovers only for distributions that are first paid to the employee, rather than doing direct rollovers. The only drawback is the cash required to replace the withholding. If client does not have the cash, I would still do the two direct rollovers, expect possibly to wait until around November to be sure the IRS does not issue new direction to plan administrators. Not aware of the newsletter addressing this question.



Submitted by Jack McManemin on Fri, 2014-02-21 03:19

After studying this analysis by Michael Kitces I’m inclined to tell my client to only roll the $85 pre-tax fom the 401k to the TIRA, but to take the $57k and not roll it to a Roth but to invest it in her individual (taxable) account.http://www.kitces.com/blog/splitting-after-tax-401k-distributions-for-roth-conversion/



Submitted by Alan - IRA critic on Fri, 2014-02-21 04:40

Kitces is also the blogger who questioned the back door Roth strategy on the basis of a potential step transaction. Meanwhile millions of mostly higher income taxpayers continue to do these and the IRS knows it. In both these cases, there is no chance whatsoever that the IRS would go back and force all these rollovers to be reconstituted. If they close the door it will only be prospectively, and appears to suggest taking advantage of both these situations while you can.



Submitted by Kathy Keadle on Sun, 2014-02-23 22:24

Please provide some clarification, you are stating that if I have a client that has $50,000 of after tax funds in his 401k, I can roll that entire  amount into a Roth?  Wouldnt the roth annual limit apply?  Also please clarify another situation.  I know that if I have a client that is age 50 and wants to open a roth with $1,000 and the next month the roth is workth $1,100 she can withdraw the $1,000 immediately but cant touch the roth until the account has been open for 5 years and is 59 1/2.  So instead of worrying about doing a 72t if I have a client that is considering retiring early, cant I just take early money out of her Traditional IRA, and convert to a roth and then pull out the original funds?



Submitted by Alan - IRA critic on Mon, 2014-02-24 03:16

  • There are no limits for rollovers, just regular contributions.
  • The second plan will not work because before age 59.5 a Roth conversion must be held 5 years before it can be withdrawn without a 10% penalty. This rule is to prevent avoiding the penalty by converting first, only to withdraw the funds. A 72t plan should be the last resort, but sometimes it is necesary.
  • With respect to the after tax rollover from a 401k plan, there are various ways to get this money into a Roth IRA without the taxable money going in as well, but there is some risk involved because the IRS has not entirely clarified the rules with respect to isolating the basis. Nonetheless, people have been doing this without any problem for the last few years.


Submitted by Kathy Keadle on Tue, 2014-02-25 18:24

so to take the after tax money and roll it over to a roth directly from their 401k, would just be coded as a recharacterization and there is no limit?But lets say a client of mine is 30 and opens  a Roth with a $1,000 and in 6 months its worth $1,005, he does have access to withdraw the $1,000 without penatly, right?  he just cant touch the growth.. 



Submitted by Kathy Keadle on Tue, 2014-02-25 18:24

so to take the after tax money and roll it over to a roth directly from their 401k, would just be coded as a recharacterization and there is no limit?But lets say a client of mine is 30 and opens  a Roth with a $1,000 and in 6 months its worth $1,005, he does have access to withdraw the $1,000 without penatly, right?  he just cant touch the growth.. 



Submitted by Alan - IRA critic on Tue, 2014-02-25 19:54

A rollover to a Roth IRA would be considered a conversion, not a recharacterization. Whether the 50k of after tax contributions can be separated from the pre tax portion of the account depends on the facts and circumstances. Any pre tax amounts included in the rollover would be taxable, but there is no dollar limit on such conversions. With respect to the other question regarding a 1,000 regular Roth contribution, the 1,000 can be distributed anytime without tax or penalty, but any earnings on the contributions must be held until both 5 years and age 59.5 is attained.



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