401(k) After-tax Rollovers to Roth IRAs

When a 401(k) distribution is made to multiple accounts, the IRS used to require that the pretax and after-tax amounts be allocated between accounts. This resulted in a sometimes surprising taxable income even if a distribution equal to the after-tax amount was deposited into a Roth IRA account.

After-tax amounts can be directed to a Roth IRA (Notice 2014-54). The IRS has changed its position and will allow the recipient to select how the pretax amount in his or her 401(k) is allocated in a direct rollover to two or more accounts. To make this selection, the recipient must inform the plan administrator of the allocation of specific pretax and after-tax amounts prior to the time of the direct rollovers. “Separate recipients” does not mean separate distributions. It means a distribution sent to multiple accounts.

Example- old rule. The 401k distribution is $100,000. 70% is from pretax contributions and 30% from after-tax contributions. The employee directs the plan administrator to transfer $70,000 to a traditional IRA and $30,000 to a Roth IRA. Previously the IRS position was that distributions must be split 70-30 between pretax and after-tax, so $21,000 (70% of $30,000) of the amount transferred to the Roth would be taxable.

Example- new rule. The 401k distribution is $100,000. 70% is from pretax contributions and 30% from after-tax contributions. The employee directs the plan administrator to transfer the pretax mount of $70,000 to a traditional IRA and the after-tax amount of $30,000 to a Roth IRA. For distributions on or after Sep. 18, 20142 , no taxable income results from the transfer to the Roth IRA. Preparer note. The change applies to pretax amounts in elective deferral accounts including the 401(k), 403(b) and the 457(b).

401(k) Planning Ideas

Always contribute enough to the 401(k) to secure employer matching contributions.
Contribute additional dollars to max out the statutory 401(k) pretax amount ($17,500 in 2014 plus $5,500 for those 50 or older).
If the plan permits, make after-tax contributions to the 401(k) plan, up to the annual defined contribution plan limits ($52,000 in 2014 and $53,000 in 2015). After-tax contributions can later be distributed tax-free to a Roth IRA.