After Tax 401K Rollover to Roth IRA, Continued

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ydnar
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After Tax 401K Rollover to Roth IRA, Continued

Post by ydnar » Tue Jan 05, 2010 7:57 pm

There has been much discussion on the rolling of 401K after tax funds directly into a Roth IRA without creating a taxable event. After much study of conflicting information, I decided to ask the IRS directly and made the decision to proceed with the rollover of my Vanguard 401k into Roth and Traditional Vanguard accounts. My request to the IRS was on Dec 9, 2009, and they called me today with their answer that the after tax money could go directly into a Roth account. I am well aware of the fact that they do not stand behind their advice and can turn on you after the fact, but I figure I can always recharacterize the Roth account if necessary. Here again are the details of my situation:

--62 Year Old with approximately 88000 after tax funds and 400,000 pretax funds in my Retirement Saving Plan with Vanguard. I am still employed, but the transfer is permitted under the plan rules.

--Vanguard encouraged me to create a Roth and Traditional IRA account on their website and has sent me the application to transfer the funds directly into the appropriate existing accounts.

--I have been working with the Vanguard Rep for sometime and they have been very helpful, but they insist that they do not provide tax guidance which is certainly understandable with all the vague guidance available from the IRS. I have had Traditional and Roth IRAs with Fidelity for years and my Fidelity Rep told me they routinely make this type of direct transfer (he may have been hoping to get some of the Vanguard business).

--I recently moved all my 401k funds into Vanguard Target Retirement 2015 for simplicity and plan to keep them there.

I know several financial articles and forum posters have described other interpretations and procedures for accomplishing this rollover, but I have decided to act now and recharacterize later if I must. Am I missing something simple here that will make me regret the decision?

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Re: After Tax 401K Rollover to Roth IRA, Continued

Post by Default User BR » Wed Jan 06, 2010 3:59 am

ydnar wrote:I know several financial articles and forum posters have described other interpretations and procedures for accomplishing this rollover, but I have decided to act now and recharacterize later if I must. Am I missing something simple here that will make me regret the decision?

What method will you be using to accomplish this rollover? Will taxes be withheld?



Brian

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ydnar
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Post by ydnar » Wed Jan 06, 2010 11:17 am

No taxes withheld because they are both direct rollovers. (Traditional and Roth)

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Post by Shawn » Wed Jan 06, 2010 3:38 pm

I've read and heard different interpretations of what can and cannot be done with 401 plans, but yesterday, I did essentially the same thing as you.

I have pre-tax and after-tax contributions in a 401a at a former employer, and pre-tax and after-tax contributions in a 401k at my current employer. There are earnings on these contributions, but the earnings on the after-tax contributions are essentially zero. In fact, they were negative on December 31 but went slightly positive due to the market gain so far this week.

So yesterday, I rolled the after-tax contributions and the earnings on the after-tax contributions from both plans into a Roth IRA. Fortunately, my current employer allows in-service distributions of after-tax contributions. My pre-tax contributions with their earnings remain in the 401 plans. I believe this will have negligible tax consequences (I'll be taxed only on the small earnings from the after-tax contributions). It would be different if it was a TIRA to Roth conversion, in which case I would need to pro-rate with any pre-tax contributions.

Both of my employer plans are at Fidelity. For simplicity and safety, I elected to open a Roth IRA at Fidelity and directly roll the 401 funds here. When I retire in a couple years, I may roll this over to a Roth IRA at Vanguard. I did all this over the phone. The Fidelity representative (retirement specialist) was very helpful and seemed quite knowledgeable. I began speaking with him in December to be ready for the conversion. I asked several times about the pre-tax contribution issue and the information that will be included on the 1099-R form that I will receive in January of next year. The Fidelity representative was very precise with his words (factual information, but no advice) ... "You are rolling over X dollars in after-tax contributions. This will not create a taxable event. You are rolling over Y dollars in earnings on after-tax contributions. This will create a taxable event."

I believe all of this will work. In fact, I'll make additional after-tax contributions to my 401k later this year, which I'll "immediately" roll into the Roth IRA. Of course, this is new territory. I won't be completely satisfied about the mechanics and tax consequences until tax time next year.

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Re: After Tax 401K Rollover to Roth IRA, Continued

Post by Redbelly » Wed Jan 06, 2010 4:28 pm

ydnar wrote:....<snip>.......

I know several financial articles and forum posters have described other interpretations and procedures for accomplishing this rollover, but I have decided to act now and recharacterize later if I must. Am I missing something simple here that will make me regret the decision?


I'm in a similar situation and started an earlier thread on the same subject. Fido has given me the go ahead to split my 401(k) into a pretax Rollover IRA and a post tax Roth. Complicating factors are that I needed to wait until 2010 due to my income and that Fido lost the 401(k) account from my former employer as of the end of the year. So, as soon as the new administrator is up and running I will execute the rollover / conversions to Fido.

Fido has vacillated on this for several months, first saying yes definitely, then backing off and saying they just were not sure.

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Re: After Tax 401K Rollover to Roth IRA, Continued

Post by YDNAL » Wed Jan 06, 2010 4:38 pm

YDNAR?

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Re: After Tax 401K Rollover to Roth IRA, Continued

Post by the intruder » Wed Jan 06, 2010 7:40 pm

ydnar wrote:There has been much discussion on the rolling of 401K after tax funds directly into a Roth IRA without creating a taxable event. After much study of conflicting information, I decided to ask the IRS directly and made the decision to proceed with the rollover of my Vanguard 401k into Roth and Traditional Vanguard accounts. My request to the IRS was on Dec 9, 2009, and they called me today with their answer that the after tax money could go directly into a Roth account. I am well aware of the fact that they do not stand behind their advice and can turn on you after the fact, but I figure I can always recharacterize the Roth account if necessary. Here again are the details of my situation:

--62 Year Old with approximately 88000 after tax funds and 400,000 pretax funds in my Retirement Saving Plan with Vanguard. I am still employed, but the transfer is permitted under the plan rules.

--Vanguard encouraged me to create a Roth and Traditional IRA account on their website and has sent me the application to transfer the funds directly into the appropriate existing accounts.

