Taxation of After-tax and pre-tax assets in qualified plan

[jane123]

A plan includes both pre-tax and after-tax assets. The participant receives a partial distribution from the plan. How is the distribution taxed? Must the distribution amount be determined on a pro-rata basis, similar to IRAs?

Thanks in advance

Jane

[Mary Kay Foss]

It depends. If the after-tax contributions were all made before 1987, they can be distributed first with no tax. If there were any after-tax contributions made in 1987 or later, a prorata recovery of basis is required.

I'm not sure what you mean by "partial distribution," though.

[jane123]

Thanks Mary.

By Partial distribution I mean distributing only part of the balance, as opposed to taking a total distribution. It’s kinds of an in-house term, once you get used to them you forget they are not used industry wide – sorry about that.

Jane

[GBurns]

jane123

It is very dangerous to develop your own in house meanings for terms.

How will you know whether things you do are correct if the terms have meanings that differ from what the industry, the IRC, the Treas Regs, the DOL and case law uses?

How will you understand any new releases of info?

[Mike Preston]

See IRS Notice 87-13, Q&A 15. The plan can apply a "first in - first out" philosophy, which will essentially make all distributions consist of the pre-87 after-tax contributions, if any, before distribution of any other amounts, or it can apply the pro-rata rule to all distributions. Whatever the plan decides upn must apply to all participants in the same manner.

[david rigby]

Pardon my paranoia, but I don't think the original question has been answered. "Partial distribution" has been defined as "distributing only part of the balance". This does not help, as GBurns correctly points out.

Under what circumstances does the distribution occur? This is not a loan is it? Is this a 401(k) plan? Does the account include rollover money? (I have probably overlooked some other important questions.)

[jane123]

Thanks for all the responses.

To answer some of your questions

It is a 401(k) plan.

It includes after-tax (non-deductible) contributions.

It is not a loan.

The plan does not include rollover money.

The participant has satisfied the requirements for receiving distributions from the plan. He wants to withdraw only $7,000, but he does not want to pay tax on the amount, so he is asking that the $7,000 be distributed only from his balance attributed to the after-tax balance. He has no pre-1987 balance.

Does anyone have a copy of Notice 87-13 that could be uploaded here?

Thanks for all your help.

Jane

[QDROphile]

You cannot treat pre-1987 after tax amounts under the pre-1987 "separate contract" rules unless the plan document correctly provides for the special treatment. Very few plans were written correctly to get this result.

[KJohnson]

I'm not sure it adds anything to what is discussed above, but here is a nice discussion:

http://benefitslink.com/modperl/qa.cgi?db=...ibutions&id=172

[Mike Preston]

QDROphile, I'm not aware of any requirement to have the document identify the methodology. I am aware that 87-13 requires consistent treatment. It has been a long time since I read 87-13 cover to cover, though, so I may not be remembering everything.

[Guest Harry O]

QDRO -

Why do you say that very few plans are written correctly to get the separate contract treatment for pre-87 money? I guess my experience has been the opposite, most plans seem to have the right language. But maybe I am missing something . . .

[QDROphile]

I guess we have different sample spaces. Maybe I attract problem plans.

[GBurns]

I can only reflect back on a couple dozen plans but I tend to agree with QDROphile that most plans (to which this is applicable) were not written to cover this, which is probably why there was a need for PLRs such as 9652031 years later and more since.

PLR 9652031 illustrates the need to document the methodology chosen.