For years, it wasn’t clear whether plan participants with after-tax money* in their accounts could roll over the after-tax portion of an eligible distribution to a Roth individual retirement account (IRA) and the pretax portion to another employer’s plan or a traditional IRA (or a combination).
In September 2014, the IRS provided the answer — and it was a thumbs up. Notice 2014-54 explains the rules for how to allocate pretax and after-tax amounts that are being distributed at the same time to multiple destinations.
Here’s an example: A participant wants one portion of a distribution to go to a new employer’s 401(k), another to go to a traditional IRA, and the balance to come to him. According to the guidance, all plan distributions that are scheduled to be made at the same time will be treated as a single distribution without regard to whether the distributed amounts are made to a single destination or multiple destinations. These rules apply to distributions from qualified plans, such as 401(k) plans, and to 403(b) and governmental 457 plans.
Background
IRS Internal Revenue Code (IRC) Section 72(e)(8) requires that partial distributions from participant accounts that contain both pretax and after-tax amounts include pro rata shares of both amounts. IRS Notice 2009-68 provided two model distribution notices with safe harbor explanations that plans can give to individuals who will be receiving eligible rollover distributions. The explanations state that when individuals have one portion of their account directly rolled over and another portion paid to themselves, each of the payments will include a pro rata portion of the after-tax contributions.
The new guidance incorporates IRC Section 402(c)(2), which says that when an amount transferred to a new employer plan or a traditional IRA contains pretax and after-tax amounts, the pretax amount will be distributed first. Thus, this guidance presents a middle-of-the-road approach that incorporates Sections 72(e)(8) and 402(c)(2) and provides new planning opportunities for participants with after-tax amounts who want to arrange a multiple destination distribution.
Applying the New Rules
The IRS notice contains four examples that clarify how payouts that include after-tax amounts and go to multiple destinations will work under the new rules.
The following facts apply in all four examples:
In example one, the participant specifies a distribution of $70,000 by direct rollover to the qualified plan of a new employer:
The participant requests that $30,000 be paid to him:
Within 60 days, the participant rolls $12,000 into a traditional IRA:
In example two, the participant specifies a distribution of $82,000 by direct rollovers:
The participant requests $18,000 to be paid to himself:
In example three, the participant specifies a distribution of $82,000 by direct rollovers:
The participant requests $18,000 to be paid to himself:
In example four, the participant specifies a distribution of $100,000 by direct rollovers:
Effective Date
The new rules generally apply to distributions made on or after January 1, 2015. However, taxpayers are permitted to apply the rules to distributions made on or after September 18, 2014.
* After-tax amounts discussed in this guidance are not designated Roth contributions
Comments are closed.