401k after-tax contributions and a Vanguard Roth IRA rollover

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AppreciateLife
Posts: 2
Joined: Sun Aug 20, 2017 10:53 am

401k after-tax contributions and a Vanguard Roth IRA rollover

Post by AppreciateLife » Sun Aug 20, 2017 1:12 pm

Hello Bogleheads –

I have 401k with a previous employer that I am looking into rolling over to my existing Vanguard IRA portfolio. Portions of the balance of the of this 401k are as follows:

After-tax contributions $47,891
Post-1986 contributions $6,349

I’ve done some searches on-line and there seems to be a way to identify the after-tax contributions that have been made to the 401k and have these after-tax contributions rolled into a Roth IRA when the entire 401k is rolled over. The applicable IRS code appears to be IRS Notice 2014-54, but honestly, it’s difficult for me to read and understand this notice.

I was wondering if there wasn’t anyone on the forum who could comment as to:

1) Whether it is possible or not to have 401k after-tax contributions allocated to a Roth IRA during the rollover of the entire 401k, and

2) What do I need to tell my former employer and Vanguard to have this happen.

As well as your learned comments, it would also be great if someone knowledgeable could point me to a competent book or link on the internet that addresses this matter.

My age is 58 yrs, 10 mos. I’ve read ‘The Boglehead’s Guide to Retirement Planning’, but couldn’t find anything in this text that addresses my questions above. I think it’s because the volume I have was last updated in 2009 and the IRS Notice came out in 2014.

I really appreciate your help, thanks, Mark

retiredjg
Posts: 30592
Joined: Thu Jan 10, 2008 12:56 pm

Re: 401k after-tax contributions and a Vanguard Roth IRA rollover

Post by retiredjg » Sun Aug 20, 2017 2:23 pm

Just double checking....you mean after tax contributions, not Roth 401k contributions. Right?


Your most likely subject matter expert on this is Alan S. If he does not see the topic, just send him a private message and ask him to look at the thread.

I think Alan may be one of the few who know how the pre-1987 contributions are handled. They have different rules from the post 1986 contributions.

One thing I do know.....yes, your after-tax contributions can go directly to Roth IRA. It is generally handled by 2 checks - one made out to Vanguard FBO (for the benefit of) AppreciateLife's IRA and one made out to Vanguard FBO AppreciateLife's Roth IRA. What usually happens is they mail the checks to you and you forward the checks to Vanguard, probably with some paperwork.

Alan S.
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Location: Prescott, AZ

Re: 401k after-tax contributions and a Vanguard Roth IRA rollover

Post by Alan S. » Sun Aug 20, 2017 5:07 pm

AppreciateLife wrote:
Sun Aug 20, 2017 1:12 pm
Hello Bogleheads –

I have 401k with a previous employer that I am looking into rolling over to my existing Vanguard IRA portfolio. Portions of the balance of the of this 401k are as follows:

After-tax contributions $47,891
Post-1986 contributions $6,349

I’ve done some searches on-line and there seems to be a way to identify the after-tax contributions that have been made to the 401k and have these after-tax contributions rolled into a Roth IRA when the entire 401k is rolled over. The applicable IRS code appears to be IRS Notice 2014-54, but honestly, it’s difficult for me to read and understand this notice.

You are on the right track. Notice 2014-54 makes it very easy to split your direct rollovers such that the pre tax balance in the plan goes to your TIRA and the after tax contributions to your Roth IRA. Since that is what you want to accomplish, the breakdown between the pre 1987 after tax contributions and the post 86 amounts is immaterial because the entire 47,891 can be directed to your Roth IRA.



I was wondering if there wasn’t anyone on the forum who could comment as to:

1) Whether it is possible or not to have 401k after-tax contributions allocated to a Roth IRA during the rollover of the entire 401k, and

2) What do I need to tell my former employer and Vanguard to have this happen.

Yes, you can as retiredjg indicated. When you request the direct rollovers, ask that the entire after tax balance in the plan be directly rolled into your Roth IRA, and the pre tax balance of the plan rolled into your TIRA as a split rollover per Notice 2014-54. No need to mention dollar amounts. If you initiate the rollovers through Vanguard, be sure their form is clear in this regard.

As well as your learned comments, it would also be great if someone knowledgeable could point me to a competent book or link on the internet that addresses this matter.

Here is the actual Notice with some examples of more complex transactions than you wish to do: https://www.irs.gov/pub/irs-drop/n-14-54.pdf

My age is 58 yrs, 10 mos. I’ve read ‘The Boglehead’s Guide to Retirement Planning’, but couldn’t find anything in this text that addresses my questions above. I think it’s because the volume I have was last updated in 2009 and the IRS Notice came out in 2014.