--I have been working with the Vanguard Rep for sometime and they have been very helpful, but they insist that they do not provide tax guidance which is certainly understandable with all the vague guidance available from the IRS. I have had Traditional and Roth IRAs with Fidelity for years and my Fidelity Rep told me they routinely make this type of direct transfer (he may have been hoping to get some of the Vanguard business).

--I recently moved all my 401k funds into Vanguard Target Retirement 2015 for simplicity and plan to keep them there.

I know several financial articles and forum posters have described other interpretations and procedures for accomplishing this rollover, but I have decided to act now and recharacterize later if I must. Am I missing something simple here that will make me regret the decision?


While there is no question that you can rollover the AT funds directly to a Roth IRA from the 401k plan, you will need to determine what portion of the AT amount rolled over to the Roth will be taxed as a distribution if you also received a taxable distributions in the same year from your 401k plan that was rolled over to a traditional IRA and/or you also maintained a traditional IRA. You need to complete IRS form 8606 to determine what will be the taxable percentage of the AT funds rolled over to the Roth IRA that will be included in taxable income.

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Re: After Tax 401K Rollover to Roth IRA, Continued

Post by ydnar » Wed Jan 06, 2010 8:01 pm

[

While there is no question that you can rollover the AT funds directly to a Roth IRA from the 401k plan, you will need to determine what portion of the AT amount rolled over to the Roth will be taxed as a distribution if you also received a taxable distributions in the same year from your 401k plan that was rolled over to a traditional IRA and/or you also maintained a traditional IRA. You need to complete IRS form 8606 to determine what will be the taxable percentage of the AT funds rolled over to the Roth IRA that will be included in taxable income.[/quote]

It was my understanding that the proportionality rules don't apply to a direct 401k rollover to an IRA...ydnar

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Re: After Tax 401K Rollover to Roth IRA, Continued

Post by the intruder » Wed Jan 06, 2010 8:19 pm

ydnar wrote:[

While there is no question that you can rollover the AT funds directly to a Roth IRA from the 401k plan, you will need to determine what portion of the AT amount rolled over to the Roth will be taxed as a distribution if you also received a taxable distributions in the same year from your 401k plan that was rolled over to a traditional IRA and/or you also maintained a traditional IRA. You need to complete IRS form 8606 to determine what will be the taxable percentage of the AT funds rolled over to the Roth IRA that will be included in taxable income.


It was my understanding that the proportionality rules don't apply to a direct 401k rollover to an IRA...ydnar[/quote]

ydnar:

where did you get that idea?

have you completed form 8606?

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Re: After Tax 401K Rollover to Roth IRA, Continued

Post by Redbelly » Wed Jan 06, 2010 9:18 pm

the intruder wrote:
ydnar wrote:It was my understanding that the proportionality rules don't apply to a direct 401k rollover to an IRA...ydnar


ydnar:

where did you get that idea?

have you completed form 8606?


I was also under that assumption, I think from the Kiplinger article.

http://www.kiplinger.com/magazine/archives/2009/01/sweet-deal-on-roth-ira-conversion.html

From the authors comments lower on the page:

That's why converting after-tax money from a 401(k) or similar workplace-based retirement account to a Roth IRA is such a sweet deal. There is no prorata rule. You can convert all of your after-tax money in a 401(k) directly to a Roth IRA without paying taxes.

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Re: After Tax 401K Rollover to Roth IRA, Continued

Post by Shawn » Wed Jan 06, 2010 9:36 pm

the intruder wrote:While there is no question that you can rollover the AT funds directly to a Roth IRA from the 401k plan, you will need to determine what portion of the AT amount rolled over to the Roth will be taxed as a distribution if you also received a taxable distributions in the same year from your 401k plan that was rolled over to a traditional IRA and/or you also maintained a traditional IRA. You need to complete IRS form 8606 to determine what will be the taxable percentage of the AT funds rolled over to the Roth IRA that will be included in taxable income.

Perhaps I'm misinterpreting your comment, but I don't understand how it applies to ydnar's situation. It sounds like ydnar has rolled after-tax 401k dollars into a Roth IRA and pre-tax 401k dollars into a TIRA. If so, I don't see how form 8606 comes into play, since there are no nondeductible contributions going into the TIRA.

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Re: After Tax 401K Rollover to Roth IRA, Continued

Post by james22 » Wed Jan 06, 2010 10:31 pm

Redbelly wrote:You can convert all of your after-tax money in a 401(k) directly to a Roth IRA without paying taxes.


The IRS has since ruled that you'll owe taxes on the gains from your after-tax investment.
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Post by ydnar » Wed Jan 06, 2010 10:37 pm

You would owe taxes on any gains in the account, but Vanguard has isolated only the after tax contributions that will be used in the transfer...no gains.

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Re: After Tax 401K Rollover to Roth IRA, Continued

Post by Jack » Wed Jan 06, 2010 10:44 pm

Redbelly wrote:
the intruder wrote:
ydnar wrote:It was my understanding that the proportionality rules don't apply to a direct 401k rollover to an IRA...ydnar


ydnar:

where did you get that idea?

have you completed form 8606?


I was also under that assumption, I think from the Kiplinger article.

http://www.kiplinger.com/magazine/archives/2009/01/sweet-deal-on-roth-ira-conversion.html

From the authors comments lower on the page:

That's why converting after-tax money from a 401(k) or similar workplace-based retirement account to a Roth IRA is such a sweet deal. There is no prorata rule. You can convert all of your after-tax money in a 401(k) directly to a Roth IRA without paying taxes.

Be careful. Not everything you read on the internet is true, no matter the source.

The article gives the impression that you can just take $6000 of after-tax money out of your 401k and convert it tax free, leaving the pre-tax money in the 401k. That would be a controversial position. Many accountants would say that you must pro-rate a partial distribution from a 401k. The article might be correct if you rolled over all of your 401k. Then you could separate the pre-tax into a traditional IRA and the after-tax into a Roth IRA, but this requires rolling over the whole 401k. You can roll over your entire 401k only if age 59 1/2 or you leave your job. At least this is the way most people interpret the rules. Your mileage may vary.

