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rollover of 401k after-tax contribs: trade-off?

I am about to get traded to a new employer. This will allow me to rollover the 401(k) from my current employer. This account has a significant amount of after tax contributions in it. My understanding is that I can choose to move this money to a regular taxable account or roll it over to an IRA.

In the first case, I could ideally put it to work hopefully nothing but unrealized long term capital gain and, at some point in the future, pay taxes on that gain at the investor-advantaged rate for long term capital gains. More likely, along the way I'd earn some dividends, and long and short-term capital gains. I'd have to pay taxes at rates based on my income along the way, but hopefully the dividends would mostly be qualified for the investor-advantaged tax rate and the long term capital gains would also get the investor-advantaged rates.

In the second case, everything I earn on it going forward would eventually get taxed as ordinary income at the tax rate I'm paying when I take it out.

So I have two questions:

1) Have I identified the right choices and associated issues?

2) Is there any strategy or tool to help identify the best choice? Near as I can tell, there is almost no way to tell. What are my tax rates along the way? What are my tax rates when I take the IRA distribution in the future? If I go the taxable investment route, what do my investment choices do along the way in terms of dividends and realized gains? Can I pick better investment choices for gains in the IRA if I don't worry about how much income is shed along the way? Do tax laws continue to favor investment income over ordinary income? Do tax rates change?

Any thoughts?

Reply to
Dick Watson
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This one is so obscure I haven't researched the details for it, but it's possible you could be one of the small number of people capable of doing a nice tax trick, either now or in 2010. The "trick" is, moving the after-tax dollars ONLY to a rollover IRA, and converting that IRA to a Roth IRA, avoiding all future income taxes on those dollars. It works best if you have little/no pre-tax dollars in IRAs at the moment.

There are two ways of getting money into a Roth, contributions or conversions. In the latter, you convert a traditional/rollover IRA to a Roth, by filling out some forms and paying taxes. If you convert $20,000 in Trad-IRA dollars you just add $20k to your income, and pay federal and state income taxes on it. But you only pay taxes on the pre-tax portion of that $20k.

So here's why the trick would be very beneficial...it seems possible that you could open an IRA to receive the after-tax contributions from your 401k, with the rest (the before-tax portion of the 401k) being transferred to your new employer's 401k plan. This is the key step and I'm not positive you can do it.

You would then do a Roth conversion on your IRA (either now or in 2010), and pay tax on that conversion. Which is zero! If your IRA contains only after-tax contributions (the proceeds from this rollover), there would be no tax on. If you need to wait until 2010 you'd just pay tax on the income between the rollover and the conversion, which probably won't be too much. Just by filing some forms you'd turn all future gains on this lump of money into tax-free gains. Given that you said the amount is "substantial" this could be an enormous benefit over the long haul.

Having other IRA dollars blows this out of the water. Even if you opened an account containing only these pre-tax rollover dollars, the Roth conversion would look at all of your IRA dollars combined to determined the taxable amount of the conversion. If 1/2 of your IRA dollars are pre-tax, half of your conversion would be considered taxable, regardless of where the money came from.

-Tad

Reply to
Tad Borek

Tad Borek wrote in news:PRPph.44254$ snipped-for-privacy@newssvr25.news.prodigy.net:

snip

This is my understanding and impression as well.

John

Reply to
John Gunn

That'd be great if I could do it, but I think it's out. I don't presently have anything in pretax IRA, but the rollover opportunity is unitary. I roll it all or I roll none of it. If I roll it all, the After Tax contributions are only about 6 or 7% of the balance. The other 93 or 94% will be pre-tax IRA when the rollover is complete.

Back to the original question: any thoughts on how to pick the optimum choice given the tradeoffs? Do I have the right issues identified?

Reply to
Dick Watson

No. Any amount withdrawn and not rolled over is considered a distribution. You can not have it transfered to a "regular" account with future capital gain treatment.

Reply to
Charlie K

Given that you don't have any other IRAs, I wouldn't give up on this idea. It seems you're saying that you can either rollover the whole

401k, or distribute the whole 401k, but not something in between. This seems strange though, given that you are even contemplating what to do with the after-tax part -- implicitly, you're able to take that out without rolling it over to your new plan, correct?

If so -- for example, if you could get a check for the after-tax portion, as would be typical -- are you sure you can't do an indirect rollover of that portion (to an IRA)? I don't know the answer but I'd certainly research it, it would be a big tax benefit. And off the top of my head I can't think of something preventing it.

-Tad

Reply to
Tad Borek

We're talking After Tax contributions here. I'm not sure I follow your point.

Reply to
Dick Watson

Maybe I was unclear.

All I have now is an IRA with all after tax contributions and a 401k with mostly pre-tax and some post tax contributions. My understanding from talking to the 401(k) provider is that in a rollover they will normally do a rollover of the pre-tax portion and will send me a check for the after-tax contributions.

I'm understanding that the latter is considered a distribution, but it's all already after-tax money, so it's a tax non-issue. Since I'm doing a rollover of the pre-tax portion, I **will** then have a large pre-tax IRA. Given that, how could I then convert the after-tax money back into a Roth IRA to make future gains on it tax free?

Perhaps we need to get back to the first post:

Do I **really** have the choice of a) taking the after tax contributions, distributed per above, and just moving them to a regular account with no current tax impact, or b) putting them right back in the IRA and adding them to my after tax basis on a form 8606?

Reply to
Dick Watson

That's normal.

True.

Yes on a. On b, yes on rolling the post-tax contributions up to IRA annual limit to a non-deductible IRA. On many levels I don't like non-deductible IRAs, so I've never looked at this. But before I tried to roll more than annual limit to non-deductible IRA I'd want a cite allowing it.

And after reading through all this, a third choice would be c) buying a cold case of Bud.

-HW "Skip" Weldon Columbia, SC

Reply to
HW "Skip" Weldon

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