A Guide to Rolling Over After-Tax Money In Your 401k
Overview of Notice 2014–54
Do you happen to have after-tax money in your 401k or 403b, assuming the fees and expenses in the IRAs are comparable to the 401k or 403b? A rollover might be beneficial.
In Notice 2014-54, the IRS provided the option for an individual to roll over their pre-tax retirement money into an IRA while rolling over their after-tax money into a Roth IRA.
If left in the plan, future earnings from the after-tax investments are withdrawn as taxable distributions. However, if rolled into a Roth IRA, those earning start growing tax-free.
The Secure Act
The Secure Act requires children, grandchildren, and any non-spouse beneficiary younger than ten to withdraw the entire inherited IRA or retirement plan in ten years. They no longer have the option of stretching the withdrawals over their lifetime.
The Secure Act, however, keeps the rules the same for spouses. They can still roll the plan over into their IRA, become the IRA owner, or remain an IRA beneficiary.
A potential planning strategy, depending on how much after-tax money is in the 401k, is to roll the after-tax to a Roth IRA, maybe leaving that for the kids. You can reasonably invest in that account aggressively. It grows tax-free, and the beneficiary can withdraw without incurring taxes. (The IRA owner also can withdraw tax-free.)
The one downside is that you must wait five years to make a total penalty-free withdrawal from the Roth account. However, you can withdraw the after-tax rolled-over amount at any time without penalty, as only the gains are subject to a 10% penalty.
No Minimum Distribution
One usually does not contribute after-tax until they have used up all their pre-tax contribution limit.
Most people with after-tax money in their 401k typically have a significant account balance.
So, even if one does not intend on leaving money to someone ten years younger, there are still benefits. There is no minimum distribution required from a Roth IRA, meaning the money can stay in the account longer and be invested more aggressively. All withdrawals are tax-free.
Increased Requirements for Financial Advisors
When you leave or retire from your employer, deciding what to do with your 401k or 403b is a big decision.
The federal government has instituted a series of rules and laws to help participants with that decision. The first law, from the U.S. Department of Labor, puts an increased requirement on financial advisors to recommend that participants roll their money over.
The other, from the Securities Exchange Commission, requires an advisor to work in the best interest of the retirement plan participant.
If you have after-tax money in your plan, the benefits of a rollover increase.
Please be sure to speak to your advisor to consider the differences between your company retirement account and investment in an IRA. These factors include, but are not limited to, changes to the availability of funds, withdrawals, fund expenses, fees, and IRA-required minimum distributions.
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Tim has offices in Boston and South Dartmouth, Massachusetts. He’s licensed to handle securities in 8 states: Massachusetts, Rhode Island, New Hampshire, New York, New Jersey, Connecticut, Maine, and Florida.