After-tax 401k contributions

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maxinout
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After-tax 401k contributions

Post by maxinout »

Hi there,

My 401k plan offers the ability to contribute money beyond the $16,500 limit, but on an after-tax basis.

I was curious if anybody knew what I would do with those contributions if/when I left the company? Where would that be rolled over to? Are there any complicated tax implications I should know about?

Thanks!
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tfb
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Post by tfb »

Rollover to Roth. Better yet if your company allows rollover before termination. It's called in-service withdrawal. You can't do it with pretax money but it's possible with after-tax money.
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jasonv
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Post by jasonv »

I have yet to understand the nuances of after-tax 401k rollovers. There an article on the Fairmark web site which gives a detailed explanation:

http://www.fairmark.com/rothira/09030801-401k-basis.htm
cliffedelgado
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Post by cliffedelgado »

+1 on looking into if in-service withdrawal of after-tax money is allowed by your company's plan

The article posted above has some good discussion. Just wanted to point out it seems more geared toward distribution after leaving a job rather than in-service withdrawal. Not saying it's not applicable in OP's case, just that it may not apply for in-service withdrawal case.
xerty24
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Post by xerty24 »

This is a good opportunity if you want to save more for retirement than the regular IRA/401k limits. If you are in this situation and your plan offers in-service withdrawals, it's a great opportunity.
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jasonv
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Post by jasonv »

xerty24 wrote:This is a good opportunity if you want to save more for retirement than the regular IRA/401k limits. If you are in this situation and your plan offers in-service withdrawals, it's a great opportunity.
So if a plan doesn't offer in-service withdrawals, then is there any advantage in after-tax contributions?
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tfb
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Post by tfb »

xerty24 wrote:This is a good opportunity if you want to save more for retirement than the regular IRA/401k limits. If you are in this situation and your plan offers in-service withdrawals, it's a great opportunity.
It's also a great opportunity if you won't work for this employer for more than 5 years.
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xerty24
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Post by xerty24 »

jasonv wrote:
xerty24 wrote:This is a good opportunity if you want to save more for retirement than the regular IRA/401k limits. If you are in this situation and your plan offers in-service withdrawals, it's a great opportunity.
So if a plan doesn't offer in-service withdrawals, then is there any advantage in after-tax contributions?
yes, but in that case it's more complicated to tell if this is a good choice vs taxable. As tfb points out, if you leave your job, you'll be able to convert to a Roth then even if you couldn't sooner. If you were going to hold this after tax money in bonds (i.e. you hold bonds in taxable now), it's also good. In other cases, longer job tenures or mostly stock AAs, it's less clear and at some point taxable is better since the after tax gains are ordinary while stock gains in taxable are treated more favorably.
jebmke
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Post by jebmke »

jasonv wrote:I have yet to understand the nuances of after-tax 401k rollovers. There an article on the Fairmark web site which gives a detailed explanation:

http://www.fairmark.com/rothira/09030801-401k-basis.htm
Strategy #3 in this article is exactly what was advised by another source of mine. It requires that you float the withholding tax for a period of time but if you do the distribution in December and file your return timely in the first quarter of the next year, the float should not be lengthy.
Stay hydrated; don't sweat the small stuff
xerty24
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Post by xerty24 »

I don't see a problem with the very simple "Strategy 1" desribed in that article. If you're doing an in service withdrawal, it must be all after tax dollars since the rules forbid pretax dollars from being withdrawn during employment, at least if you're below retirement age.
Default User BR
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Post by Default User BR »

xerty24 wrote:I don't see a problem with the very simple "Strategy 1" desribed in that article. If you're doing an in service withdrawal, it must be all after tax dollars since the rules forbid pretax dollars from being withdrawn during employment, at least if you're below retirement age.
Not quite. It won't contain any pre-tax contributions, but it will come with a share of taxable earnings. That's why it's best to do any such distributions as soon as possible to minimize the tax bite there. Or use Strategy 4 to isolate the basis.



Brian
gtaylor
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Is there a solo 401k with non-Roth after-tax features?

Post by gtaylor »

I have been funneling money into after-tax 401(k) contributions with the idea of periodically doing "Strategy 1" from that article. Sadly, it appears from the article, and from reading the IRS notices, newsletters, and code in depth, that that would result in a tax bill as a function of the pretax balance in my 401(k).

