What to do with after tax 401K contributions

[Guest MikeF]

I will be taking a new job soon and I have after tax contributions in my current 401K plan. What options are available for the after tax contributions? Is it best to leave it in the current 401K? Can I transfer it to my new employer's 401K? Can it be put in a rollover IRA?

I don't currently need the money so it I would like to avoid the tax implications of taking the distribution.

[MWeddell]

If your vested account balance exceeds $5,000, you have the right to defer distribution until the later of age 62 or the plan's normal retirement age. Some plans give you this right if your vested account balance exceeds $3,500. Also, some plans may give you the right to take a partial distribution, so you could leave your after-tax contributions in the plan and take a distribution of the remaining assets.

None of your other choices allow you to keep the after-tax contributions inside a tax-deferred vehicle. For example, if you elect a direct rollover from your soon-to-be-former employer's plan, you'll get the pre-tax money rolled over but you'll get a second check made payable to yourself for the after-tax contributions. There's no taxable income in the short run but you've lost the chance to have your after-tax money earn income on a tax-deferred basis.

As far what's best when you aren't interested in spending the after-tax money, it depends on your investment choices in your soon-to-be-former employer's plan, but you're probably better off to leave the money where it is in the former employer's plan if you can. You might want to check to make sure you can elect a distribution whenever you want at a future date. A small minority of plans give you the opportunity to take a distribution within 90 days after termination of employment and if you don't take a distribution then the plan locks up your money until you reach normal retirement age.

[Guest MikeF]

Thanks for the reply. I will need to do some further checking on my current 401K options. I'm not sure what you meant by "There's no taxable income in the short run" because I assume if I take any distribution of the after tax money I will have to pay taxes on the earnings. I heard you cannot take a distribution of just the after tax contributions but you must also take a portion of the earnings, is that true?

[MWeddell]

Yes, that's true for after-tax contributions made since 1988: one cannot take a distribution of just the contributions and no earnings.

However, if one takes a distribution of the whole account as a direct rollover, all of the taxable portion of the account will be a direct rollover and just the after-tax contributions will be distributed directly to the participant. Hence, no taxable income in the short run, but one has lost the future opportunity to have the after-tax contributions continue generating tax-deferred investment earnings.

Hope that is a bit clearer now.