Rollover of after-tax 401k with large gain

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Rollover of after-tax 401k with large gain

Postby goGators » Fri Apr 05, 2013 12:26 am

Hi All,
I have read many posts on this topic but could not find a clear answer to my situation. I hope you could help me.

I would like to make an in-service direct rollover of my after-tax 401k which is managed by Fidelity. My after-tax account has significant amount of gain which will result in a large tax bill if I don't do it right.
I contacted Fidelity and was told that they could split the entire after-tax amount into two (2) parts:
a) contribution (basis) and b) gain
They then directly roll the contribution amount (a) into a Fidelity Roth IRA and the gain (b) into a Fidelity Rollover IRA.

1) Do I own any tax if the rollover executed as described above? This is for after-tax portion only. The pre-tax 401K still remains in my employer's plan.
2) What is the IRS view on such transactions?

Thank you.
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Re: Rollover of after-tax 401k with large gain

Postby Default User BR » Fri Apr 05, 2013 2:14 am

You won't owe any taxes. I've always been a bit leery of this strategy, but so far the IRS hasn't been saying anything as far as I know. What I've done in the past was take a single distribution and put it all in a traditional IRA, then roll the earnings back to the 401(k) and convert the basis.


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Re: Rollover of after-tax 401k with large gain

Postby goGators » Fri Apr 05, 2013 6:25 am

Thank you very much, Brian. I'll check with Fidelity to see if they could directly roll the earnings back. My goal is to empty out the after-tax account then make regular conversions of future after-tax contributions like many others on this board. Would this roll back strategy still give me a large taxable gain in future transactions?
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Re: Rollover of after-tax 401k with large gain

Postby MN Finance » Fri Apr 05, 2013 8:44 am

Yes, as long as Fidelity can separate the pre/post tax portions, this is not only allowable, but in nearly all cases the best move.
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Re: Rollover of after-tax 401k with large gain

Postby Alan S. » Fri Apr 05, 2013 12:55 pm

Fidelity's twin direct rollover proposal flys in the face of IRS Notice 2009-68 which states that such a distribution should be taxed as if the entire amount was first rolled to a TIRA and followed by a conversion. That would trigger Form 8606 and result in the after tax amount being split between the two IRAs instead of being isolated to the Roth IRA only. While doing this for the last 3 years since the Notice was issued has not triggered IRS inquiries, it is risky if the IRS were to issue new 1099R reporting instructions before November that would result in a taxable amount showing in Box 2a.

One solution is to roll the entire amount to a TIRA, report the basis and then roll the pre tax TIRA balance back into the plan as mentioned.

Another is Fairmark's strategy 3 which entails a distribution to the participant (20% withholding on the pre tax amount). Within 60 days the participant first rolls the pre tax balance to a TIRA and after this is done, the after tax amount to a Roth IRA replacing the withholding to complete the rollovers. The reason that this is much safer than the twin direct rollovers is Sec 402(c)(2) of the tax code that clearly states that the first dollars rolled over by a participant are considered to be the pre tax dollars. The same rule does not apply to direct rollovers because a distribution is not made to the participant. This is a better solution than the FIdelity proposal IF you can handle the replacement of the withheld amount (reduce your current withholding from other sources to recover this sooner) and your plan will not accept rollovers from IRA accounts.

If you still want to roll the dice for the convenience of the twin direct rollovers, you can reduce the risk of the IRS altering 1099R reporting by waiting until November to do the rollovers. By November it is too late for the IRS to change 1099R reporting for the year as there is not enough time for plans to re program their tax reporting software.
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Re: Rollover of after-tax 401k with large gain

Postby Default User BR » Fri Apr 05, 2013 1:28 pm

The indirect method is a possibility. The withholding is mandatory for distributions from qualified plans, but it's only on the taxable portion. If you had say $2000 in earnings, you'd have to come up with $400 to replace the withholding when you completed the rollover. I've preferred the rollback method because MyMegaCorp has a number of great choices so I don't see too much benefit to having a traditional IRA to deal with in addition to all the other accounts I tend to accumulate.


