L1: 401K Distribution
I have read a number of your posts and have found them very helpful. Thank you.
I am currently 55 and considering starting a SEPP using an existing 401K from an employer I left before the age of 55. I prefer not to roll over my 401K into an IRA because a substantial part of the account is locked into interest rates from years ago that
are nowhere to be found in today’s market. Most of this account (about 97%) is before tax money and gains. About 1% is after tax money with the remaining 2% Roth investment. If I begin this SEPP I intend to receive the money once a year (annually) since I
am only allowed two distributions a year and I want to save one for a ‘do-over’ in case there is some kind of mistake by the custodian that I need to have corrected. I have asked the custodian if I can specify that ALL of the distribution be from before tax
money and they have said yes. My question is this: If next year they change their policy and require that all distributions be from a mixture (for example 97% before tax) would that bust my SEPP even though the total money dispersed remained exactly the same?
If it makes any difference, I will not be asking them to withhold any taxes; I would handle that myself with estimated tax payments.
2011-11-03 16:20, By: kdc, IP: [188.8.131.52]
L2: 401K Distribution
I do not believe that they are permitted to “co-mingle” the accounts. I believe that the ROTH 401-K must be kept sepoarate from the traditional 401-k.
Therefore, I believe that you can direct that all of your distributions come from your traditional 401-k. If possible, I would have them distribute your after-tax 401-k monies now, before starting the SEPP. If that is not possible, ask them if they will
keep those monies in a separate account.
Use our “reverse calculator” to determine how much of your total 401-K plan should be designated as your “SEPP Universe” if you do not need/want the maximum that can be distributed. If you use all of the non-ROTH 401-K funds, then 97/98 ths of the distributions
will be taxable. If you have to use all of your 401-K funds in the universe, then 97% will be taxable.
In any case, the annual distributions are based upon the total amount in the SEPP Universe, and the taxability aspect is irrelevant.
2011-11-03 17:07, By: dlzallestaxes, IP: [184.108.40.206]
L3: 401K Distribution
While the IRS has not clarified if a Roth 401k could be combined in the same universe with the pre tax 401k account, I would expect that it would be OK because the Roth 401k is NOT a different retirement plan, just a different
account within the existing pre tax 401k. A Roth 401k cannot exist by itself under the tax code. But the real problem here is that since we do not know for sure whether the IRS will consider this one plan or two, we also do not know whether the total balance
of both needs to be included in the opening balance or just the pre tax account. Perhaps the fact that the original company match for the Roth 401k contributions must go into the pre tax account makes these two accounts intertwined to the extent that the best
guess you could make would be to include the total balance, but then only take distributions from the pre tax account. Again, the bad part is that you must make this guess if you want to use the 401k to fund your SEPP plan.
If you take that guess, do not further complicate the issue by taking any distributions from the Roth account. With respect to the pre tax account that also contains after tax contributions (1% of total), you probably cannot
distribute this balance by itself UNLESS it is all from pre 1987 after tax contributions. If not pre 87, then the after tax amount will probably come out pro rated with the pre tax, and a very small amount of your SEPP distribution would be tax free. That
is OK because the IRS does not care how much is taxable as long as the gross distribution is exactly correct.
In the final analysis, using your qualified plan is much more problematic than doing the direct IRA Rollover to a TIRA for the pre tax account and to a Roth IRA for the Roth portion. Then you wouldstart the SEPP using only the
I don’t think anyone is capable of giving you the odds of incurring IRS problems if you use your qualified plan for the SEPP.
2011-11-04 00:26, By: Alan S., IP: [220.127.116.11]
L2: 401K Distribution
dizallestaxes & Alan,
Thank you for responding to my 401K distribution question. Your replies, as usual, were very helpful. I have contacted my custodian and have been able to roll over the 2% Roth component of my
401K into an existing separate Roth account. I will use the 98% remaining as the basis for my SEPP once I am able to generate a new document that supports the new value of my 401K. I would have preferred to use the quarterly statement from 12/31/10 since that
seems to be more universally accepted, but of the two choices I would rather not be the Beta test site for the IRS on an intertwined Roth/401K SEPP. Would the printed copy of the online daily status of my account showing the total value of the account the
day after removing the Roth funds be sufficient to verify the adjusted starting point for my SEPP or do I need some form of official statement from my custodian? If the online daily status is not enough I may be able to get a broader statement that is similar
to a quarterly statement which will show all activity from October 1, 2011 to November 8, 2011 including the removal of the Roth money and the new account value. I would prefer, if possible, to not have to wait till next year to use the next ‘formal’ quarterly
statement of 12/31/11.
2011-11-04 21:40, By: kdc, IP: [18.104.22.168]
L3: 401K Distribution
It isn’t necessary or required to use a 12/31 valuation date. You can use any valuation date that is a reasonable representation of the actual account value. In your case, any online statement that reflects the 98% balance should be acceptable.
Also remember that the effective date is the date of the 1st distribution and that is the date that establishes the maximum interest rate. For plans with an effective date in November2011, the maximum rate would be 1.95%.
2011-11-04 21:54, By: Gfw, IP: [22.214.171.124]
L4: 401K Distribution
Just to clarify – gfwmeant that thestatement with the 98% balance must be for a date AFTER the Roth 401k funds were transferred out to a Roth IRA. Therefore, the balance on which your calculations are based would only include
the pre tax 401k account balance on the date you select and for which you will make a copy of the plan balance.
You will have to be very cautious to not EXCEED your annual distribution amount. Using an IRA, if such an error is made, the excess amount can be rolled back to the IRA. But with a 401k, that option will not be available in most
all cases. If too much is taken out, any rollover of the excess amount to an IRA would bust your plan because the IRA is considered a different type of plan.