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Re: After Tax 401K Rollover to Roth IRA, Continued

Post by the intruder » Wed Jan 06, 2010 11:35 pm

Shawn wrote:
the intruder wrote:While there is no question that you can rollover the AT funds directly to a Roth IRA from the 401k plan, you will need to determine what portion of the AT amount rolled over to the Roth will be taxed as a distribution if you also received a taxable distributions in the same year from your 401k plan that was rolled over to a traditional IRA and/or you also maintained a traditional IRA. You need to complete IRS form 8606 to determine what will be the taxable percentage of the AT funds rolled over to the Roth IRA that will be included in taxable income.

Perhaps I'm misinterpreting your comment, but I don't understand how it applies to ydnar's situation. It sounds like ydnar has rolled after-tax 401k dollars into a Roth IRA and pre-tax 401k dollars into a TIRA. If so, I don't see how form 8606 comes into play, since there are no nondeductible contributions going into the TIRA.


You are correct if he elects an indirect rollover, has 20% withheld from his taxable distribution and he rolls over the pre tax money including the 20% withholding amount to a traditional IRA before rolling over the AT money to the roth IRA which he did not mention. If he elects a direct rollover of the AT funds to a Roth and the pre tax money a traditional IRA without 20% withholding then he must do a pro rata allocation. Note: in the first line of his post the OP refers to a "direct rollover without creating a taxable event".

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Post by james22 » Thu Jan 07, 2010 3:58 am

james22 wrote:VG's response to my query:

Please be aware that, due to IRS regulations, an active employee is not able to take after-tax contributions by themselves; you must also withdraw any applicable earnings and gains, which will be pre-tax money and will be taxable at conversion to the Roth IRA.

...

As of the close of business on December 15, 2009, you are eligible to request an In-service withdrawal of up to $X, of which $X is taxable. This amount is subject to change due to market fluctuation.

...

Tax Consequences

...

For a rollover withdrawal, Vanguard will not withhold any taxes. Rolling over pre-tax assets (including earnings of after-tax assets) to a Roth IRA will be a taxable event. Therefore, the distribution will be reported as a rollover and a taxable event. The 10% early distribution penalty tax is not accessed for the money being rolled into the Roth IRA. You will be responsible for all tax consequences at the time that you file your taxes. You might want to speak to a tax advisor to determine all tax consequences.

Vanguard will send you a 1099-R form in early February of the year after you take a withdrawal to assist you in filing your taxes.
This whole episode is likely to end so badly that future children will learn about it in school and shake their heads in wonder at the rank stupidity of it all... Hussman

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Re: After Tax 401K Rollover to Roth IRA, Continued

Post by Default User BR » Thu Jan 07, 2010 4:42 am

Shawn wrote:Perhaps I'm misinterpreting your comment, but I don't understand how it applies to ydnar's situation. It sounds like ydnar has rolled after-tax 401k dollars into a Roth IRA and pre-tax 401k dollars into a TIRA. If so, I don't see how form 8606 comes into play, since there are no nondeductible contributions going into the TIRA.

I haven't found anything in the IRS publications that supports this. Everything I see says that a rollover to a Roth is the as if it were rolled to a TIRA and converted. I don't see any support for a direct rollover of after-tax to a Roth and taxable to a TIRA. The INDIRECT method discussed elsewhere is possible, but that requires tax withholding.

I'm not sure what the Kiplinger article is based on. I might be wrong and just haven't found the correct documents, but I'd be real careful. I'm thinking of making my own call into the IRS on this. I'm all for something that makes it easier for me to get my after-tax contributions out without having to roll stuff back into the 401(k).


Brian

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Re: After Tax 401K Rollover to Roth IRA, Continued

Post by Shawn » Thu Jan 07, 2010 11:48 am

the intruder wrote:You are correct if he elects an indirect rollover, has 20% withheld from his taxable distribution and he rolls over the pre tax money including the 20% withholding amount to a traditional IRA before rolling over the AT money to the roth IRA which he did not mention. If he elects a direct rollover of the AT funds to a Roth and the pre tax money a traditional IRA without 20% withholding then he must do a pro rata allocation. Note: in the first line of his post the OP refers to a "direct rollover without creating a taxable event".

I guess my question is ... where on Form 8606 does it account for this (e.g., line number on the form, page number in the instructions)? Form 8606 states how to handle nondeductible (after-tax) contributions made to a TIRA, including after-tax rollovers from an employer plan, but it says nothing about pre-tax contributions or pre-tax rollovers to a TIRA. I believe this is what ydnar is doing. I easily could be missing something on the form or in the instructions, but I have gone through it several times. Yes, if you roll a TIRA into a Roth IRA, Form 8606 handles the needed pro-rating between pre- and after-tax funds, but I don't see any mention of pre-tax 401k to TIRA or after-tax 401k to Roth IRA rollovers.

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Re: After Tax 401K Rollover to Roth IRA, Continued

Post by Shawn » Thu Jan 07, 2010 12:07 pm

Default User BR wrote:
Shawn wrote:Perhaps I'm misinterpreting your comment, but I don't understand how it applies to ydnar's situation. It sounds like ydnar has rolled after-tax 401k dollars into a Roth IRA and pre-tax 401k dollars into a TIRA. If so, I don't see how form 8606 comes into play, since there are no nondeductible contributions going into the TIRA.

I haven't found anything in the IRS publications that supports this. Everything I see says that a rollover to a Roth is the as if it were rolled to a TIRA and converted. I don't see any support for a direct rollover of after-tax to a Roth and taxable to a TIRA. The INDIRECT method discussed elsewhere is possible, but that requires tax withholding.

I haven't found anything in an IRS publication that supports this either. However, I haven't found anything in an IRS publication that contradicts this. Some people have mentioned IRS Rule 402, which I've tried to read, but found it incomprehensible.

The Fairmark people suggest it can't be done without the 3 step indirect approach that you suggest. However, I've been on their web site, described my situation, and obtained mixed feedback. The Kiplinger article states it can be done. Fidelity and apparently Vanguard state it can be done. My plan literature implies, but does not explicitly state, that it can be done. I haven't seen anything (other than Fairmark) that states one needs to pro-rate 401k to Roth IRA conversions. I haven't seen any IRS form that handles such pro-rating (it doesn't appear to be on 8606, which is specific to TIRA to Roth conversions).

