Contributions from Bernie Benyak, CPA, CFP, Tax Director
The IRS released Notice 2014-54 on September 18, 2014 that provides new guidance to taxpayers for taking distributions from their company retirement plans that contain both pre-tax and after-tax funds. This notice definitively answers one of the most hotly debated questions in the retirement planning community in recent years – Can a taxpayer with pre-tax and after-tax plan money directly convert their after-tax money (basis) to a ROTH IRA while also directly rolling over their pre-tax money to a traditional IRA?
The answer was a resounding “Yes!” By permitting this strategy, taxpayers will be able to retain the tax-deferred status on the pre-tax portion of their distributions and simultaneously convert only the after-tax portion to a ROTH IRA, tax free. Although the notice says it will generally apply to distributions taken in 2015 or later, it also says taxpayers can apply a reasonable interpretation of the existing rules, including the guidance in this notice. So, practically speaking, the guidance is effective immediately.
Here is an example of how this would work:
John has $250,000 in a traditional 401(k) and has decided to leave his employer. The $250,000 in his plan consists of $175,000 pre-tax contributions and cumulative earnings and $75,000 after-tax contributions.
John could potentially move the entire $250,000 to an IRA tax free by doing a direct rollover within 60 days, but the future earnings on both the pre-tax and after-tax amounts now held within the personal IRA would be taxable when distributed.
The better option for John would be to take advantage of the guidance offered in Notice 2014-54 and split the distribution from his employer retirement plan by having the pre-tax portion sent to a traditional IRA and having the after-tax portion converted to a ROTH IRA. The $75,000 of after tax money would now be transferred to a ROTH IRA tax free and future distributions along with earnings would be tax free if part of a qualified distribution.
As you consider your retirement planning options and the implications of this new notice, you may have some questions. We are happy to help so please contact us at (719) 630-1186 or through our Secure Email.