Roll over Post-1986 401(k) to Roth IRA

Question

I have a 401(k) that only has "post-86 after-tax" contributions and earnings.

I left the company and was thinking about rolling over the whole balance to a personal Roth IRA. This would be a direct rollover from one provider to the other.

I believe that there should not be any tax implications at all. Is it correct? Is there anything else that I should be aware of?

Answer 1

Post-86 After tax contributions to a 401k are after tax. The earnings on that money is taxable, but not the contributions.

This means:

• If you invest $0 in pre-tax money in your 401k
• If you invest $10,000 in after-tax money in your 401k
• If your investment grows by $5,000

You'll have $15,000 in the 401k and $10,000 is considered after-tax and $5,000 is considered pre-tax.

The after-tax portion can be converted to a Roth IRA without paying taxes or penalties.

New in September 2014 The IRS has made substantial changes that now enable this to happen. You can request a distribution from your 401k provider where they divide the money into pre-tax and after-tax funds. In my example, you'd get a check for $10,000 that you could send to a Roth IRA and a check for $5,000 you could add to a traditional Roll-over IRA.

Neither of those would be taxable events and you'd end with a Roth IRA with $10K and a Traditional, Rollover IRA with $5K in it.

Notes:

• Until September 2014, the 401k after-tax methods were all based pro-rata making it either impossible or difficult depending on which tax advisor you asked to separate out after-tax and pre-tax money.
• See this article that reasonable sums up the change: http://www.thinkadvisor.com/2014/09/29/irs-blesses-401k-rollovers-with-pre--after-tax-con?t=philanthropy
• See this table describing tax effects of various 401ks: http://www.money-zine.com/financial-planning/retirement/comparing-401k-contributions/
• If your after-tax contributions are greater than your balance, you can convert all of your funds to a Roth IRA because they are 100% after-tax.
• Your 401k company should be able to tell you what % of your funds are pre-tax and what are post-tax.
• There are specific steps to take to make sure that the funds are correctly accounted for with your 401k company. This just changed which means that 401k administrators may not yet know how to do this.
• The IRS allows 401k companies to do this, but it does not require them to support non-pro-rata withdrawals so as to optimize for taxes.