I could easily be wrong, but I have not seen anything in writing. In fact, my understanding is that 401k to Roth rollovers are handled by Tax Form 1099-R, which I will receive from Fidelity next January. I've asked Fidelity what will be on the form, and the pro-rating of pre-tax dollars doesn't seem to come into play.

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Re: After Tax 401K Rollover to Roth IRA, Continued

Post by Redbelly » Thu Jan 07, 2010 3:57 pm

Jack wrote:
Redbelly wrote:
the intruder wrote:
ydnar wrote:It was my understanding that the proportionality rules don't apply to a direct 401k rollover to an IRA...ydnar


ydnar:

where did you get that idea?

have you completed form 8606?


I was also under that assumption, I think from the Kiplinger article.

http://www.kiplinger.com/magazine/archives/2009/01/sweet-deal-on-roth-ira-conversion.html

From the authors comments lower on the page:

That's why converting after-tax money from a 401(k) or similar workplace-based retirement account to a Roth IRA is such a sweet deal. There is no prorata rule. You can convert all of your after-tax money in a 401(k) directly to a Roth IRA without paying taxes.

Be careful. Not everything you read on the internet is true, no matter the source.

The article gives the impression that you can just take $6000 of after-tax money out of your 401k and convert it tax free, leaving the pre-tax money in the 401k. That would be a controversial position. Many accountants would say that you must pro-rate a partial distribution from a 401k. The article might be correct if you rolled over all of your 401k. Then you could separate the pre-tax into a traditional IRA and the after-tax into a Roth IRA, but this requires rolling over the whole 401k. You can roll over your entire 401k only if age 59 1/2 or you leave your job. At least this is the way most people interpret the rules. Your mileage may vary.


Here is a second source re pro-rata Roth conversion from a 401(k):

http://www.investopedia.com/articles/retirement/08/convert-401k-roth.asp

iv) If the plan participant has after-tax funds in his qualified plan account, the conversion of plan assets to a Roth IRA will NOT be subject to the pro-rata rule, which states that participants have to pay personal income taxes on any deductible pretax contributions. It does not apply to after-tax funds converted to a Roth IRA because the participant has already paid taxes on those contributions.

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Re: After Tax 401K Rollover to Roth IRA, Continued

Post by Jack » Thu Jan 07, 2010 5:15 pm

Redbelly wrote:
Jack wrote:Be careful. Not everything you read on the internet is true, no matter the source.

The article gives the impression that you can just take $6000 of after-tax money out of your 401k and convert it tax free, leaving the pre-tax money in the 401k. That would be a controversial position. Many accountants would say that you must pro-rate a partial distribution from a 401k. The article might be correct if you rolled over all of your 401k. Then you could separate the pre-tax into a traditional IRA and the after-tax into a Roth IRA, but this requires rolling over the whole 401k. You can roll over your entire 401k only if age 59 1/2 or you leave your job. At least this is the way most people interpret the rules. Your mileage may vary.


Here is a second source re pro-rata Roth conversion from a 401(k):

http://www.investopedia.com/articles/retirement/08/convert-401k-roth.asp

iv) If the plan participant has after-tax funds in his qualified plan account, the conversion of plan assets to a Roth IRA will NOT be subject to the pro-rata rule, which states that participants have to pay personal income taxes on any deductible pretax contributions. It does not apply to after-tax funds converted to a Roth IRA because the participant has already paid taxes on those contributions.

The article does not state that you can roll over just the after-tax portion. The assumption is that you roll over the entire 401k, not just the after-tax part. Then you can separate out the after-tax part for the Roth without pro-rating.

And this part is meaningless "It does not apply to after-tax funds converted to a Roth IRA because the participant has already paid taxes on those contributions" since that is also true of traditional IRAs and they definitely are subject to pro-rating. My understanding, and I could be wrong, but that if you do a partial distribution from your 401k, that it is subject to pro-rating between pre- and after-tax portions.

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Post by ydnar » Thu Jan 07, 2010 7:05 pm

The IRS website contains information that I don't think I have seen quoted yet. It is Notice 2009-75, Rollovers from Employer Plans to Roth IRA's. Part III, Question 1, Answer 1
III. ROLLOVERS FROM AN ELIGIBLE EMPLOYER PLAN TO A ROTH IRA
Q-1: What amount is included in gross income as a consequence of a
rollover to a Roth IRA from an eligible employer plan (i.e., a qualified plan
described in § 401(a), an annuity plan described in § 403(a), a plan described in
§403(b), or a governmental § 457(b) plan)?
A-1: (a) Rollovers to a Roth IRA of distributions that are not made from a
designated Roth account. If an eligible rollover distribution from an eligible
employer plan is rolled over to a Roth IRA and the distribution is not made from a
designated Roth account, then the amount that would be includible in gross
income were it not part of a qualified rollover contribution is included in the

distributee’s gross income for the year of the distribution. For this purpose, the
amount included in gross income is equal to the amount rolled over, reduced by
the amount of any after-tax contributions that are included in the amount rolled
over, in the same manner as if the distribution had been rolled over to a non-Roth
IRA that was the participant’s only non-Roth IRA and that non-Roth IRA had then
been immediately converted to a Roth IRA.
Thus, the special rules relating to
net unrealized appreciation at § 402(e)(4) and certain optional methods for
calculating tax available to participants born on or before January 1, 1936 are not
applicable.

In their usual way of explaining things, the IRS has written something bordering on unreadable, but I feel that it still supports my plan in that:

--I am taking a full distribution of my 401K
--The portion that I want to roll into the Roth is totally aftertax funds that should not need to be added to my AGI Am I misunderstanding the mess that they have printed?

Randy

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Post by Redbelly » Thu Jan 07, 2010 7:36 pm

ydnar wrote:.........<snip>...........
In their usual way of explaining things, the IRS has written something bordering on unreadable, but I feel that it still supports my plan in that:

--I am taking a full distribution of my 401K
--The portion that I want to roll into the Roth is totally aftertax funds that should not need to be added to my AGI Am I misunderstanding the mess that they have printed?