However, it is also clear that the "all IRA account balances are considered together for basis computations" rules do not apply to 401(k) after-tax -> Roth IRA rollovers; it's just the ratio within that one account. So going forward I could make after-tax non-Roth contributions to an otherwise empty 401(k), and have the desired tax treatment. I am both a W2 employee and Self Employed, so there is no reason I can't have two 401(k)s. However...

I have not been able to find a vendor offering a canned Solo 401(k) program that includes the after-tax but not Roth contribution feature. Does anybody offer such a plan? Is it even possible to operate a Solo 401(k) with this plan without running afoul of some law, reg, rule, letter, etc?
Default User BR
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Re: Is there a solo 401k with non-Roth after-tax features?

Post by Default User BR »

gtaylor wrote:I have been funneling money into after-tax 401(k) contributions with the idea of periodically doing "Strategy 1" from that article. Sadly, it appears from the article, and from reading the IRS notices, newsletters, and code in depth, that that would result in a tax bill as a function of the pretax balance in my 401(k).
Are you sure? It is possible to take in-service distributions of after-tax contributions that do not bring any pre-tax contributions, although as I mentioned they will bring earnings. In fact, if you aren't of age or have a qualifying event, you can't take pre-tax contributions out.



Brian
xerty24
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Post by xerty24 »

Default User BR wrote:
xerty24 wrote:I don't see a problem with the very simple "Strategy 1" desribed in that article. If you're doing an in service withdrawal, it must be all after tax dollars since the rules forbid pretax dollars from being withdrawn during employment, at least if you're below retirement age.
Not quite. It won't contain any pre-tax contributions, but it will come with a share of taxable earnings. That's why it's best to do any such distributions as soon as possible to minimize the tax bite there. Or use Strategy 4 to isolate the basis.
Yes, I forgot to mention that part. The earnings on the after-tax investments, prior to their conversion, are taken proportionally along with the after-tax balance if you do an conversion. If you do this promptly and/or hold your investments in cash while waiting for your in-service withdrawal & conversion, this won't be an issue. When I last did this, the fees for the various transfers, etc, that were involved were higher than my earnings so I ended up converting a balance (slightly) below my basis.

If you're in the situation where you're thinking about holding the after-tax portion for a very long time and hope to somehow separate those principle contributions from their earnings, I agree you'll have a hard time making that happen. I see now that that's what the articles' convoluted Strategies 3 - 5 were after.
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Post by Default User BR »

xerty24 wrote:If you're in the situation where you're thinking about holding the after-tax portion for a very long time and hope to somehow separate those principle contributions from their earnings, I agree you'll have a hard time making that happen. I see now that that's what the articles' convoluted Strategies 3 - 5 were after.
It's not that difficult if your company plan accepts rollovers from IRAs. Then it's just a matter of rolling in the amount equal to the taxable portion.



Brian
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tfb
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Re: Is there a solo 401k with non-Roth after-tax features?

Post by tfb »

gtaylor wrote:I have not been able to find a vendor offering a canned Solo 401(k) program that includes the after-tax but not Roth contribution feature. Does anybody offer such a plan? Is it even possible to operate a Solo 401(k) with this plan without running afoul of some law, reg, rule, letter, etc?
I'm sure it's legal. Solo 401k plans follow the same rules as corporate 401k plans. Finding a low cost provider is the challenge because the demand isn't there.
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gtaylor
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Re: Is there a solo 401k with non-Roth after-tax features?

Post by gtaylor »

Default User BR wrote:
gtaylor wrote:I have been funneling money into after-tax 401(k) contributions with the idea of periodically doing "Strategy 1" from that article. Sadly, it appears from the article, and from reading the IRS notices, newsletters, and code in depth, that that would result in a tax bill as a function of the pretax balance in my 401(k).
Are you sure? It is possible to take in-service distributions of after-tax contributions that do not bring any pre-tax contributions, although as I mentioned they will bring earnings. In fact, if you aren't of age or have a qualifying event, you can't take pre-tax contributions out.
Brian
No, I'm not sure, and I can't find a clear answer in the IRS regs, pubs, etc.

This IRS newsletter quoted by the article ( http://www.irs.gov/pub/irs-tege/rne_fall08.pdf ) states:

"No, you may not take a distribution of only your after-tax contributions. Any distribution from a retirement plan account in which there is basis is treated as consisting of both pre-tax amounts (your employer’s pretax contributions and earnings) and your after-tax contributions." It goes on to describe the ratio math, which is specific to within the one 401(k) account, since the account aggregating rule does not apply.

