After-tax Rollovers

[Guest turbodiesel39]

EGTRRA has made after-tax rollovers possible. I have read that if someone is rolling after-tax money into an IRA, it can be done through a direct or an indirect manner. However, for rollovers into a qualified plan, it can only be a direct rollover. Can anyone confirm whether or not this information is true? Can there be an in-direct rollover into a qualified plan?

[mbozek]

Why would an employee want to rollover after tax money which is available without any taxation and lock it up in a qualified plan or IRA where the a/t funds will be paid out pro rata over the expected payout period? From a financial standpoint it is not sound. The a/t funds can be invested in a municipal bond fund which will churn out tax free interest or an index fund which generates little capital gains and are available w/out any restriction.

[Guest dmj1998]

turbodiesel39 - sec. 643 of EGTRRA appears to state that a direct transfer is required.

mbozek - pre-egtrra, participants doing rollovers with substantial AT balances were confronted with a "windfall" of cash that could no longer accrue earnings on a tax-deferred basis. by allowing these dollars to be rolled over, ppts. are being protected from themselves in terms of keeping their retirement assets working in a tax-favored vehicle and not buying a new car. Index funds are excellent investments, but they do generate current tax liabilities, which can be a hassle if someone is not used to dealing with them. municipal bond funds are more useful in terms of capital preservation and current income and not growth of principal. they are also not as riskless as they may appear.

[Guest BigAl]

In response to MBOZEK's statement about why an employee would want to tie-up after tax funds in an IRA, I have a case I tried to get an explanation on in an earlier post today. The after tax money that is rolled from the 401K to an IRA, I believe could then be immediately converted to a ROTH IRA, and then all the capital gains would be tax free. Do you agree. Read my previous post that the IRS sent to me on my question. I would appreciate your opinion, and anyone elses.

[mbozek]

If and only if the after tax funds could be separately transferred to an Roth IRA (and this appears unlikely based upon another post) then the investment makes sense because the taxpayer has the best of all worlds- tax free compounding of interest and ability to withdraw the funds after the minimum deposit period. Otherwise investing AT money in an IRA is a poor investment because the taxpayer has to compute the pro rata amt that must be withdrawn each year under the MDR and loses the liquidity of the funds in a regular account. But this does raise a further Q as to why an employee would invest AT money in a plan since it costs so much more, e.g. $1.5 for each $1 invested for some one in the 33% fed/st tax bracket. Economically the employee will never be able to equal the tax free compounding of tax deferred contributions with AT contributons.

[MGB]

mbozak,

Your discussion implies that after-tax money that is eligible for rollover can somehow be transformed into pre-tax money. Given that it is impossible to do, your argument has no meaning. Obviously it is better to have pre-tax money instead of after-tax money. That is not the situation here. Here, the person already has after-tax money in an account. It doesn't make sense to take it out instead of rolling it over (assuming it is going to be used for retirement in either situation).

[MGB]

turbodiesel,

In response to your original question (all of the replies have been off-topic), your understanding is correct. To transfer after-tax money to a qualified plan, it must be in a direct trustee-to-trustee transfer. Once the person gets their hands on the after-tax money, it can only be rolled over to an IRA.

For an exhaustive discussion of all of EGTRRA's provisions, you can check out some things I wrote immediately after the law was passed (there are additional writings there concerning later guidance also - another one is about to be released covering many recent issues). The original writings are called "Legislative Information Bulletins." You can find them on our website under "Publications," then "Employee Benefits."

http://www.milliman.com

[mbozek]

MGB: I dont know here u got that implication because i always noted that the funds would remain after tax dollars. My analogy pointed out that it took $1.5 AT dollars to equal $1 pre tax dollar since taxes had to be paid. The reason I diskile AT money in a retirement plan is because it has to be paid out pro rata as part of the retirement distribution and making such a determination with multiple IRA involves complex calcuations. Since the AT money can be removed from the plan with no tax consequence upon distributon and invested in tax managed funds which minimize income tax there is little financial advantage into tying up AT money in a retirement plan. Also the appreciation on AT dollars invested outside of a IRA in a capital asset are eligible for stepped up basis at the death of the owner. Appreciation on AT money held in an IRA or retirement plan are taxed as ordinary income after owner dies. I would appreciate a demonstration of the math that makes AT money a more valuable asset when it is tied up in an IRA or qualfied plan than invested in a capital asset subject to the 10/20% cg rates.

[Appleby]

Additional comments on Roth conversion of after-tax assets

The EGTRRA regulation did not address this issue. Until then, we rely on the IRA distribution rules.

Under the IRA distribution rules, for an IRA that consists of taxable an non-taxable assets, distributions, including amounts moved to a Roth IRA as a conversion, is taxed on a pro rata basis.

IRA owners should continue to file IRS form 8608 to determine taxable portion of their distribution or conversion amount.

Plan participants who chose to rollover non-taxable assets, should remember that they are responsible for maintaining accounting records to keep track of track of both the after-tax contributions that are rolled over and the earnings on them. For this reason, individuals choose to keep the after tax amounts in a separate IRA.