Automatic rollover of mandatory distributions of after-tax money

[Guest Mike Melnick]

The automatic rollover requirement (of mandatory distributions between 1,000 and 5,000) does not make an exception for after-tax distributions as far as I can tell.

Consider an extreme case where a terminated participant is entitled to a lump sum of $1,050 consisting of $1,000 of his own after-tax contributions and $50 of taxable interest. If the employer wants to force a cash-out, the entire distribution would be subject to the automatic rollover rules. Or is there some exception?

[WDIK]

http://benefitslink.com/boards/index.php?showtopic=28446

[E as in ERISA]

Check out 401(a)(31)©, which previously said that the (A) direct rollover rules only applied to eligible rollover distributions that would be included in income. It is now applicable to (B) automatic rollovers. But was amended to say that the rule does not apply if the money is going to a qualified plan or IRA. (Since some after tax can now be rolled over to a qualified plan or IRA, the exception doesn't appear to apply). But what about Roth 401(k)? Will two IRAs need to be set up?

[Guest Mike Melnick]

WDIK, thank you for the reference to the earlier thread, which I missed.

As Katherine points out, 401(a)(31)© is the applicable Code Section, which is unclear.

It states that the automatic rollover requirement (of 401(a)(31)(B) ) only applies to taxable amounts unless the receiving trust is willing to account for after-tax distributions separately. Taken literally then, the legal requirement (to automatically rollover) would depend on the policies of the IRA trustee chosen to accept the transfer?

I suppose that you can make an argument that if the plan chose an IRA trustee who does not separately account for after-tax money (or did not choose any IRA trustee for that matter) then you could ignore the after-tax money for purposes of determining if the automatic rollover requirement applies. I am not sure if I buy that argument.

[E as in ERISA]

I thought only the qualified plan has to separately account for it, not the IRA. See 401(a)(31)©(i) compared to (ii). Since the auto rollovers are only going to IRAs, I didn't see that as the issue.

[Guest Mike Melnick]

Good point. On reflection, I think your reading is the correct one.

To summarize: 401(A)(31)© says the eligible rollover rules do not apply to after-tax distributions, unless the receiving DEFINED CONTRIBUTION plan agrees to account for them separately. Since the mandatory rollover rules require transfers to IRA's, the (conditional) exception in 401(A)(31)© (which allows you to disregard after-tax money) still applies to the mandatory rollovers.

Simply stated, we may disregard after-tax contributions in applying the mandatory rollover rules.

[E as in ERISA]

I would have summarized it differently with the potentially opposite result : 401(A)(31)© says the eligible rollover rules do not apply to after-tax distributions, unless (i) to a DEFINED CONTRIBUTION plan that agrees to account for them separately OR (ii) TO AN IRA (with no requirement to separate). In other words, direct rollover and automatic rollover rules apply if the plan can accept after tax money. So doesn't that mean after tax is automatically rolled over?

[Guest Mike Melnick]

OK. I see that the reference in 401(a)(31)©(ii) to 402©(8)(B) does include IRA’s. So I guess I have come full circle. I wonder why 401(a)(31)© even mentions the after-tax contributions in the first place? Where are they excluded from the eligible rollover rules?

[E as in ERISA]

401(a)(31)© existed before EGTRRA (it was labeled (B) until the mandatory rollover rules appeared). At that time, it just said that the direct rollover rules did not apply to after tax money. It did not include the exception for that rolled to a qualified plan or IRA. But when they changed to eligible rollover rules to include aftertax money, then they created that rather large exception....which makes the general rule almost void for many plans.