On the other hand, my company's plan, and apparently IRS regulation, do indeed state that only the after-tax contributions can be withdrawn in service. The new direct Roth rollover clauses allow for the earnings to be taxed and not hit with a 10% penalty, so the attributable earnings can presumably come too.

So, either a) common sense rules and the supposedly after-tax-only distribution is taxed like what it is supposed to be; or b) insanity reigns and the plan feels that they have distributed after-tax moneys while the IRS expects taxes based on the pre-tax / total balance ratio of the distribution.

Option (b) has the unfortunate property that my trustee's records will have a $0 after-tax balance while the after-tax 401k balance for IRS purposes would be some leftover portion that wasn't distributed for tax purposes. I would then have to do all the tracking of those two balances and attributable gains myself, forever, which would be something of a pain.

Option (a) is, as one of the articles out there says, "pure gold". But I am having trouble convincing myself that it is kosher. Having gone through a mangled IRA transaction that triggered an IRS challenge letter, I know that I will need to have a clear understanding of the pubs and regs that define the taxation for this transaction, just so I can answer the inevitable "you did what now?" letter from the IRS.
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Post by Default User BR »

As best I can determine, that Q&A referred to distributions following a qualifying event, termination or whatever, not an in-service distribution. When you do a distribution of the after-tax amount, you'll get a statement from the qualified plan showing the amount and the basis. You then file 8606 for the new IRA, establishing the basis at that time.



Brian
Ron
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Re: After-tax 401k contributions

Post by Ron »

maxinout wrote:Hi there,

My 401k plan offers the ability to contribute money beyond the $16,500 limit, but on an after-tax basis.

I was curious if anybody knew what I would do with those contributions if/when I left the company? Where would that be rolled over to? Are there any complicated tax implications I should know about?

Thanks!
I did this for many years, with my former company's 401(k) provider - Fidelity.

At retirement, Fidelity split out my pre/after tax contributions (all gains went to the pre side) and established my "commercial account" with a roll-over IRA, in addition to a taxable (MM) account, into which my post-tax contributions were deposited.

Being that the post-tax contributions went to the MM taxable account and I did (and continue) to use that account to transfer my roll-over transfers on a monthly basis (and paying taxes at the same time, upon transfer).

It is also the accounts in which my Fidelity (Amex/Visa) CC card rebates are transferred (a bit over $700, this year alone).

It's really not a problem IMHO, and it gives you an account in order to manage your retirement income/transfers, and worked out quite well for me. I had no intent to re-direct my after tax to any type of IRA, but to use it in early retirement as income, which in turn delayed withdrawls from my rollover IRA for quite a bit of time. It's a bit easier to handle it in this manner than to think of those $$ as 401(k)/IRA contributions (which they are not), and you feel you need to invest them in a like IRA investment.

- Ron
Last edited by Ron on Tue Nov 09, 2010 12:20 pm, edited 1 time in total.
gtaylor
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Post by gtaylor »

Default User BR wrote:As best I can determine, that Q&A referred to distributions following a qualifying event, termination or whatever, not an in-service distribution. When you do a distribution of the after-tax amount, you'll get a statement from the qualified plan showing the amount and the basis. You then file 8606 for the new IRA, establishing the basis at that time.
Yes, I'm beginning to think that it must be so. Evidently there are so few people doing in-service distributions that it is sort of under-documented. Or, you know, the whole thing might just be over-regulated.

So I guess I'll give it a whirl. Seems like there is a 95% chance that any IRS nastygrams can be rebuffed by pointing to the 1099-R from the trustee, and for that matter they'll tend to generate question based mostly on 1099/W2 info in the first place.

In any case my conscience will be clear; no dollars would be taxed twice, no dollars would be untaxed outside of the in-Roth earnings, and basis will remain clear throughout.
Ron
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Post by Ron »

gtaylor wrote:Evidently there are so few people doing in-service distributions that it is sort of under-documented. Or, you know, the whole thing might just be over-regulated.
Just for "documentation purposes", I did an in-service distribution and I did have "above the line" contributions.

My former company allowed a portion of 401(k) assets to be rolled into a traditional IRA after the age of 55 (every plan is different).

I did establish a TIRA and rolled over the maximum allowable portion, which allowed me to invest in funds unavailable to me as a 401(k) participant.

However, my "excess contributions" were not able to be moved. They were kept with my 401(k), and distributed to me (see above post for details) upon retirement.