In some other situations than yours, the pre 87 after tax contribution amount still presents an advantage because these amounts can be distributed ALONE without earnings upon request, as they could have been prior to 2014-54. See http://fairmark.com/retirement/roth-acc ... yer-plans/.
For example, suppose you were doing back door Roths every year, so you did not want more pre tax dollars in your TIRA. With your plan balance you could request a direct rollover of ONLY the pre 87 after tax contribution balance to your Roth IRA, and no earnings on those contributions would have to be distributed. But you would have to leave the rest of the plan balance intact until you were retired and no longer doing back door Roth IRAs. This would get the 41,000+ of pre 87 contributions into your Roth IRA with no current tax due and your back door Roth contributions could continue as before. Or if you simply wanted the distribution to pay expenses (no rollovers), you could get the pre 87 balance distributed to you by itself and tax free. Therefore, there are still benefits of the grandfathered pre 87 balance, but in your situation they do not apply.

I really appreciate your help, thanks, Mark

AppreciateLife
Posts: 2
Joined: Sun Aug 20, 2017 10:53 am

Re: 401k after-tax contributions and a Vanguard Roth IRA rollover

Post by AppreciateLife » Tue Aug 22, 2017 6:15 am

I want to sincerely thank ‘retiredjg’ and ‘Alan S.’ for responding so quickly and adroitly to my inquiry regarding 401k rollovers.

Over the years I’ve been handling my own investments, mostly adhering to the simple rules of index mutual funds espoused by John Bogle and Vanguard (that is, except for a minor self-inflicted wound during the ‘tech bubble’). Now that I’m getting closer to retirement, I looking to consolidate everything to Vanguard, allocating the funds into a ‘four fund’ portfolio scenario, that I learned about on bogleheads.org.

Looks like a person only gets ‘one shot’ with a 401k rollover and I sure don’t want to mess it up. If I may ask another question of the forum, that would be great.

Below is a table of ‘Contribution Balances’ from a recent 401k statement of my former employer

Contribution Balances
Your Contributions and Earnings
After-tax Contributions 8%
Before-tax 43%
Company Contributions & Earnings
Retiree Medical 5%
ESOP Match on After-tax 13%
ESOP Match on Before-tax 31%
Total 100%

My apologies for the unreadability of the table above. I couldn’t find a better way to format this information for the post.

The way I understand things right now, when I request the rollover from my former employer I would get two checks: one check for the after-tax contributions (8%), which would go to a Roth IRA, and a second check for everything else (before-tax, retiree medical, ESOP after-tax match and ESOP before-tax match) for 92%, which would go to a TIRA.

My question is, is there a benefit that I should be aware of regarding the retiree medical and ESOP before- and after-tax amounts as I roll this 401k over? For example, maybe the retiree medical amount can be put into an HSA. Or maybe the ESOP after-tax match can also be put into a Roth IRA.

Any advice you may have on this matter would be greatly appreciated. Thank you, Mark

retiredjg
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Joined: Thu Jan 10, 2008 12:56 pm

Re: 401k after-tax contributions and a Vanguard Roth IRA rollover

Post by retiredjg » Tue Aug 22, 2017 6:50 am

An employer may match an after-tax contribution, but the match itself is always pre-tax.

I think you could direct the match to the Roth IRA, but there would be no benefit since that would be a taxable conversion. I would not do it. I believe using the wording Alan mentioned..."ask that the entire after tax balance in the plan be directly rolled into your Roth IRA, and the pre tax balance of the plan rolled into your TIRA as a split rollover per Notice 2014-54. No need to mention dollar amounts...." is important to keep things from getting messed up.

I have no idea about the HSA.

Alan S.
Posts: 6912
Joined: Mon May 16, 2011 6:07 pm
Location: Prescott, AZ

Re: 401k after-tax contributions and a Vanguard Roth IRA rollover

Post by Alan S. » Tue Aug 22, 2017 3:25 pm

Mark, you are correct. It is critical to make the best choices when you do rollovers of any type, but even more so when the plan balance is large following several years of employment. And YOUR plan here presents the most complex combination of options possible since you have both NUA potential AND after tax contributions!

Do you have any other breakdowns in dollars, rather than this one in %s?

It is not clear why retiree medical is included here, but this suggests that there is a dollar balance set aside to pay premiums. How you would apply this for this particular employer could vary, so you will have to get those details from the plan administrator.