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Re: Rollover of after-tax 401k with large gain

Postby goGators » Sat Apr 06, 2013 7:49 am

If I choose to go with the indirect method (another name for "Fairmark's strategy 3"?) and assume I have $12,000 total ( $10,000 basis + $2,000 earnings) in my after-tax account,
are these following steps I need to execute:

1) Ask Fidelity for a distribution (NOT rollover) of my after-tax ONLY money
2) Fidelity will send me a check of $11,600 ($12,000 total - $400 withholding)
3) I then roll $2000 into a traditional IRA (TIRA)
4) After the TIRA transaction is complete, roll $10,000 ($9,600 balance from distribution + $400 from other sources) into a Roth IRA?

I have multiple accounts with Fidelity: 401K, Rollover IRA (TIRA), Roth, and regular (taxable) brokerage accounts

For step 2, could I just ask Fidelity to distribute the after-tax 401K money directly to my regular Fidelity brokage account? then
for steps 3 and 4, call them to move the money from the brokerage account to the Rollover and Roth, respectively?

What would my 1099R(s) look like if I complete the above steps?
what would happen to my 20% withholding in step 2? Is it similar to the tax withheld in my paycheck and counted toward paid tax amount in my 1040?

Thank you so much for educating me on this subject.
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Re: Rollover of after-tax 401k with large gain

Postby mrpotatoheadsays » Sat Apr 06, 2013 8:04 am

goGators wrote:1) Do I own any tax if the rollover executed as described above? This is for after-tax portion only. The pre-tax 401K still remains in my employer's plan.
2) What is the IRS view on such transactions?
Thank you.


http://www.forbes.com/sites/josephstein ... gravation/
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Re: Rollover of after-tax 401k with large gain

Postby goGators » Sat Apr 06, 2013 10:04 am

mrpotatoheadsays, thanks for the link.

I think I begin to understand why it is preferred to keep pre-tax money in a 401K instead of a traditional IRA (TIRA) when converting my after-tax 401K to a Roth.
It seems to me that the IRS treats 401Ks and IRAs as two (2) separated entities even though both are for retirement purpose.

With that in mind, I think Brian's advice "...roll the earnings back to the 401(k) and convert the basis..." would be the best approach since it results in $0 in my TIRA.
If my plan does not accept rollovers from IRA accounts, then Alan S.'s "Fairmark's strategy 3" would be safer due to Sec 402(c)(2) of the tax code.

One more question for all:
Alan S. wrote "....report the basis and then roll the pre tax TIRA balance back into the plan...". How do I report the basis?

Thank you!
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Re: Rollover of after-tax 401k with large gain

Postby Default User BR » Sat Apr 06, 2013 12:41 pm

goGators wrote:One more question for all:
Alan S. wrote "....report the basis and then roll the pre tax TIRA balance back into the plan...". How do I report the basis?

Form 8606. You will need to fill that out anyway for the conversion. Get a copy from the web and review it and the instructions.


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Re: Rollover of after-tax 401k with large gain

Postby goGators » Wed Apr 10, 2013 6:52 am

Default User BR wrote:... put it all in a traditional IRA, then roll the earnings back to the 401(k) and convert the basis.Brian

Why is it ok to separate the earnings from the basis when roll from a tIRA to a 401k but not from a 401k to a tIRA or a Roth?
Thank you.
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Re: Rollover of after-tax 401k with large gain

Postby Default User BR » Wed Apr 10, 2013 11:05 am

goGators wrote:
Default User BR wrote:... put it all in a traditional IRA, then roll the earnings back to the 401(k) and convert the basis.Brian

Why is it ok to separate the earnings from the basis when roll from a tIRA to a 401k but not from a 401k to a tIRA or a Roth?
Thank you.

From IRS Publication 590:
Tax treatment of a rollover from a traditional IRA to an eligible retirement plan other than an IRA. Ordinarily, when you have basis in your IRAs, any distribution is considered to include both nontaxable and taxable amounts. Without a special rule, the nontaxable portion of such a distribution could not be rolled over. However, a special rule treats a distribution you roll over into an eligible retirement plan as including only otherwise taxable amounts if the amount you either leave in your IRAs or do not roll over is at least equal to your basis. The effect of this special rule is to make the amount in your traditional IRAs that you can roll over to an eligible retirement plan as large as possible.

http://www.irs.gov/publications/p590/ch01.html#en_US_2012_publink1000230568


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