- Ron
otto77357
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Recently retired

Post by otto77357 »

I recently retired, and in October I completed a trustee-to-trustee 401K rollover from my Fidelity 401K to my Vanguard IRA accounts. The 401K included pre-tax contributions, after-tax contributions, and Roth-401K contributions. Fidelity issued three checks -- one for the after-tax contributions, excluding any earnings (basis), a second check for the current value of the Roth-401K account, and a third check for everything that remained.

According to Fideltiy (and I sure hope they were correct), I could roll checks one and two into my Roth IRA and check three into my T-IRA. Those were the instructions I provided to Vanguard, and that's what they did.
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Re: Recently retired

Post by jebmke »

otto77357 wrote:I recently retired, and in October I completed a trustee-to-trustee 401K rollover from my Fidelity 401K to my Vanguard IRA accounts. The 401K included pre-tax contributions, after-tax contributions, and Roth-401K contributions. Fidelity issued three checks -- one for the after-tax contributions, excluding any earnings (basis), a second check for the current value of the Roth-401K account, and a third check for everything that remained.

According to Fideltiy (and I sure hope they were correct), I could roll checks one and two into my Roth IRA and check three into my T-IRA. Those were the instructions I provided to Vanguard, and that's what they did.
Were the checks made out to you or to Vanguard? If they are made out to Vanguard, according to the Fairmark article, it might not work the way you intended.
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otto77357
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Post by otto77357 »

The checks were mailed to me, but were made out to Vanguard "for the benefit of" me. I forwarded the checks to Vanguard with instructions. Did I screw up?
scrabbler1
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Post by scrabbler1 »

When I left my company about 2 years ago, I had to empty my 401(k) because I was liquidating the company stock (ESOP) I had in it. A small amount of the money in it was from some after-tax contributions I had made in the 1990s.

This was my one chance to separate those after-tax contributions from their tax-advantaged earnings (like the earnings from the pre-tax contributions). So, I took the after-tax contributions in cash which were, of course, not subject to any further taxes. I used those dollars to pay some of the taxes on the ESOP I cashed out. I also rolled into an IRA everything else in the 401(k) such as pre-tax contributions and all earnings on pre-tax and after-tax contributions - no taxes on any of that (yet).

I suppose I could have rolled those after-tax contributions into a Roth IRA, but I never intended to do that because of the tax bill on the ESOP cash-out.

I made all my special instructions clear to the 401(k) Plan administrator and they executed everything just as I requested.
jebmke
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Post by jebmke »

otto77357 wrote:The checks were mailed to me, but were made out to Vanguard "for the benefit of" me. I forwarded the checks to Vanguard with instructions. Did I screw up?
I really am not sure. I was going to do it the same way but then was advised not to. Apparently the relevant IRC is not clear but many are now suggesting that a direct rollover (trustee to trustee) is different than a distribution (trustee to you -- which you then deposit to the IRAs). I don't think you will know until after you file your 2010 taxes.
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scrabbler1
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Post by scrabbler1 »

otto77357 wrote:The checks were mailed to me, but were made out to Vanguard "for the benefit of" me. I forwarded the checks to Vanguard with instructions. Did I screw up?
I don't think so. When I did my rollover from the 401(k) into my IRA 2 years ago, the check was made out to Fidelity on my behalf and mailed to me per my instructions.

I had already been given an account number by Fidelity prior to receiving the check, so it was included on the check. When I took the rollover check to my local Fidelity office, they handled it according to my instructions (i.e. split it into 2 mutual funds). A few months later, when I received a 1099-R form for the rollover, it was also completed correctly, indicating it is a rollover so no taxes were withheld (and none were due).
Sidney
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Post by Sidney »

scrabbler1 wrote:
otto77357 wrote:The checks were mailed to me, but were made out to Vanguard "for the benefit of" me. I forwarded the checks to Vanguard with instructions. Did I screw up?
I don't think so. When I did my rollover from the 401(k) into my IRA 2 years ago, the check was made out to Fidelity on my behalf and mailed to me per my instructions.

I had already been given an account number by Fidelity prior to receiving the check, so it was included on the check. When I took the rollover check to my local Fidelity office, they handled it according to my instructions (i.e. split it into 2 mutual funds). A few months later, when I received a 1099-R form for the rollover, it was also completed correctly, indicating it is a rollover so no taxes were withheld (and none were due).
But if I read your earlier post correctly you did not attempt to roll the after-tax part to a ROTH. That is the issue here. Did I read your earlier post right?
I always wanted to be a procrastinator.
scrabbler1
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Post by scrabbler1 »

Sidney wrote:
scrabbler1 wrote:
otto77357 wrote:The checks were mailed to me, but were made out to Vanguard "for the benefit of" me. I forwarded the checks to Vanguard with instructions. Did I screw up?
I don't think so. When I did my rollover from the 401(k) into my IRA 2 years ago, the check was made out to Fidelity on my behalf and mailed to me per my instructions.

