401K rollover

You are here:
< Back

L1: 401K rolloverMy wife is rolling over her 401K to an IRA. A portion of the money in the 401K is from after tax contributions. The 401K adminstrator said that she could take the after tax portion of the 401K as direct payment to her without incurring a 10% penalty even though she is only 45. She would then do a direct rollover of the pre tax money into the IRA. Is this correct?2008-08-08 12:15, By: Ron, IP: [75.167.10.116]
L2: 401K rolloverYes. Just make sure to take the after-tax contributions out first before you roll over the remaining funds to the IRA.2008-08-08 13:49, By: dlzallestaxes, IP: [96.245.168.21]

L2: 401K rollover
She may also be able to have the after tax amount transferred directly to a Roth IRA. This direct Roth transfer is newly available in 2008 and there are a few issues the IRS has yet to clarify, but it may be worth it to wait until they do. This is a much faster and tax efficient method of funding a Roth IRA than doing a customary Roth conversion. The 100,000 modified AGI limit applies to this until 2010 when it disappears.
A 401k plan is only required to offer ONE transfer, and the above plan would require TWO transfers, one for the after tax amount to a Roth IRA and the other the direct rollover of the pre tax amount to a traditional IRA. So she would need to see if the plan would do the two transfers. She cannot take the cash and roll it over to a Roth IRA herself.2008-08-08 17:29, By: Alan S., IP: [24.116.165.60]

L2: 401K rolloverTo my knowledge, the following is the only IRS release to date on Sec 824 of the PPA, and it does not fully clarify a couple procedural issues.
http://www.irs.gov/pub/irs-drop/n-08-30.pdf2008-08-08 17:32, By: Alan S., IP: [24.116.165.60]

L2: 401K rolloverRon:
Generally the process for transferring a K-plan, which contains after-tax contributions,to an IRA Rollover Account works like this:
1. Your wife will either complete transfer paperwork, which contains the IRA Rollover Account number and custodian information, and mail it to the K-plancustodian, or she will simply call the custodian and give verbal information and instructions to make the transfer, all on a recorded line.
2. Your wife has the option to either receive a check for the after-tax contributions, but no earnings, or she may include this amount in the total that is transferred to the IRA Rollover Account. If she takes the after-tax funds out, there is no penalty or tax on this amount. If you have an immediate need for some extra funds, then you have a ready source.
2a. However, if you do not need these funds right now, then seriously consider including it with the pre-tax funds you transfer into the new IRA. By transferring all funds to the new IRA, you have the advantage of continuing growth on the account. The more invested the more the growth potential.
If you choose item 2a and transfer all funds into the new IRA Rollover Account, you will need to account for the “basis of the after-tax contributions” by simply completing IRS Form 8606. This is not a complicated form and either your tax preparer or your tax preparation program can handle it quite simply. The importance of Form 8606 is to give you credit for having already paid taxes on these contributions when you start making distributions from your IRA and you will only be taxed on a portion of the withdrawal. Since you wife is 45 and assuming her retirement at age 65, she”ll have 20 more years of earnings on these after-tax funds.Hope this information helps.Jim2008-08-11 07:54, By: Jim, IP: [70.167.81.119]

L2: 401K rolloverSorry Jim, but I disagree with you 100%. If you transfer “after-tax” contributions from the 401-K to an IRA, you will recover this “tax-free” money in dribs and drabs over the rest of your life. Let”s assume that the “after tax ” contributions (only, not earnings) amounted to $ 50,000 out of a total 401-K of $ 500,000. Further, let”s assume that by the time you start withdrawals it has grown to $ 1 million, and never changes after that, for simplicity. Then 5% ( $ 50,000 / $ 1 million) of ALL FUTURE withdrawals will be tax-free for you lifetime in order to recover that $ 50,000 tax free.
I ALWAYS recommend taking the after-tax tax-free contributions NOW. In the above example, the additional $ 50,000 future growth will be TAXED AT PREFERENTIAL 15% capital gains rates if invested in equities, as well as any dividends thereon. If youroll it over to ther 401-K, all future dividends will be taxed at 25%-35%, and all future growth on the “after-tax” portion will likewise be taxed at 25%-35%, rather than at 15%.
And, there is no such thing as keeping the “after tax” portion in a separate account. ALL IRA BALANCES are included in the form 8606 calculation.2008-08-11 10:51, By: dlzallestaxes, IP: [96.245.168.21]

