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In service rollover of after-tax 401(k) funds

In my 401(k), I have a fair chunk of after-tax contributions. That money is eligible for rollover to an IRA. In such a rollover, a share of earnings comes with it. From talking to the plan reps, it looks like it's about half each, that is rolling over $10k of after-tax contributions would bring about that much in taxable earning along.

My reason for wanting to do this is that my tax-advantaged space outside the 401(k) is limited, and there are some things I'd like for my AA that either aren't available or don't have good choices in the plan.

When I do that, is it best to plan for an immediate Roth conversion? My marginal rate was 25% last year, with a state tax of 6%. I am under the income limits for Roths, and in fact that's all I have as far as IRAs (not all that far).

It's unclear to me yet whether my plan allows the new (as of 2008) rollover directly to a Roth. Someone on one of the forums said that if a rollover is possible at all from the plan (it is) then a Roth would be possible without anything special from my plan administration.

At any rate the two-step rollover to TIRA then Roth conversion process would still be possible. If I'm going to convert to Roth, it seems easier to pick an amount that I would be able to do all at once, to avoid repeated filing of IRS form 8606, plus I'd want to avoid bumping myself up in tax brackets.

Are there any convenient online tools that will assess the impact of a Roth conversion on tax bracket given a guesstimate of the taxable income without the conversion?

If I don't convert now to a Roth, then (as I understand it) I have to file form 8606 next year and then whenever distributions are taken in the future.

Another suggestion from the forum was to roll to a TIRA, then roll back to the 401(k). If I read IRS Pub 590, correctly, then only the taxable money would roll back into the plan.

That would give a TIRA with nothing but non-taxable funds, so an immediate Roth conversion would be no tax impact. I, as I understand it, would be able to roll back out the taxable funds from the 401(k) as I wished, so I could do some later and pay the taxes for a Roth if desired.

Brian

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Default User
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My recollection (1994 time frame) was that after tax money in a 401k (but not the gains there on) can be withdrawn first without tax consequence but once the 401k was rolled in to an IRA the after tax dollars was treated like any other after tax contribution.

Sorry but I can't cite chapter and verse.

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Reply to
Avrum Lapin

I certainly could withdraw it, but I don't want to. The goal is to get it into a different tax-advantaged account with better options than the company 401(k).

Brian

Reply to
Default User

Brian, you should research a recent IRS Notice, 2008-30. At least one commentator says that it implicitly allows you to rollover ONLY the after-tax part directly into a Roth IRA, as a "qualified rollover contribution" (jargon for the 401k-to-Roth direct transfer). And you could rollover the pretax money into a traditional/rollover IRA. If you could do that there wouldn't be any federal tax on the portion moved to a Roth.

In the past if you two-stepped it, meaning 401k to IRA, then converting all or part of your IRA(s) to a Roth, the tax treatment was different. You'd need to add up all your IRA values, and figure out the percentage that is after-tax money...let's say it's $30k in IRAs, $10k is after-tax contributions. Only 1/3 of every dollar converted to a Roth would be after-tax money, regardless of which account the money came from.

But using the 401k-to-Roth provision you could convert the full $10k, and only the full $10k, without incurring federal income tax. I don't know if all states follow this as well.

One other thing mentioned in the notice...plan administrators need to honor requests to rollover directly to a Roth IRA.

-Tad

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Reply to
Tad Borek

That's an interesting take. I'll find that notice and review it.

I don't have any other TIRAs. The partial nature of the conversions had me concerned, which is why I was considering only doing a rollover of a size where I could handle all the taxable portion at once. Handle in terms of not moving myself up a tax bracket. Covering the tax isn't too much of a concern, I just don't want to pay more than is necessary by sliding up a bracket.

Yes, I see. I don't know what MO would do.

Will they? What's the difference from their standpoint? Sending two checks to the receiving institution?

Brian

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Default User

Very generally...the issue is that plan administrators have certain responsibilities and liabilities, including some that are triggered when distributing funds. And some "legally permissible" aspects of these plans only take effect if the plan documents are amended accordingly.

But Notice 2008-30 says, for example, that the administrator doesn't need to verify that the participant qualifies to make the transfer to a Roth - see Q-5.

-Tad

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Reply to
Tad Borek

Ah, ok. I still don't know if our plan does direct to Roth rollovers or not. There would be some convenience to getting the whole done at once. I could get all after-tax immediately in a Roth and look at converting or not parts of the TIRA holding the taxable earnings.

Part of the problem is talking to reps at the plan adminstrator. The first one told me I could also rollover all the company match money too. This initially got me quite interested. However, when I reviewed the plans docs, if you do that they stop matching for six months. No thanks.

The second got all freaked when I said I wanted to roll over the after-tax and the earnings to the same IRA. He told me I'd be double-taxed. It did make me go research it, and I found out about IRS Form 8606. This site was useful:

I hadn't thought about qualifying for a Roth. I guess if they don't have to verify income levels, it isn't too much of a problem. I'll read that when I get a chance. I'll have to press them again for an answer as to whether they allow direct to Roth.

Brian

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Default User

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