401k After Tax Account

Submitted by MIKE KRUCHTEN on Tue, 2020-10-20 13:52

Client has approx. 800k in 401k value and 30k in after tax account. Plan allows employees to remove after tax funds anytime. I have read numerous articles about these funds being able to be converted to a Roth but must use pro rata calculation so if this client does convert almost all the conversion would have to be reported as taxable??

What I’m confused about is more 401k record keepers are promoting super back door Roth 401k techniques by auto converting after tax additions weekly. Since the employer contributions go to pre tax bucket I’m confused why this would not need to be reported pro rata. My experience is it has not but maybe the client was supposed to break this out when taxes are filed?

Also, the plan states they simply send funds out to clients and don’t code as a rollover or conversion, the client needs to report on their end. I don’t want to process a Roth conversion after client receives the funds if the conversion would be deemed ineligible. The plan is large but very common to be given wrong information.



Submitted by William Tuttle on Tue, 2020-10-20 15:09

  • IRS Notice 2014-54, allows the independent rollover of “separately accounted” for after-tax assets. This includes a pro rata of just the employee after-tax contributions and associated pre-tax earnings. Despite some poor wording on the IRS website, no other accounts are included in any pro-rata considerations.
  • If the plan does not allow a direct rollover of distributable after-tax assets, they would be in direct violation of IRS regulation 26 CFR § 1.401(a)(31)-1 – Requirement to offer direct rollover of eligible rollover distributions.
  • A distribution of rollover eligible pre-tax assets is subject to mandatory 20% withholding. If there are non-trivial pre-tax earnings this could be of concern with an indirect rollover.
  • There are two possible rollover options.
  • A rollover of both after-tax contributions and pre-tax earnings to a Roth IRA with the earnings taxable. Here again with non-trivial pre-tax earnings, this may not be desirable.
  • A tax-free split rollover of after-tax contributions to a Roth IRA and pre-tax earnings to a rollover eligible pre-tax account such as a traditional IRA.
  • One caveat to the IRS regulations. They do not require more than one direct rollover. If the employer is dragged kicking and screaming to do a direct rollover, they may not be inclined to do more than one. This is ok. You do the direct rollover of the pre-tax earnings to a traditional IRA, avoiding the mandatory 20% withholding, take the after-tax contributions as a distribution and do an indirect rollover to a Roth IRA. Under the regulations they must also allow this combination.

    • Submitted by Alan - IRA critic on Tue, 2020-10-20 16:16

    Agree. It’s very strange that this deeply flawed IRS web page has been allowed to persist for several years. How many times could the IRS have been alerted that it is incorrect and misleading to website users, and still no revision. The IRS needs to be re introduced to separate account rules under Sec 72(d)(2), as well as partial in service distributions.

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