The IRS Clarifies Rules on Rollovers of Retirement Plan Monies
After years of ambiguity around what is and is not allowed regarding the disbursement of after-tax contributions to an employer-sponsored retirement plan, the IRS ruled in September of 2014 that plan participants can roll those dollars into a Roth IRA tax free.
IRS Notice 2014-54, Guidance on Allocation of After-Tax Amounts to Rollovers, “provides rules for allocating pretax and after-tax amounts among disbursements that are made to multiple destinations from a qualified plan.”1 Importantly, the Notice states that all disbursements from a retirement plan made at the same time will be treated as a single distribution even if they are sent to multiple new accounts. Prior to this ruling, the IRS treated distributions from a retirement plan that were rolled over to multiple new accounts as separate distributions, each requiring that a proportional share of pretax and after-tax monies be disbursed.2
A Simplified Process
Now individuals holding both pretax and after-tax amounts in their plan can transfer — through direct, trustee-to-trustee 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. In the past, this could only be accomplished through indirect 60-day rollovers, not through simplified direct rollovers.2
More Clarification, Please
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As with many IRS rulings, Notice 2014-54 raised many questions with taxpayers. In response, the IRS recently issued some answers to those commonly asked.
Q: If I have both pretax and after-tax monies in my retirement account, can I roll over just the after-tax monies to a Roth IRA, leaving all of the pretax monies intact?
A: No, the new rule does not change the requirement that each distribution from a plan — including partial distributions — must include a “proportional share” of the pretax and after-tax amounts.
Example: If your account balance is $100,000 and consists of $80,000 in pretax amounts and $20,000 in after-tax amounts, and you request a distribution of $50,000, your distribution would consist of $40,000 of pretax amounts and $10,000 of after-tax amounts.2
In order to roll over all of your after-tax contributions to a Roth IRA, you could take a full distribution (all pretax and after-tax amounts), roll over all the pretax amounts directly to a traditional IRA or another eligible retirement plan, and roll over all the after-tax amounts directly to a Roth IRA.
Q: Can I roll over my after-tax contributions to a Roth IRA and the earnings on my after-tax contributions to a traditional IRA?
Yes, since earnings on after-tax contributions are considered pretax monies, after-tax contributions can be rolled over to a Roth IRA while the earnings on those contributions can be directed to a separate traditional IRA and avoid being taxed until they are distributed.
Plan Sponsors: A New Opportunity
The new guidelines present an opportunity for plan sponsors to reach out to participants to determine which individuals have after-tax money in their plans and explain the new rules — and the new opportunity — to them. Further, for those participants who are not currently making after-tax contributions, advisors may want to encourage them to do so, if their employer plan allows.
With the current annual pretax contribution limit of $18,000 — or $24,000 for individuals age 50 or older — high-earning employees who are not making after-tax contributions are missing out on the chance to sock away significantly more (the annual total contribution cap on defined contribution plans is $53,000 in 2015) while benefitting from tax-deferred investment growth.
1 The Internal Revenue Service, Notice 2014-54, Guidance on Allocation of After-Tax Amounts to Rollovers, September 18, 2014.
1 The Internal Revenue Service, Employee Plans News, December 23, 2014.
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Post by Phil Ratcliff
Phil Ratcliff, President of rebel Financial, is a senior financial advisor that holds an AIF®, CFP®, ChFC®, and CLU® certifications. He started his career at American Express Financial Advisors in 2003, then moved to AXA Advisors for 7 years before founding rebel Financial LLC in 2013.
