New IRS Ruling on Rollovers of After-Tax Amounts

Notice 2014-54 clears up ambiguity & opens the door to tax-free Roth conversions.

Do you contribute to a qualified retirement plan at work, such as a 401(k), 403(b) or 457 plan? Does your account have a large balance? If so, you’ll be glad to hear about a new IRS ruling that may give you a nice tax break in the future.

At some point in your life, you may want to roll the funds in that workplace retirement account into an IRA. If those dollars represent both pre-tax and after-tax contributions, wouldn’t it be nice to roll the pre-tax amounts into a traditional IRA and the after-tax amounts into a Roth IRA?

For years, the IRS discouraged this. In 2009, the IRS implicitly warned against such a move. At least that is how many tax advisors read IRS Notice 2009-68, which didn’t explicitly bar such “split” rollovers but strongly suggested they would raise red flags.1

Still, some tax professionals saw “split” rollovers as doable with certain logistics. They advised their clients to withdraw the whole 401(k) balance as a first step and make outside funds available to counteract the resulting 20% income tax withholding. In other words, the plan participants wound up paying withholding on the distribution even though the goal was an IRA rollover.2

Now the IRS has changed its mind. Starting January 1, 2015, you will be able to roll over after-tax dollars from a qualified retirement plan into a Roth IRA without paying taxes on the distribution. IRS Notice 2014-54 states this will now be permissible.2

In fact, Notice 2014-54 says that “taxpayers are permitted to apply the proposed regulations to distributions made before the applicability date, so long as such earlier distributions are made on or after Sept. 18, 2014.” So it doesn’t frown on such a move before 2014 ends.3

The IRS has really simplified things. Under Notice 2014-54 you can make a “split” rollover and have it count as one distribution instead of two. Also, the IRS is abandoning the pro rata tax treatment of such rollover amounts. Previously, if you had $100,000 in a qualified retirement plan and rolled $70,000 in pre-tax dollars into a traditional IRA and $30,000 in after-tax dollars into a Roth IRA, then 70% of the dollars going into each IRA would be taxed under the pro rata tax treatment. Under the new ruling, a plan participant can take the $30,000 of after-tax funds out of the plan and convert it to a Roth IRA tax-free.4

This has to be done in one fell swoop. The IRS ruling does note that rollovers of pre-tax and after-tax dollars from a qualified retirement plan to IRAs must occur at the same time. If they don’t, they will be regarded as separate distributions. The IRS will understand “reasonable” administrative delays in this matter.2

Do you have after-tax amounts in your 401(k), 403(b) or 457 plan? This is worth determining, because the IRS just opened the door to a tax-free Roth conversion for anyone who does.
1 – [9/18/14]
2 – [9/19/14]
3 – [9/18/14]
4 – [9/30/14]

This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The NASDAQ Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is not possible to invest directly in an index. NYSE Group, Inc. (NYSE:NYX) operates two securities exchanges: the New York Stock Exchange (the “NYSE”) and NYSE Arca (formerly known as the Archipelago Exchange, or ArcaEx®, and the Pacific Exchange). NYSE Group is a leading provider of securities listing, trading and market data products and services. The New York Mercantile Exchange, Inc. (NYMEX) is the world’s largest physical commodity futures exchange and the preeminent trading forum for energy and precious metals, with trading conducted through two divisions – the NYMEX Division, home to the energy, platinum, and palladium markets, and the COMEX Division, on which all other metals trade. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability and differences in accounting standards. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This material was prepared by MarketingLibrary.Net Inc., for Mark Lund, The 401k Advisor, Investor Coach and author of The Effective Investor. Mark offers investment advisory services through Stonecreek Wealth Advisors, Inc. an independent, fee-only, Registered Investment Advisor firm providing 401k consulting for small businesses and private investment management services for professional athletes and select individuals. Stonecreek is located in Salt Lake City, Murray, West Jordan, Sandy, Draper, South Jordan, Provo, Orem, Lehi, Highland, Alpine, American Fork all in Utah.