Rollover of a 401k containing after tax contributions

Submitted by Mike Snow on Tue, 2017-08-22 12:40

Experienced this for the first time recently when an employer notified a retiring employee of their options pertaining to leaving the firm as it pertain to their retirement accounts. There was money designated under a 401k Roth, there was a Traditional 401k and then a deferred compensation piece. What was interesting was around the Traditional 401k. The employee had after tax contributions designated under this plan that the employer stated could be sent to him by check as it was non-qualified monies? They stated that the gains from these contributions would be rolled over into an IRA with the remainder of his 401k. I assume since the gains are part of the Rollover IRA which means ultimately they are subject to RMD. From a tax perspective, are these differentiated in any way as far as tax say like under a Cap Gain rate? Or are they just taxed as ordinary income?

Lastly, how would the 1099-R look on that Traditional 401k rollover? Would it show the deduction of the after tax monies on the transaction?



Submitted by Alan - IRA critic on Tue, 2017-08-22 19:17

  • This is typical of larger employer 401k plans or employer plans with several higher paid employees.  The after tax contributions are technically referred to as “employee contributions” which go into a separate sub account within the plan per Sec 72(d)(2) This separate account also contains the earnings on these after tax contributions.  This  money is still “qualified”, but the after tax contribution amount can be distributed tax free. Since the IRS issued Notice 2014-54 allowing split rollovers, it is commonplace for retired employees to request that all after tax money in the plan be directly rolled to a Roth IRA and all pre tax amounts to a TIRA account.  
  • Prior to that Notice, many people found a way to achieve the same result by receiving a distribution of the after tax amount and then doing a 60 day rollover to their Roth IRA. Other retirees and some active employees just kept the after tax distribution and did not roll it over, and still others rolled the after tax money into a TIRA and filed an 8606 to document the IRA basis. That was first made possible in 2002.
  • Note that all money in qualified plans or TIRA accounts are subject to RMDs, whether pre tax or basis. If the TIRA contains basis, the RMD amount therefore does not change, but part of that RMD is non taxable per Form 8606. The taxable portion is always taxed at ordinary income rates. But it is far more beneficial to do as this retiree did, split the rollover and send the after tax amount to a Roth IRA, where it will continue to grow tax free and without RMDs.
  • Now, this employee has both designated Roth after tax dollars and non Roth after tax employee contributions both of which are transferred to the Roth IRA. Separate 1099R forms are required to report these direct rollovers. The designated Roth amount is coded H in Box 7, taxable amount box 2a is 0, Box 5 indicates the designated Roth contribution amount, and the first year of designated Roth contributions is in Box 11. For the entire non Roth direct rollover including the after tax employee contributions, Box 2a will be 0, Box 5 will show the after tax contribution amount, and Code G in Box 7. It is also possible that some administrators will split this second 1099R into 2 forms, one for the pre tax amount and one for the after tax amount.

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