Randy


I also found this, but did not mention it as is is so difficult to understand and does not address the separation of pre and after tax contributions. My intention is also to take a full distribution and sweep the pretax contributions and earnings into my rollover IRA and the after tax portion into a new Roth IRA.

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Post by ydnar » Thu Jan 07, 2010 9:06 pm

Redbelly,

I think that is what they are saying in a backdoor type way by saying that the portion that is counted as taxable is everything but the after tax amount. You have to assume that the normal rollover rules would apply to the remainder of pretax and earnings.

Randy

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Post by jebmke » Thu Jan 07, 2010 9:14 pm

From 2008 Pub 575, p26

If you roll over only part of a distribution that includes both taxable and nontaxable amounts, the amount you rollover is treated as coming first from the taxable part of the distribution.


Theoretically, if you did a distribution and then did two separate rollovers (partials), the first one being an amount equal to all the taxable money to a tIra and then the second one (both within 60 days) to a Roth, might this clause say that the residual amount is the after-tax dollars? The key is the order of the two partial rolls. You would want the first one to go to a traditional IRA.
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Post by MediumTex » Wed Mar 03, 2010 3:26 pm

I'm a little late to this discussion, but take a look at IRS Publication 575, page 16, top of second column.

http://www.irs.gov/pub/irs-pdf/p575.pdf

The example the IRS provides here is the basis for being able to take a distribution from a 401(k) plan of ONLY after-tax contributions (including earnings on those after tax contributions).

This seems to address the issue raised in the OP.

To me, we are realy talking about two separate issues here. The first issue is how to receive a distribution of only after-tax amounts (plus earnings on those amounts). The second issue is how to get those after-tax amounts into a Roth IRA with a minimum amount of trouble.

I have seen plans that do distributions on a pro rata basis based upon the entire account balance (i.e., after-tax and pre-tax contributions, plus earnings on all amounts), and I have seen plans that do the pro rata calculation based upon the after-tax amounts and earnings thereon only--this is the methodology described in the section of Publication 575 cited above.

Take a look at your plan summary and if it says you can take a distribution of after tax amounts only, it normally means that the plan is using the more narrow Publication 575 methodology described above.
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Post by Redbelly » Wed Mar 03, 2010 5:01 pm

The way I ended up doing it was to rollover all my pretax contributions and pretax earnings from the 401(k) to the Rollover IRA. Then I had only after tax contributions and after tax earnings left in the 401(k) account. I asked for two checks to be cut, both made out to Fidelity. One check was after tax contributions, which went to a Roth account and the second was after tax earnings, which went to the Rollover IRA.

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Post by Default User BR » Wed Mar 03, 2010 5:27 pm

MediumTex wrote:To me, we are realy talking about two separate issues here. The first issue is how to receive a distribution of only after-tax amounts (plus earnings on those amounts). The second issue is how to get those after-tax amounts into a Roth IRA with a minimum amount of trouble.

I have seen plans that do distributions on a pro rata basis based upon the entire account balance (i.e., after-tax and pre-tax contributions, plus earnings on all amounts), and I have seen plans that do the pro rata calculation based upon the after-tax amounts and earnings thereon only--this is the methodology described in the section of Publication 575 cited above.

Take a look at your plan summary and if it says you can take a distribution of after tax amounts only, it normally means that the plan is using the more narrow Publication 575 methodology described above.

Depending on when the after-tax contributions were made and the market events, the earnings can be quite significant. When I found out about the after-tax rollover (we can do that in-service at any age) and pulled out all the old accumulated stuff, it ended up being about 50/50. I subsequently rolled the taxable portion back into the 401(k). That's one of the ways to do a conversion of the after-tax money.



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Post by MediumTex » Wed Mar 03, 2010 6:24 pm

Redbelly wrote:The way I ended up doing it was to rollover all my pretax contributions and pretax earnings from the 401(k) to the Rollover IRA. Then I had only after tax contributions and after tax earnings left in the 401(k) account. I asked for two checks to be cut, both made out to Fidelity. One check was after tax contributions, which went to a Roth account and the second was after tax earnings, which went to the Rollover IRA.


Doesn't that approach (i.e., setting up your traditional IRA with pre-tax dollars before setting up your Roth IRA with after-tax dollars) require you to aggregate ALL of your traditional IRAs when determining the taxes due in conjunction with your conversion of your new traditional IRA holding after-tax amounts into a Roth?

In other words, don't you need to have basically no other traditional IRAs with pre-tax dollars in them in order to be able to successfully convert a traditional IRA holding after-tax dollars into a Roth IRA without triggering any taxes on the conversion?

It seems like you should have taken your 401(k) after-tax dollars and the earnings on those after-tax dollars first, rolled that to a traditional IRA, then converted to a Roth IRA, paid the taxes on the earnings component of the after-tax amounts, THEN rolled the remaining pre-tax amounts from the plan into a traditional IRA.
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Post by MediumTex » Wed Mar 03, 2010 6:27 pm

Default User BR wrote:Depending on when the after-tax contributions were made and the market events, the earnings can be quite significant. When I found out about the after-tax rollover (we can do that in-service at any age) and pulled out all the old accumulated stuff, it ended up being about 50/50. I subsequently rolled the taxable portion back into the 401(k). That's one of the ways to do a conversion of the after-tax money.

Brian


Was there any issue with respect to the 10% penalty on early withdrawals on the after-tax earnings or was there a distribution event (e.g., termination, age 59 1/2, etc)?
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Post by Redbelly » Wed Mar 03, 2010 8:29 pm

MediumTex wrote:
Doesn't that approach (i.e., setting up your traditional IRA with pre-tax dollars before setting up your Roth IRA with after-tax dollars) require you to aggregate ALL of your traditional IRAs when determining the taxes due in conjunction with your conversion of your new traditional IRA holding after-tax amounts into a Roth?

In other words, don't you need to have basically no other traditional IRAs with pre-tax dollars in them in order to be able to successfully convert a traditional IRA holding after-tax dollars into a Roth IRA without triggering any taxes on the conversion?