Also be sure to avoid any confusion over your net and gross distribution, because you will be dealing with 20% withholding. Technically, such withholding only applies to eligible rollover distributions and your SEPP distributions
cannot be rolled over. But the plan may not recognize your SEPP and will probably insist on the 20% amount of your pre tax balance. Any amount that goes to the IRS still counts as part of your SEPP distribution, as does the very small post tax amount you will
receive that is apparently around 1% of the plan balance.
NOTE: While it would yet be another factor to consider for the future, IF your 401k account holds highly appreciated employer shares, you may want to retain those shares in the account. The reason is that if you take a qualifying
LSD the appreciation is taxed at the lower LT cap gain rates. But you cannot take an LSD until after your SEPP plan has ended.
2011-11-05 00:27, By: Alan S., IP: [126.96.36.199]
L5: 401K Distribution
ANOTHER CLARIFICATION :
Since you are currently 55, when did you “separate from service” with that employer ?
If earlier in 2011, even if before you became 55, you are eligible for distributions from your 401-K without being subject to the 10% penalty.
2011-11-05 01:28, By: dlzallestaxes, IP: [188.8.131.52]
L2: 401K Distribution
Thanks again for your input. Just to clarify:
I was force terminated by the employer associated with the 401K I would like to use at the age of 53 so the 55 rule does not apply. I now have a printed paper from the online status of the 401K account showing the value of the fund after the Roth monies
were completely removed (to be transferred to an existing separate Roth account). There are no employer shares in the fund. There still is what now amounts to a little over 1% of after tax money in the account but as you have pointed out, I have checked and
I cannot withdraw that money as an isolated withdrawal. I have been told that I can designate the distribution as all before taxes which would eliminate any extra paperwork; I will confirm that next week. But I understand now that is not an issue as far as
setting up a workable SEPP. I am also researching the possibility of not having any withholding taken out of the distribution and paying the estimated taxes myself.
I have used most of your calculators and they have been very helpful. I did not try the reverse calculatorÛ as the current low interest rates have successfully eliminated any need or desire to reduce my annual distribution. I appreciate your concerns about
using a 401K instead of rolling this over into an IRA. Besides the previously mentioned financial advantage in my current funds, I have learned in my research that 401K accounts are better protected against legal proceedings than IRA’s are. I have no issues
pending or anticipated but in my case I believe the extra security offsets the need to be very meticulous in handling my distributions. Nothing in life is risk free. Actually, my biggest concern, as you can see from my first post, is what happens if the rules
within my 401K plan change. Removing the Roth money has eliminated the problem of the plan changing the mix of the distribution. Thank you for pointing out that potential problem. Are there any other cases you may have learned of where a plan wide change within
a 401K resulted in a SEPP getting busted?
2011-11-05 13:39, By: kdc, IP: [184.108.40.206]
L3: 401K Distribution
I can’t recall any specific cases, but only a small % of SEPP plans use an employer plan rather than an IRA.Additional comments:
1) Hopefully, you still can change and otherwise manage your 401k plan investments. You should sell any shares needed in the plan so that your SEPP distribution is made in cash rather than shares. That is the only way to be sure
that the exact value you need distributed will be distributed and show on the 1099R.
2) You may have difficulty convincing the plan that they do not need to withhold 20% because this is automatic to plan administrators, and many reps either have never dealt with a SEPP plan or they are not aware that a SEPP distribution
is NOT rollover eligible. You may have to refer them to the tax code section 402(c)(4)(A) to convince them. Here is copy:
(4) Eligible rollover distribution
For purposes of this subsection, the term ‘eligible rollover
distribution’ means any distribution to an employee of all or
any portion of the balance to the credit of the employee in a
qualified trust; except that such term shall not include –
(A) any distribution which is one of a series of
substantially equal periodic payments (not less frequently than
annually) made –
(i) for the life (or life expectancy) of the employee or
the joint lives (or joint life expectancies) of the employee
and the employee’s designated beneficiary, or
(ii) for a specified period of 10 years or more,
(B) any distribution to the extent such distribution is
required under section 401(a)(9), and
(C) any distribution which is made upon hardship of the
3) They will issue the 1099R showing the box 2a taxable amount around 1% less than the gross distribution because of your small amount of after tax contributions. This should not cause a problem since many IRA SEPP participants
have basis in their IRA and must attach Form 8606 to their return showing the after tax amounts. The IRS only cares about your gross distribution amount with respect to the SEPP.
4) The largest threat to your SEPP would probably be if the plan document did not allow you to take annual distributions and required a lump sum. That would obviously bust the plan. If the plan administrator was changed it might
also result in some inconsistencies. To be absolutely sure of your options, you should request a copy of the plan document, since the summary plan description (SPD) will not provide the type of detail you need about withdrawal flexibility after leaving the
company. They might charge you a copying fee, but cannot deny your request for a copy of the plan document.
5) While the plan will probably do nothing to support your SEPP, it is still to your advantage to tell them what you are doing up front. It is possible that they could flag your account and prevent some unanticipated problem.
Your 1099R will almost surely be coded with a “1”, so you will need to file a 5329 to claim the SEPP exception (Code 02). This is easy to do and is not a red flag to the IRS.
6) If you start your SEPP this year, your 1040 for 2011 will have to report both the Roth 401k rollover and your SEPP distributions on lines 16a and 16b, with the Roth 401k amount showing as a rollover.
Note: Immaterial to the SEPP, but you should update your Roth IRA records to track the amount transferred from the plan. Your Roth 401k contributions will be treated as Roth IRA regular contributions and any earnings will be
treated as Roth earnings. You need to know that if you make Roth IRA distributions prior to age 59.5 when your Roth IRA will be fully qualified.
2011-11-05 17:06, By: Alan S., IP: [220.127.116.11]