I had already been given an account number by Fidelity prior to receiving the check, so it was included on the check. When I took the rollover check to my local Fidelity office, they handled it according to my instructions (i.e. split it into 2 mutual funds). A few months later, when I received a 1099-R form for the rollover, it was also completed correctly, indicating it is a rollover so no taxes were withheld (and none were due).
But if I read your earlier post correctly you did not attempt to roll the after-tax part to a ROTH. That is the issue here. Did I read your earlier post right?
That is right. I was aware I could have rolled it into a Roth but wanted to cash the principal (i.e. contributions, not earnings) out. Had I chosen to do that, I suppose, but do not know for sure, I would have received a additional and separate rollover check made out to Fidelity on my behalf which would have begun a Roth IRA. Could the earnings on those after-tax contributions been included in the Roth IRA? I do not know, what I was doing was messy enough without trying to figure THAT out!
the intruder
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Re: Recently retired

Post by the intruder »

otto77357 wrote:I recently retired, and in October I completed a trustee-to-trustee 401K rollover from my Fidelity 401K to my Vanguard IRA accounts. The 401K included pre-tax contributions, after-tax contributions, and Roth-401K contributions. Fidelity issued three checks -- one for the after-tax contributions, excluding any earnings (basis), a second check for the current value of the Roth-401K account, and a third check for everything that remained.

According to Fideltiy (and I sure hope they were correct), I could roll checks one and two into my Roth IRA and check three into my T-IRA. Those were the instructions I provided to Vanguard, and that's what they did.
While you received 3 checks to rollover how they will be taxed is a different question.

Clearly the amounts transferred from the Roth 401k are not included in income tax since they are rolled over to a Roth IRA.

As for the after tax amount converted to the Roth IRA, IRS Notice 2009-68 implies that since your transfer was a direct rollover, the after tax amount excluded from income tax would be a pro rata amount of the AT amount plus the pre tax 401k account balance. This positon ignores IRC 401(c))(2) which provides that the first amounts transfered from a Q plan are to be considred pre tax disgtribution. It appears that FIDO issued 3 checks to avoid have to determine whether the prae tax amount was first distribution was the first amount distributed.

In other words under Notice 2009-68, if you converted 10k of AT to the Roth IRA and rolled over 90k of pre tax to a t-IRA then only 1k of the 10k transferred to the Roth would be AT funds. 9k would be a taxable distribution.

Unfortunately the IRS has not articulated how AT amounts from qual plans are to be taxed when converted to a Roth IRA and the pre tax amounts rolled over to a T-IRA. However in 2010 conversions from a qual plan to a Roth IRA will be requred to complete an 8606 form so the IRS can keep track of the AT amounts. Presumably the IRS will detail how the the AT amounts will be allocated to the Roth IRA in the instructions to the 8606 form.
coinflip
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Post by coinflip »

Does anybody else have experience using in-service distributions to convert after-tax 401k contributions to a Roth IRA? It seems like it would be a great strategy if you are short on tax-advantaged space.

For example, my company's 401k plan allows total annual contributions (employee plus employer) up to $49,000. If I max out the pre-tax contributions, that leaves roughly $22,000 for after-tax contributions after accounting for the employer match. Making those contributions and converting them to a Roth IRA without any tax consequences would be great, since that money would otherwise go to a taxable account.

However, the process seems complicated. The strategy advocated by the [url=ttp://www.fairmark.com/rothira/09030801-401k-basis.htm]Fairmark article[/url] posted above seems to require distribution of all 401k funds to avoid pro-rated taxation of after-tax contributions.

Other sources give conflicting information. This WSJ article makes it sound like such conversions may not be allowed.

And this Investopedia article advocated a simpler approach than the Fairmark methodology.

I would appreciate it if anyone could provide additional clarification.
Default User BR
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Post by Default User BR »

It really won't matter too much to you, as your rollover will be largely after-tax. Potentially, some taxable earnings might come with it. If so, then you'd need to decide whether to pay the tax on those, or roll them back into the plan to isolate the basis.



Brian
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