It also appears that your employer matching contributions were made in ESOP shares, so you are participating in an ESOP plan. This link may help explain how they relate: http://www.oeockent.org/download/ESOPS/ ... ns.pdf.pdf

Employer stock, whether ESOP or non ESOP is eligible for net unrealized appreciation (NUA) if you do a qualified lump sum distribution (LSD) of the entire balance of similar plans in a single year. With NUA you will owe ordinary incomes taxes on the cost basis of the shares (what the shares were worth when contributed to your account) in the year of distribution, and later on when you sell those shares you pay the lower LTCG rate on the NUA amount. If you utilize NUA, you always need to be concerned first with diversification (remember Enron, WorldCom etc) rather than tax benefits. Therefore, you may need to sell many of these shares sooner rather than later and you would owe the CG taxes in the year you sell the shares. Note that NUA is mutually exclusive with an IRA rollover meaning that if you use NUA to get the LTCG tax rates, the shares or their proceeds will remain outside of any retirement account. The distribution of ESOP shares would therefore have to be made to a taxable brokerage account. The most critical factor with ESOP shares is the cost basis % relative to the value of the shares. Very generally, you would not normally consider using NUA if the cost basis was over 30%, UNLESS you needed this money for expenses in the next couple of years. So you need to get a cost basis quote from the plan to determine what this % is.

NOTE: With some ESOP plans, you are only allowed to distribute something like 20% per year. If your plan includes this restriction, NUA is essentially disabled since only the last 20% would qualify for the required LSD.

It gets more complex. When you have NUA shares combined with after tax contributions (the 8%), you need to know how the plan assigns the after tax contributions to your plan balance, ie the ESOP shares. This determines whether the cost basis for the NUA shares is reduced by the after tax contributions so you owe less in the year of distribution, or whether the after tax contributions are applied to the rest of the plan balance, in which case you could do the split rollover of the after tax amount to your Roth IRA, but pay ordinary taxes on the unreduced cost basis for the shares.

By now, you are probably completely confused, and while the plan might provide you with actual numbers and your options, but will not advise you on which choices to actually make. Like any complex issue, remember that you have time to investigate further, and if you can ELIMINATE certain options up front things get simpler fast. For example, if your NUA shares cost basis is too high, you can eliminate NUA up front and just do the split rollovers discussed earlier. However, it is possible that your NUA cost basis is very low, something like perhaps 5% (usually depends on how many years the shares have been purchased and how much the shares have gained), in which case paying the lower LTCG rates on 95% of that value and deferring those taxes is compelling.


jksyn
Posts: 3
Joined: Sat Nov 11, 2017 8:26 pm

Re: 401k after-tax contributions and a Vanguard Roth IRA rollover

Post by jksyn » Sat Nov 11, 2017 9:09 pm

Don't know if this forum item is closed. Hopefully not, since I have a question somewhat is the same vein. I too had after tax dollars in my 401K qualified plan when I was basically forced to roll over the 401K account to an IRA when the company I had worked for closed in early 2013. Obviously this rollover even took place prior to the 2014-54 ruling so everything went to a Traditional IRA. Notice 2014-54 indicates that Taxpayers can use the new rule for distributions prior to September 18, 2014 except for distributions from designated Roth accounts. Does Notice 2014-54 give me any recourse at this point?
I know that the IRS stated that the 2014 notice does not apply IRA's with non-deductible contributions but my non-deductible /post tax contributions were actually not made originally into an IRA. There were comments in other forums that seem to opine that the IRS allowance for prior distributions was an amnesty for those that had executed roundabouts prior the to 2014-54 Notice. I had looked into those roundabouts back in 2013 and it seemed to me that that most financial advisors had concluded they were not legitimate except possibly for the one that involved a good bit of withholding tax. Since I didn't want to chance running afoul of IRS, I didn't attempt any of those strategies to split the rollover into a Roth and a TIRA. Instead I roll-overed everything into a single TIRA. If 2014-54 exemption for prior distributions only deals with those roundabout distributions it would seem that those who played by the IRS' 2009 notice rules wouldn't be getting a fair shake?!?. Any insight on options that might be applicable would be appreciated.

retiredjg
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Joined: Thu Jan 10, 2008 12:56 pm

Re: 401k after-tax contributions and a Vanguard Roth IRA rollover

Post by retiredjg » Mon Nov 13, 2017 8:06 am

jksyn, welcome to the forum. :happy

I was hoping you'd get an answer from Alan S. who seems to know the most about this notice. Since he has not answered, I'll voice an opinion - I seriously doubt there is anything to do at this point to "un-do" your rollover.

I don't know what you mean by "roundabouts" so I didn't understand part of your post.

I do recall that some posters reported that their employers had split their rollovers into traditional and Roth prior to the notice. I don't know if that was common practice or if it was done by only a few.

