IRS FAQs clarify after-tax contribution rollover rules

Where a participant’s account balance in a plan includes both pretax and after-tax amounts, the IRS has clarified that guidance provided in IRS Notice 2014-54 does not alter the requirement that each distribution from a plan must include a proportional share of the pretax and after-tax amounts in the account. Accordingly, any partial distribution from the plan must include some of the pretax amounts in an account. An employee cannot take a distribution of only the after-tax amounts and leave the pretax amounts in the plan, according to the IRS. In order to roll over all of the after-tax contributions to a Roth IRA, the employee could take a distribution of the full amount (all pretax and after-tax amounts) in the account, roll over all the pretax amounts in a direct rollover to a traditional IRA or another eligible retirement plan, and roll over all the after-tax amounts in a direct rollover to a Roth IRA.

Pro rata share of pretax and after-tax amounts

If a participant’s account balance in a plan includes both pretax and after-tax amounts, then distributions from the account generally are considered to include a pro rata share of both pretax and after-tax amounts. For example, if an employee’s account balance is $100,000, and consists of $80,000 in pretax amounts and $20,000 in after-tax amounts, and he or she requests a distribution of $50,000, the distribution would consist of $40,000 of pretax amounts and $10,000 of after-tax amounts.

Prior to the issuance of Notice 2014-54, the IRS treated disbursements from a retirement plan that were rolled over to multiple destinations as separate distributions to each destination, with each distribution treated as containing a pro rata portion of the pretax and after-tax amounts. Notice 2014-54 provides that all disbursements from a retirement plan scheduled to be made at the same time are treated as a single distribution even if they are sent to multiple destinations.
As a result of this notice, taxpayers with pretax and after-tax amounts in their plan, for example, can transfer through direct rollovers the pretax portion of the distribution (including earnings on after-tax amounts) to a traditional IRA and the after-tax portion of the distribution to a Roth IRA. (Previous interpretations allowed accomplishing this result through 60-day rollovers but not direct rollovers.) The guidance provided in Notice 2014-54 applies only to distributions from Code Sec. 401(a) qualified plans (such as profit-sharing and 401(k) plans), 403(b) plans, and 457(b) governmental plans. The guidance in Notice 2014-54 does not apply to distributions from IRAs.

Rollover of plan earnings

Employees who want to roll over their after-tax contributions to a Roth IRA and roll over earnings on their after-tax contributions to a traditional IRA are allowed to do so, according to the IRS. Earnings associated with after-tax contributions are pretax amounts in the account. Thus, after-tax contributions can be rolled over to a Roth IRA without also including earnings. Under the guidance, all pretax amounts in a distribution may be rolled over to a traditional IRA and, in that case, will not be included in income until distributed from the IRA.

Source: IRS Employee Plans News, December 23, 2014.

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