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IRS issues new rule on after-tax rollovers to IRAs

The IRS recently issued Notice 2014-54 — called

The IRS recently issued Notice 2014-54 — called "Guidance on Allocation of After-Tax Amounts to Rollovers" — which will affect distributions that are made on or after Jan. 1, 2015. Credit: iStock

I'm 62 and moving my 401(k) into an IRA in a trustee-to-trustee transfer, except for $42,000 of after-tax contributions, which the 401(k) plan is sending directly to me. I want to invest that $42,000 in a Roth IRA, but get conflicting advice about whether that's allowed.

The Internal Revenue Service finally answered this question a few days ago. Yes, it is allowed.

Before IRS Notice 2014-54 was issued, making after-tax contributions to a tax-deferred retirement account was always like "adding cream to a cup of coffee. There was a little cream in every sip," says Ed Slott, a Rockville Centre tax accountant. Each distribution — including amounts converted to Roth IRAs — contained taxable and after-tax money. If after-tax contributions represented 10 percent of the account, for example, 10 percent of each distribution was tax-free.

Nevertheless, he adds, most tax practitioners believed you could separate after-tax from pretax contributions by taking two checks for your account balance instead of doing a trustee-to-trustee transfer. Say your balance was $1,042,000. You got a $42,000 check for after-tax contributions and an $800,000 check for the pretax $1 million because 20 percent was withheld for taxes. To get an eventual refund for that 20 percent, you had to deposit $1 million in an IRA within 60 days — making up the missing 20 percent from other money. A couple of days later (still within the 60 days) you put the $42,000 into a Roth.

The new IRS notice makes it much simpler. Do the trustee-to-trustee transfer of all your pretax money to the traditional IRA. No tax is withheld in trustee-to-trustee transfers. And send the check for after-tax money to a Roth IRA. The only requirement is that you notify your 401(k) administrator that's what you're doing, so it reports the distributions appropriately to the IRS.

Websites with more information and

TO ASK THE EXPERT Send questions to Ask the Expert/Act 2, Newsday Newsroom, 235 Pinelawn Rd., Melville, NY 11747-4226, or email Include your name, address and phone number. Questions can be answered only in this column. Advice is offered as general guidance. Check with your own advisers for your specific needs.

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