There can still be a way to split your pre-tax money and your basis in an IRA if you have a 401k or similar plan that will accept a rollover from IRA. Are you aware of that?

jksyn
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Joined: Sat Nov 11, 2017 8:26 pm

Re: 401k after-tax contributions and a Vanguard Roth IRA rollover

Post by jksyn » Mon Nov 13, 2017 1:47 pm

RetiredJG
Thank you for the reply. :happy Sadly, based on my research, I'm coming to the same conclusion that there is nothing I can do at this point :( This is an especially disappointing situation because a good bit of the post tax contributions were actually pre-1987 after-tax contributions which merited special treatment while in the 401K.

My use of the term "roundabouts" was in reference to different strategies I had seen which were developed claiming legitimacy based on the perceived lack of clarity in IRS's 2009 Notice.

Yes, I am aware of the procedure of rolling the IRA back into a 401K. However, it was because my company 401K was being permanently closed that the full rollover to an IRA was executed so going back to that 401K is not an option and, unfortunately, at this time I don't have the option of another 401K. Even if I did, I wonder how one would document the post tax amount for the receiving plan's administrator and IRS.

In 2014-54 the IRS proclaimed:
"For distributions made prior to September 18, 2014, taxpayers may generally apply
same reasonable interpretation standard described in the preceding paragraph.
However, if such a distribution is made from a designated Roth account, the allocation
of the pretax amounts must be made in accordance with the rules set forth in the
§ 402A regulations that were in effect on the date of the distribution. "

I have not been able to find anything that explains that paragraph in 2014-54 or put forth an example/sample case of how it could be used. As I noted before, it would seem that it is applicable to those who had previously split their distribution to multiple destinations including a Roth IRA despite Notice 2009. In which case, those taxpayers followed the old rule of thumb that it is easier to ask for forgiveness than to ask for permission. They took a risk and received forgiveness/amnesty with Notice 2014-54

retiredjg
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Re: 401k after-tax contributions and a Vanguard Roth IRA rollover

Post by retiredjg » Mon Nov 13, 2017 1:57 pm

jksyn wrote:
Mon Nov 13, 2017 1:47 pm
...so going back to that 401K is not an option and, unfortunately, at this time I don't have the option of another 401K. Even if I did, I wonder how one would document the post tax amount for the receiving plan's administrator and IRS.
If you had the option of doing this, you would not send the post tax money to the 401k at all. You'd send everything BUT the post tax money to the 401k and then convert the post tax money to Roth.

Any possibility you have some income that would allow you to open a Solo 401k?

I'm guessing there is no solution for it and that you'll just have to use Form 8606 to keep from paying tax on that money a second time. Not ideal, but not impossible either.

Alan S.
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Location: Prescott, AZ

Re: 401k after-tax contributions and a Vanguard Roth IRA rollover

Post by Alan S. » Mon Nov 13, 2017 8:14 pm

I fully agree with the conclusions you collectively have reached.

Many people and even their plan administrators rolled the dice prior to 2014 and their gamble was rewarded by 2014-54. There were various methods of "isolating basis" prior to the Notice, but the simplest one at that time was to do a direct rollover of the pre tax balance to a TIRA, receive a cash distribution of the after tax amount and then do a 60 day rollover of the after tax amount to a Roth IRA. A total distribution involving 20% withholding was even safer, but not very convenient. There is a tax code provisions that supported those two methods all along.

But for you and anyone else that actually ended up rolling basis into your TIRA, you are pretty much stuck with that barring having a current employer plan that will accept pre tax dollars rolled from your TIRA. Once after tax dollars are contributed to your IRA, they can only come out pro rated per Form 8606, other than the rollover to a 401k or similar plan, a QCD, or HSA one time rollover, neither of which are likely to solve the problem. I have never heard of a case where a different kind of solution was approved.

IRS instructions indicate that the next time you would otherwise file Form 8606, you should enter the after tax portion of the 401k rollover on line 2 of the form.

Regrettably, your pre 87 after tax contributions (known as "grandfathered money") could have been separately distributed to your Roth IRA without the uncertainty regarding the post 86 after tax amounts, since the pre 87 amounts have always been available for separate distribution. You probably did not have much of a balance.

jksyn
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Joined: Sat Nov 11, 2017 8:26 pm

Re: 401k after-tax contributions and a Vanguard Roth IRA rollover

Post by jksyn » Mon Nov 13, 2017 10:51 pm

Alan S and retiredjg,
Thank you both for your counsel and suggestions. Your responses were greatly appreciated! While it is obvious I made some errors in handling the rollover of my 401K in 2013, it is quite apparent that my biggest mistake was not coming to this great site several years ago for advise.
Once again - Thanks

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