It seems like you should have taken your 401(k) after-tax dollars and the earnings on those after-tax dollars first, rolled that to a traditional IRA, then converted to a Roth IRA, paid the taxes on the earnings component of the after-tax amounts, THEN rolled the remaining pre-tax amounts from the plan into a traditional IRA.


The after tax dollars went straight from the 401(k) to the Roth. No taxes owed. The after tax earnings went straight to the Rollover IRA. No taxes due until I withdraw this money.

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Post by MediumTex » Wed Mar 03, 2010 10:07 pm

Redbelly wrote:The after tax dollars went straight from the 401(k) to the Roth. No taxes owed. The after tax earnings went straight to the Rollover IRA. No taxes due until I withdraw this money.


The way you described the transaction, though, it sounds like at the time of the rollover of the after-tax amounts, you already had other existing traditional IRAs (even if it was just the IRA you had just set up with your pre-tax contributions you rolled from your retirement plan to a traditional IRA).

If at the time you rolled the after-tax amounts out of the plan you had other traditional IRAs, the subsequent conversion of the after-tax traditional IRA to a Roth IRA (which it sounds like happened as part of the same transaction), there would be the issue of aggregating all of your traditional IRAs when converting any one of the IRAs to a Roth (even if the one you want to convert consists of 100% after-tax amounts).

In other words, getting after-tax amounts from a retirement plan to a Roth IRA is not normally possible to do without triggering some taxation if you already have other traditional IRAs with pre-tax amounts in them at the time you receive the after-tax distribution.

You have to aggregate all traditional IRAs when converting any of them to a Roth. You can't just convert the traditional IRAs holding after-tax dollars.

The problem you run into in all of this is that the retirement plan and the various IRA custodians don't have a clear picture of your entire situation, and will often tell you something incorrect about how the whole transaction is supposed to (or needs to) happen.

I may be misunderstanding something about your situation, though.
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Post by Default User BR » Thu Mar 04, 2010 2:46 am

MediumTex wrote:
Default User BR wrote:Depending on when the after-tax contributions were made and the market events, the earnings can be quite significant. When I found out about the after-tax rollover (we can do that in-service at any age) and pulled out all the old accumulated stuff, it ended up being about 50/50. I subsequently rolled the taxable portion back into the 401(k). That's one of the ways to do a conversion of the after-tax money.

Was there any issue with respect to the 10% penalty on early withdrawals on the after-tax earnings or was there a distribution event (e.g., termination, age 59 1/2, etc)?

It was not a triggering event. As it was a direct rollover, there was no withholding, and no tax or penalty was due.



Brian

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Post by Redbelly » Thu Mar 04, 2010 10:40 am

MediumTex wrote:
Redbelly wrote:The after tax dollars went straight from the 401(k) to the Roth. No taxes owed. The after tax earnings went straight to the Rollover IRA. No taxes due until I withdraw this money.


The way you described the transaction, though, it sounds like at the time of the rollover of the after-tax amounts, you already had other existing traditional IRAs (even if it was just the IRA you had just set up with your pre-tax contributions you rolled from your retirement plan to a traditional IRA).

If at the time you rolled the after-tax amounts out of the plan you had other traditional IRAs, the subsequent conversion of the after-tax traditional IRA to a Roth IRA (which it sounds like happened as part of the same transaction), there would be the issue of aggregating all of your traditional IRAs when converting any one of the IRAs to a Roth (even if the one you want to convert consists of 100% after-tax amounts).

In other words, getting after-tax amounts from a retirement plan to a Roth IRA is not normally possible to do without triggering some taxation if you already have other traditional IRAs with pre-tax amounts in them at the time you receive the after-tax distribution.

You have to aggregate all traditional IRAs when converting any of them to a Roth. You can't just convert the traditional IRAs holding after-tax dollars.

The problem you run into in all of this is that the retirement plan and the various IRA custodians don't have a clear picture of your entire situation, and will often tell you something incorrect about how the whole transaction is supposed to (or needs to) happen.

I may be misunderstanding something about your situation, though.


I think the misunderstanding is that when you convert a portion of a TIRA to a Roth, you must take the money prorata between pre and after tax money among all your IRAs. The new law allows one to take after tax money from a 401(k) without using prorata distribution. Do a search here - this has been discussed in other threads.

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Post by Default User BR » Thu Mar 04, 2010 12:12 pm

Redbelly wrote:I think the misunderstanding is that when you convert a portion of a TIRA to a Roth, you must take the money prorata between pre and after tax money among all your IRAs. The new law allows one to take after tax money from a 401(k) without using prorata distribution. Do a search here - this has been discussed in other threads.

You can take just after-tax money out, BUT it brings a share of earnings (if contributed post-1986). Depending on individual circumstances, that might or might not be significant.



Brian

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After-tax direct rollover

Post by ydnar » Sat Mar 13, 2010 12:56 pm

I mentioned in an earlier post that I made a decision to proceed with my direct rollover based not only on Vanguard advice and articles on the subject, but also on verbal advice received from the IRS retirement site where you can email questions to the "experts". I have twice asked them for an email confirmation of their verbal guidance and the silence has been deafening. Has anyone else experience this same situation where the IRS refuses to document verbal guidance?

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Re: After-tax direct rollover

Post by MediumTex » Tue Mar 23, 2010 11:59 am

ydnar wrote:I mentioned in an earlier post that I made a decision to proceed with my direct rollover based not only on Vanguard advice and articles on the subject, but also on verbal advice received from the IRS retirement site where you can email questions to the "experts". I have twice asked them for an email confirmation of their verbal guidance and the silence has been deafening. Has anyone else experience this same situation where the IRS refuses to document verbal guidance?


Yes, it is standard practice.

The rules we are dealing with here are arbitrary, complex and always in a state of flux. The idea that there is some bureaucratic nerve center housing the answers to these questions is false.

Formal guidance is normally issued only when the soup gets too thick to stir.

This state of chronic dysfunction is good for practitioners like me, but bad for virtually everyone else. There is no there there.

It's just standard modern Kafka-ism. Nothing remarkable really (though endlessly ridiculous).
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Post by jetjockey » Sun Mar 28, 2010 7:29 pm

You can take just after-tax money out, BUT it brings a share of earnings (if contributed post-1986). Depending on individual circumstances, that might or might not be significant.

