After-tax distributions

[Guest slt]

I know that after EGTRRA, after-tax contributions can be "rolled over" into a qualified plan (or IRA), etc. and that a distribution will not be considered an eligible rollover distribution if it includes after-tax amounts. However, has anyone thought about the effect of the withholding rules? Generally, eligible rollover distributions are subject to a mandatory 20% withholding requirement. Suppose that someone receives a distribution of eligible rollover amounts, including after tax amounts and does NOT effect a 401(a)(31) direct rollover. Does the employer now have to withhold 20% on the entire amount (including the after-tax amount). Presumably, the participant would just get a refund the next year with respect to any withholding on the after-tax amounts. But still, technically, the after-tax amount IS part of an eligible rollover distribution and 3405© couldn't be more clear as to the tax effects. I checked the legislative history and noticed that nothing is mentioned. Code section 402© itself impllies that there is a separate accounting for the amounts not included in gross income and those that are, but is this really enough for me to reach the conclusion that they intended that 3405© would not apply to after tax amounts? Does the last sentence of 31.3405©-1, Q&A-10 (B) ($5,000 death benefits) give me proof that the IRS is really saying that the 20% withholding occurs with respect to amounts not excludible from gross income? What about the fact that these regulations have not been amended for EGTRRA? Thanks for any help!

[Guest Harry O]

Actually, section 3405© says that in the case of any "designated distribution" that is eligible for rollover, 20% of "such distribution" shall be withheld from the portion not rolled over.

Section 3405(e)(1) defines "designated distribution" as any distribution from the plan but it does not include any portion which "it is reasonable to believe is not includible in gross income."

It seems to me that the term "designated distribution" would exclude after-tax contributions. Thus, the 20% withholding tax would only apply to the taxable portion of the eligible rollover distribution.

This is the same result that applies to distributions that contain net unrealized appreciation on employer stock (which is excluded from income in certain cases). See Reg. 1.3405©-1, Q&A 12.

[Guest slt]

Perfect. Makes absolute sense. Thanks so much!