L2: 401K rolloverThanks to everyone for your informative responses. We decided to take the after tax 401K contribution amount as a seperate payment that will be invested in out taxable account.2008-08-11 11:32, By: Ron, IP: [75.167.10.116]

L2: 401K rolloverThanks DLZ for your comments and the example. However, you missed my point. I”ll address each of your comments within your comments.
Sorry Jim, but I disagree with you 100%. If you transfer “after-tax” contributions from the 401-K to an IRA, you will recover this “tax-free” money in dribs and drabs over the rest of your life. Let”s assume that the “after tax ” contributions (only, not earnings) amounted to $ 50,000 out of a total 401-K of $ 500,000. Further, let”s assume that by the time you start withdrawals it has grown to $ 1 million, and never changes after that, for simplicity. Then 5% ( $ 50,000 / $ 1 million) of ALL FUTURE withdrawals will be tax-free for you lifetime in order to recover that $ 50,000 tax free.You have given a very good example of how IRS Form 8606 works to determine what amount of the distribution is taxable and what amount is “return of basis” and not taxable, which is one of the points of my original post. My second point was that by transferring the after-tax contributions to the IRA Rollover Account along with the pre-tax contributions along with all of the accumulated growth, the new IRA Rollover Account would have the opportunity for continued, tax-deferred growth until needed for income in retirement. FACT: If you are not paying taxes on your earnings, over time you will have a bigger pile of money than if you pay taxes on the earnings as you go during the same time period and with the same growth rate.
I ALWAYS recommend taking the after-tax tax-free contributions NOW.
I used to always take this position also andrecommend taking out the after-tax contributions when the K-plan was moved, but now I takethe “it depends on theindividual situation” position. Everyone”s situation is different so the blanket statement to “always takeout the after-tax funds” just won”t fly today!In the above example, the additional $ 50,000 future growth will be TAXED AT PREFERENTIAL 15% capital gains rates if invested in equities, as well as any dividends thereon. If youroll it over to ther 401-K, all future dividends will be taxed at 25%-35%, and all future growth on the “after-tax” portion will likewise be taxed at 25%-35%, rather than at 15%.I disagree with listing the tax rates like you have done, especially since we don”t know Ron”s income situation. Under current tax law, distributions from IRA”s / 401(k)”sare taxed as “ordinary income” while capital gains from equity investmentshave a different tax rate, depending on the taxpayer”s marginal tax rate. Today we have “preferential tax rates” for equity dividends, but that is probably an “endangered species.” Since every taxpayer’s situation is different, it’s impossible to state what tax rate they will pay in the future. And after the November election, who knows what the tax rates will look like!
And, there is no such thing as keeping the “after tax” portion in a separate account. ALL IRA BALANCES are included in the form 8606 calculation.
I never suggested having “separate account(s)” for the pre-tax and after-tax portions. I believe that I was quite clear that both the pre-tax and after-tax portions would go into a single account, andaccounting for the basis, when distributions are made, is done via the Form 8606. I”m not sure where you got the idea that I suggested the two categories of funds would ever be segregated into separate accounts.Jim2008-08-11 13:30, By: Jim, IP: [70.167.81.119]

L2: 401K rolloverSorry, but I should have clarified my IRA point. There is no problem if you are setting up a NEW IRA account with the after-tax funds, and do not have another IRA account already, and will never have one in the future.
Usually taxpayers have one or more IRA accounts already, and do not realize that the 8606 calculations require all IRA accounts to be treated as one; or at some time in the future they roll over their 401-K into an IRA, or inherit a spousal IRA, and the 8606 tax-free portion becomes significantly reduced each year as it is recovered over a lifeteime.
I didn”t mean to imply that you had stated this aspect, but rather how it affects taxpayers who do get into this situation.
I agree that we do not know what will happen after the election, but I have to plan under present laws, and make changes later, if necessary.

Ordinary tax rates are 10% points or 20% higher now than Capital Gains rates. While taxpayers filing joint tax returns might be at an ordinary tax rate of 15% ( and capital gains of -0- now), whenever one of them dies, the surviving spouse will usually be in a 25% ordinary tax beacket (> $ 30,000 taxable income), as will their beneficiaries usually. While all tax situations are different, as you stated, I have never found any situation where it is beneficial not to take the “after-tax” contributions rather than rolling them over to an IRA. As always, we all have our own opinions.2008-08-11 14:37, By: dlzallestaxes, IP: [96.245.168.21]