Brian


This is the key point I believe. For example, at my company, my 401k plan is segregated...that is, it has my pre-tax contributions PLUS earnings in one pile, and my after tax contributions PLUS earnings in another pile. I have been told by my administrator that prior to age 59, I can rollover/convert the after tax contributions PLUS earnings to a Roth IRA, without penalty. But I believe I am only subject to tax in that year to the earnings on that pile alone, and not a pro-rata of all my pre-tax contributions and earnings which remain inside the 401k.

Page 29, of IRS publication 575, cited by someone earlier, has a paragraph entitled, Rollovers to ROTH IRAs. If you read that section, it clearly discusses gross income that will be reported (i.e. earnings), and the part that will not be reported, (i.e., return of contributions that were taxed to you when paid, which are the after-tax contributions). Nowhere do I see any reference to pro-rate or aggregate across all pre and post tax monies. Since my company is only allowing me to move my after tax contributions and earnings to a Roth IRA, prior to age 59, then it seems to me to make sense that I'm only on the hook for paying the tax on that portion of my rollover...i.e....the earnings on my after-tax contributions, which have been carefully segregated and accounted for on my statement.

By contrast, I believe when you convert from a traditional IRA with non-deductible contributions to a Roth IRA, then yes, you pro-rate across IRA's, etc, to determine the proportion that is subject to taxes. That is why you have to keep that annoying 8606 going every year to keep track of those non-deductible contributions, so that you can calculate the proportion that is taxed, and you don't hit again on the non-deductible contributions that you have already paid tax on.

Does this sound right?

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Post by Default User BR » Sun Mar 28, 2010 9:00 pm

jetjockey wrote:Page 29, of IRS publication 575, cited by someone earlier, has a paragraph entitled, Rollovers to ROTH IRAs. If you read that section, it clearly discusses gross income that will be reported (i.e. earnings), and the part that will not be reported, (i.e., return of contributions that were taxed to you when paid, which are the after-tax contributions). Nowhere do I see any reference to pro-rate or aggregate across all pre and post tax monies.

You are correct. As I mentioned before, the distribution of the after-tax contributions will bring with it a share of taxable earnings (unless there aren't any). There will be statement that shows the taxable and non-taxable portions of the distribution. The money that stays in the qualified plan does not factor into it. Now, if you have a traditional IRA with taxable money in it, that will count towards a pro-rata computation.



Brian

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Post by Shawn » Sun Mar 28, 2010 11:00 pm

jetjockey wrote:This is the key point I believe. For example, at my company, my 401k plan is segregated...that is, it has my pre-tax contributions PLUS earnings in one pile, and my after tax contributions PLUS earnings in another pile. I have been told by my administrator that prior to age 59, I can rollover/convert the after tax contributions PLUS earnings to a Roth IRA, without penalty. But I believe I am only subject to tax in that year to the earnings on that pile alone, and not a pro-rata of all my pre-tax contributions and earnings which remain inside the 401k.

[...]

Does this sound right?

Yes.

My employer plan, which is administered by Fidelity, is similar to yours. Fidelity refers to these different pots of money as sources. One source is pre-tax contributions plus earnings, another is after-tax contributions plus earnings, another is employer contributions plus earnings. I believe sources are equivalent to the "contracts" referred to in IRS Publication 575. They are separate entities that are independently handled. Hence, a person can distribute one source of funds without being impacted by the broader pro-rata rule. The pro-rata rule still applies, but only within the limited context of each source (e.g., you can't distribute only the after-tax contributions and leave their earnings behind). This is much different than a TIRA where all funds from all IRA's are effectively combined into one giant pot.

Each employer plan has a different set of rules. Some (most?) do not allow after-tax contributions. Some (most?) don't allow in-service distributions of after-tax contributions. While I could be wrong, my impression is that employers don't need to segregate the various fund sources into different contracts. Hence, some people may not have the flexibility to move after-tax contributions in this way. The fact that individual plans may have slightly different rules can be a source of confusion, as people may be talking about slightly different things.

I've been making after-tax contributions to my 401k over the last few years after learning that the $100K income limit for Roth conversions would be eliminated beginning in 2010. The earnings on my after-tax contributions have been essentially zero. In fact, they were negative at the end of December but went positive by $4k when the market rose in the early part of this year. Since my employer allows in-service distributions of after-tax contributions, on January 5 I rolled my $107K of after-tax contributions and their earnings from my 401k into a Roth IRA. The forms I received from Fidelity clearly stated that $103K was non-taxable and $4k was taxable. I will make $32.5K of additional after-tax contributions to my 401k in 2010, and then do another rollover to the Roth IRA later this year.

I'm utilizing the same process with a TIRA, since I have no pre-tax contributions. Hence, I'm in a situation where I can put almost $40k/yr into a Roth IRA with little or no tax consequences (obviously they are taxed as income during the contribution year). It's a free lunch.

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Post by jetjockey » Mon Mar 29, 2010 10:21 am

Okay, just got off the phone with Fidelity conversion specialist. I have my 401k at Schwab with my company, and asked them how do I move that after tax 401k to Fidelity without big tax consequences.

Well, guess what? He was very familiar with the confusion out there, and did say that they would put a G on the 1099R, which is a normal rollover to the Roth, HOWEVER, he is very unclear as to how the IRS will interpret or rule on this, and that the jury is still out on whether or not money moved from 401Ks will or will not be treated similarly to the rules for IRA conversions.

His advice to me was to definitely consider waiting until we all get a better picture from the IRS on their ruling in this matter. It is not clearly defined yet, and it would be best to continue probing IRS, and getting a definitive answer from them, publication update for 2010, and clarification by using examples. That's my take anyways...so I'm going to wait, because it could have dramatic tax consequences for me if I make this move without firm conviction that it will be treated in a tax friendly manner.

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Post by jetjockey » Mon Mar 29, 2010 10:42 am

More follow-up.

