IRS issues new rule on after-tax rollovers to IRAs
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 nwsdy.li/aftertaxcontributions and nwsdy.li/rothconversion
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