qualified plan to IRA: only transferring the after-tax contributions

[Guest ashore]

Hi,

if a client has both after-tax and pre-tax monies in a qualified plan, can he roll only the after-tax contributions to an IRA, or does he have to roll over 100% of the qualified plan? I'm asking what the law says about this, I realize that the plan itself may limit this.

Thanks in advance,

Alex Shore

[Guest Fishchick]

From IRS Pub 590 p. 22

"Kinds of rollovers from a traditional IRA. You may be able to roll over, tax free, a distribution from your traditional IRA into a qualified plan, including the Federal Thrift Savings Fund, a deferred compensation plan of a state or local government (section 457 plan), and a tax-sheltered annuity (section 403b) plan. The part of the distribution that you can roll over is the part that would otherwise be taxable (incluible in your income). Qualified plans may, but are not required, to accept such rollovers."

Hope that helps.

[Guest ashore]

Hi,

I'm asking about rolling over TO an IRA the after-tax contributions (only). Not the earnings or the pre-tax contributions and earnings. Therefore, the "cost basis" of the IRA would be the cost of the contributions. Then I would look at converting the IRA to a Roth IRA, since the cost basis is basically the same as the value, there would be no/little tax due. Then we've converted the growth of an asset from tax-deferred to tax-free.

If qualified plans are allowed to roll-out the after-tax contributions and retain the other monies, then we can establish the high cost basis IRA to convert. IF they have to roll out pre-tax first or earnings first, then we have to consider the tax due on the Roth conversion to determine if it is feasible.

Thank you for your help,

Alex

[Appleby]

Not possible. According to the law...If a distribution from a qualified plan includes pre-tax and post-tax assets, any amount rolled over will be deemed to include the pre-tax portion first. This prevents you from converting only the after-tax amount. The only way to convert only the after-tax amount is if your are able to rollover the pre-tax amount from the IRA to a qualified plan ( qualified plans cannot accept rollovers of after-tax form IRAs)…the remaining balance in the IRA would then be after-tax amounts- which you could then convert to a Roth IRA

[Guest ashore]

Thank you.

[Guest Fishchick]

Sorry, I misread your question.

Appleby's answer is correct.

[txdd]

I'm still confused about the question.

If the qual plan distributes ONLY the after tax amount then the distribution contains no pre-tax assets and the IRA would have zero basis. True?

Now as to part 2 of the question: The taxablility of the Roth conversion would be figured on the basis of ALL tax-deferred IRA's of that person, not just the one that accepted the rollover. So the tax free Roth conversion would only work if that person had no other IRA's. Is that right?

[Appleby]

I'm still confused about the question.

If the qual plan distributes ONLY the after tax amount then the distribution contains no pre-tax assets and the IRA would have zero basis. True?

Now as to part 2 of the question: The taxablility of the Roth conversion would be figured on the basis of ALL tax-deferred IRA's of that person, not just the one that accepted the rollover. So the tax free Roth conversion would only work if that person had no other IRA's. Is that right?

The plan cannot distribute only after-tax assets. If a participant’s balance includes both pre-tax and after-tax amounts, any distribution must include a pro-rated amount of pre and post-tax assets( Notice 87-13 ). An exception applies to pre-1987 balances ( grandfathered) ,that allows the participant to distribute only post-tax amounts

Yes! To part two of your question

[FundeK]

The plan cannot distribute only after-tax assets.

I have seen plans written to allow in-service distributions of after tax dollars only. Would he then be able to roll over only the after tax $? (If it is not a hardship distrbution of course)

[Mary Kay Foss]

Your question was answered by Appleby above. If a plan had after tax contributions before 1987 and if it kept track of those contributions separately, then those contributions can be distributed tax free. Of course any earnings on them would be taxable.

If the plan did not have after tax contributions before 1987, all distributions are taxed pro rata. Some of the basis is recovered with each distribution but not all of it.

It doesn't matter what source the plan takes the distribution from, after-tax contributions can only be recovered tax-free if they were made before 1987 and the employer kept track of them separately.