Shawn, you and I think alike, and am very happy for you, because your method is exactly what I wanted to do, however, this past year, the after-tax pot grew pretty well for me, so now I do have considerable earnings in there that I will have to pay tax on with a conversion, so now, I'm a bit ambivalent about making the move, because the tax hit would be considerable for me, especially in my bracket. Ditto even more for my Traditional IRA which has grown considerably in twenty-five years, using seed capital of those yearly non-deductible contributions. (wish we all had these problems, eh?) It would be a super move if the cost basis in these accounts, like yours, were pretty much equal to the conversion balance, but earnings growth for me makes the decision more difficult. I've always believed in deferring as much tax as possible..."never pay a tax today that can be put off until tomorrow". Because who knows years from now what our tax structure will look like? If a flat tax every came into play, or God forbid, some hybrid of that or a consumption/VAT tax, then all this tax planning might become moot.

Getting back to topic....One other item I saw in Publication 575 that gave me pause...page 29, top of second column, in referring to rollovers from qualified retirement accounts: "any amount rolled over into a Roth IRA is subject to the same rules for converting a traditional IRA into a Roth IRA. For more information, see Converting From Any Traditional IRA into a Roth IRA in chapter 1 of Publication 590."

That phrase is what many blogs, other than this one, are prompting a warning to folks to stand pat, until we truly understand how the IRS is going to treat separate buckets of money coming out of 401ks.

Good luck tho'....I agree very much with your strategy and hope it will not be retroactiveley impacted by any adverse rulings from IRS.

Ray

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Post by Shawn » Mon Mar 29, 2010 1:42 pm

jetjockey wrote:Good luck tho'....I agree very much with your strategy and hope it will not be retroactiveley impacted by any adverse rulings from IRS.

I haven't eliminated the possibility of an adverse ruling from the IRS, although it would not be catastrophic for me since most of my 401k funds are in after-tax dollars. It would be a "tolerable nuisance," and there are other things I could do to reduce any tax pain.

But unlike a TIRA, there is no tracking mechanism for employer plans. That is, one uses IRS Form 8606 to track non-deductible (after-tax) contributions in a TIRA, but no such mechanism is available for employer sponsored plans. The plan administrator (e.g., Fidelity) would need to do this, but they would have no way of knowing the contributions a person has in employer plans at other firms.

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Phone Call From IRS Retirement Advice Center

Post by ydnar » Fri Apr 09, 2010 5:57 pm

I never received the written response from the IRS that I had requested, but I did get a phone call a while back exactly reversing the position they had taken last year when I originally asked. My initial post describes what I did after receiving their blessing. I can't help but smile at how crazy they make me, but guess I will do what is necessary to correct it all when they finally put out policy. The agent who called said that they were considering their position and , if they change it, will make the new guidance public. I just shake my head over the whole mess.

Randy

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Post by cliffedelgado » Fri Apr 16, 2010 6:12 pm

did anyone else notice in IRS publication 590 chapter 2

i had to remove link from post as i'm a new member..

"Unlike a conversion of a traditional IRA to a Roth IRA, rollovers from employer plans to Roth IRAs are not reported on Form 8606. However, for 2010, a rollover from an employer plan to a Roth IRA will be reported on Form 8606."

Although this doesn't say clearly if the after-tax goes to roth ira and pre-tax can go to trad ira, at least it means they'll be keeping better track and there will be a place to declare what you are doing. any comments?

I've gone through the thread. what exactly is the open issue?

is the legality of post-tax going into roth ira at the same time pre-tax is going to trad IRA without invoking the pro-rata rule the issue?

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Post by Redbelly » Sun Apr 18, 2010 12:43 pm

cliffedelgado wrote:I've gone through the thread. what exactly is the open issue?

is the legality of post-tax going into roth ira at the same time pre-tax is going to trad IRA without invoking the pro-rata rule the issue?


Yes, I believe that is the crux of the issue. There has been a lot of discussion on this subject at the Fairmark forum lately. If you haven't read up there, it is worth the trip.

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AT funds in 401K?

Post by Steevo » Wed Jan 12, 2011 11:28 am

I am following this thread, and other similar threads, and the question that nags at me is "How do you get after tax dollars INTO your 401k in the first place?"
My contribution amount is set at 21% of salary, which maxes out my contribution in about July each year (16,500 + 5,500), and at that point, they just stop the contribution. There is no option in my plan to keep contributing with after tax dollars, or to split my contribution (even within the $22k limit) into pre and post tax buckets.
Is this an option that only some 401k plans have?

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Re: AT funds in 401K?

Post by Chin Strap » Wed Jan 12, 2011 11:29 am

Steevo wrote:Is this an option that only some 401k plans have?


Your 401k provider must allow after tax contributions, not all do.

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Re: AT funds in 401K?

Post by Redbelly » Wed Jan 12, 2011 5:01 pm

Steevo wrote:I am following this thread, and other similar threads, and the question that nags at me is "How do you get after tax dollars INTO your 401k in the first place?"
..........


My employer allowed us to contribute up to $4x,000 to the 401(k). Exact number escapes me - set by law. The first $15,000 or so was pre tax. The rest was after tax.

Incidentally, the legality of the direct rollover to a Roth of after tax contributions still seems to be up in the air. I have posted at Fairmark and have been advised by Alan S., who seems very credible, to wait and see if the IRS clarifies, otherwise sit tight. Worst case, I recharacterize back to a TIRA and 8606 the after tax portion.

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Re: AT funds in 401K?

Post by airahcaz » Fri Apr 01, 2011 6:47 pm

Redbelly wrote:
Steevo wrote:I am following this thread, and other similar threads, and the question that nags at me is "How do you get after tax dollars INTO your 401k in the first place?"
..........


My employer allowed us to contribute up to $4x,000 to the 401(k). Exact number escapes me - set by law. The first $15,000 or so was pre tax. The rest was after tax.

Incidentally, the legality of the direct rollover to a Roth of after tax contributions still seems to be up in the air. I have posted at Fairmark and have been advised by Alan S., who seems very credible, to wait and see if the IRS clarifies, otherwise sit tight. Worst case, I recharacterize back to a TIRA and 8606 the after tax portion.


So worst case is a rollover of AT to a tIRA then do a standard conversion to Roth?
1) Invest you must 2) Time is your friend 3) Impulse is your enemy 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course. (Plagiarized, but worth stealing)

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