After-tax Money in 401k
Hello. Customer has after-tax money in his 401k. He is planning to retire this year. He will be 58. When he retires, can he take the after-tax money without a penalty, since he is under 59 1/2? It should be tax free, right?
I saw an article in Forbes recently that indicated if a person has after-tax money in their 401k, they can roll it to a Roth IRA. What are the catches?
Permalink Submitted by Alan - IRA critic on Wed, 2015-02-11 18:17
Notice 2014-54 authorizes the employee to designate the destination accounts for a rollover. Therefore, after separation he could request a single lump sum distribution under which the pre tax dollars are rolled to a TIRA and the after tax dollars to a Roth IRA. No current taxes would be due. He could do that now as well, but only with the portions of his plan that are distributable for those under 59.5. Would be easier to just wait until he retires and then roll the entire plan balance to respective IRAs.
Permalink Submitted by Ben Meyer on Wed, 2015-02-11 20:01
Many 401(k) plans will allow distribution of after-tax contributions (non-Roth) prior to separation and under age 59 1/2. But there may be some downside in doing this. Many plans will then impose a restriction on making any further contributions for a period of time, such as six months. You would also not receive any employer match during this period. Also the IRS penalty of 10% for early distributions might possibly apply, unless the distribution is rolled over onto an IRA within 60 days.
Permalink Submitted by Julie Brangenberg on Thu, 2015-02-12 15:40
Upon retirement, if the person takes the after-tax money as a distribution before 59 1/2, is a penalty imposed?
Permalink Submitted by Alan - IRA critic on Thu, 2015-02-12 16:14
There is never a penalty on the after tax money, only the taxable money shown in Box 2a of the 1099R. If entire distribution is composed of after tax contributions, there will be no value in 2a. And if the person separated in the year they reached 55 or later, there is no penalty on the pre tax money either. In that case, the 1099R would be coded 2 in Box 7.
Permalink Submitted by Julie Brangenberg on Thu, 2015-02-12 20:38
I didn’t realize there is no penalty after separation at 55. Does dist. have to come from qualified plan to avoid penalty, or does it apply after rollover to traditional?
Permalink Submitted by Alan - IRA critic on Thu, 2015-02-12 20:52
Only applies to distributions directly from a qualified plan. It does not apply to IRA distributions. This age 55 exception may enable early retirees to tap their qualified plan directly and avoid a 72t (SEPP) plan, but the plan must also be willing to offer flexible distributions and not force a lump sum distribution,
Permalink Submitted by Julie Brangenberg on Tue, 2015-03-10 14:57
In reading 2014-54, I am a little confused about the last sentence you see here. Why does the taxpayer need to have sufficient funds outside of the plan if they are rolling over the pretax monies to a TIRA and after-tax monies to a RIRA? Is it because they are taking a cash distribution and they will need to pay the taxes?First, the participant could take an eligible rollover distribution as a single cash distribution. Second, by taking advantage of the rule in § 402(c)(2) that distribution amounts that are rolled over are treated as consisting first of pretax amounts, the participant could roll over the pretax amounts included in the distribution to one destination, such as a traditional IRA. The remaining amount of the distribution would be after-tax, which the participant could either roll over into a Roth IRA or retain without incurring any tax liability. The option to roll over all after-tax amounts into a Roth IRA, however, would only be available to taxpayers with sufficient funds available outside of the plan to be able to roll over the entire amount distributed, including the 20 percent of the taxable portion of the distribution paid to the IRS as withholding pursuant to § 3405(c).
Permalink Submitted by Alan - IRA critic on Tue, 2015-03-10 15:19
The quoted portion was intended to explain one of the reasons for the ruling on two direct rollovers (pre tax to TIRA and after tax to Roth) being treated as a single transaction. Under 402(c)(2) of the code the taxpayer could just ask for a distribution of the entire amount and then do the two rollovers with the pre tax portion first. But since distribution to the taxpayer (not a direct rollover) results in mandatory 20% withholding on the pre tax amount (earnings), in order to fully complete the rollovers the taxpayer would need enough other cash to replace the 20% that was withheld. Now with the 2014-54 Notice, the taxpayer can accomplish this by direct rollovers and avoid the withholding issue altogether.
Permalink Submitted by Julie Brangenberg on Fri, 2015-03-13 13:56
We called the Plan provider for the 401k. They said client is eligable to rollover after-tax dollars and it won’t affect his ability to contribute to the plan. We just tried to rollover the basis part of the after-tax accounts into a Roth. But the Rep. said that due to the Prorata Rule, he would have to rollover the entire after-tax account and roll the earnings to a Traditional and the Basis to a Roth. Did we receive correct information?
Permalink Submitted by Alan - IRA critic on Fri, 2015-03-13 18:25
Yes. Sounds like a typical after tax sub account distribution option. Other than any pre 1987 after tax contributions, earnings on the after tax contributions must always be distributed along with the post tax contributions. But Notice 2014-54 allows the client to select the destination accounts for the pre tax and post tax dollars distributed, and the plan provider appears to recognize that.