Early Withdrawal from RO IRA with 401k After Tax Contributions

Submitted by Gary Vyneman on Fri, 2014-03-21 22:24

I have a client who is in his 40s that rolled over a 401k into an IRA that had after tax contributions in it. Prior to doing so, he also, through the plan sponsor, took an early distribution from that 401k. Now, in order to pay the tax / penalty that resulted from such early distribiution, he is now in need of another distribution from the IRA. My questions are:

1. We assume that we can designate this distribution to be the after tax amounts, along with any pro-rated appreciation.

2. Will there be a special form to file with the IRS / CA that will be necesary to indicate that the distribution is after tax and part appreciation?

3. I’m assuming that the appropriate filings would be in the hands of the return preparer, and as the FA we only need to prepare the distribution request (which of course would call for the 20% withholding.

Thanks in advance for the insight! Not run in to this before.

Gary



Submitted by Alan - IRA critic on Fri, 2014-03-21 23:33

  1. All after tax contributions rolled into an IRA are recorded on line 2 of Form 8606 and distributions from the IRA are pro rated as calculated in Parts I or II of Form 8606. Client cannot designate that IRA distributions come from after tax dollars first, since pro rate rules apply. If client had the after tax contributions in the 401k paid to him on a separate check and did not roll this amount into an IRA, he would have that money without taxes due to pay bills including taxes.
  2. Form 8606 is the form as explained above. There is no separate form for CA, but if he made IRA contributions in CA before 1987, he may have a higher basis for CA tax purposes than the 8606 indicates for federal.
  3. You can have any amount withheld for an IRA distribution. The default rate is 10%. THe 20% withholding rate only applies to qualified plan distributions such as a 401k.
  4. If you think client cannot identify how much after tax 401k contributions were rolled into the IRA, please advise.
  5. Note that client will get a separate 1099R for the 401k distribution and another one for the direct rollover to the IRA.

Submitted by Gary Vyneman on Mon, 2014-03-24 21:47

Thanks much alan for this:  Extremely helpful for me, early in my IRA experience.  A couple of other Qs spring to mind:  1.   I have now looked at the 8606, anmd am assuming that Line 1 would inlcude the amounts that were after tax put in to the 401k (and hence then rolled over to the IRA in 2013)?2.  I’m guessing that you then use IRS Form 5329 for the Penalty Piece?Many thanks again,G 

Submitted by Alan - IRA critic on Mon, 2014-03-24 23:12

  1. No, line 1 of the 8606 is used to report non deductible contributions made to the IRA for the current year.  If after tax 401k contributions are rolled into the IRA, report them on line 2 of the 8606, the next time an 8606 would otherwise be called for. Therefore, if the 8606 is not otherwise needed for 3 years, then make a note to report the after tax amount on line 2 on an 8606 with the 2016 return. This rule is awkward and confusing, but that is what the IRS wants.
  2. The 10% penalty on an early distribution does not need a form to report it. The penalty can just be entered on line 58 of Form 1040. The 5329 would be needed only if the client qualified for an exception to the penalty.

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