Rollover of employee contributions?

[Guest mikeak]

Participant is receiving lump sum distribution from DB plan and wants total rollover into IRA. Account includes after-tax employee contributions. Can contributory amount be included in rollover? Any constraints or cautions?

[mbozek]

There is a question of why the employee would want to roll over after tax money into a tax deferred IRA where the compounded earnings will be subject to marginal income taxation at a future date instead of being distributed in a non taxable distribution. The reasons to receive the AT funds include liquidity and the maximum 5%/15% tax rate on dividends. Another reason not to rollover the AT money is to avoid the annual calculation to determine the amount of the AT money that is not taxed in the MRD from IRAs.

The only reason to rollover the AT money to the IRA is if the particpant is concerned that creditors may attach his assets and state law protects IRAs from creditors claims.

[MGB]

Yes, they can rollover. However, the receiver of the rollover must be one that will accept after-tax contributions (if it is going to another plan, this may not be the case).

I do not agree with mbozek's anti-after-tax stance.

I have two reasons for doing it (these are also personally-based, and are the reasons I contribute the max after-tax funds to an IRA each year).

1) The retirement money leakage problem (for low-income and middle class, this is a much larger issue than the reasons posted against doing this). Money in an IRA is "out-of-sight, out-of-mind". If it is in liquid assets, it is more likely to be spent on current consumption instead of being saved.

2) Short-term investing. I like to buy/sell securities instead of buy-and-hold. I never hold anything long enough to reap the capital gains rates. Churning my investments in the IRA is doable because of deferred taxes. I have modeled doing this both in and out of the IRA and the IRA works better in the long run.

[mbozek]

MGB: While I dont disagree with you premise I dont think its applies to most persons who receive a distribution of AT money for the following reasons

1. An employee who needs the funds will take it from any available source, including IRAs. People who need cash for current expenses will not be deterred by the 10% penalty tax on withdrawals from tax deferred funds in an IRA.

2. The models on trading stocks in IRAs do not include estate planning issues. There is a trade off between no tax on IRA trades and the stepped up basis on non retirement capital assets at death. Funds invested in capital assets held outside of an IRA get a stepped up basis at death which eliminates capital gains tax on the sale of the assets by heirs. (e.g., $10,000 in AT funds which are invested in stock worth $50,000 at owners death can be sold with no cap gains tax at death. If AT funds are invested in IRA, heir will have to pay income tax on $40,000 at heirs marginal tax rate.) Earnings on AT funds in an IRA are subject to IRD at the marginal rate of the heir. Also unlike you, most employees are better off investing in index funds which have low turnover, low costs and maximum 5%/15% tax on LT capital gains as well as the 15% max rate on dividends in assets held out side an IRA and not at the marginal rate of the IRA owner.