But you must follow some rules to correctly roll over your after-tax 401(k) funds correctly. Here are some common concerns and questions about how this type of rollover works.
IRS Rules About Rolling After-Tax Funds to a Roth
The financial planning and tax community wasn’t sure for many years whether after-tax funds in a company plan could legally be rolled into a Roth IRA. An IRS ruling clarified this in September 2014. The answer is a definite “Yes.” You’re permitted to roll the after-tax contributions from a qualified company retirement plan to a Roth IRA. But there’s a catch. You must also roll over your pre-tax 401(k) contributions in a proportional amount based on what you’ve put into your fund. Your rollover distributions will always be 10% after-tax and 90% pre-tax if your 401(k) has $200,000 in it, and 10% of that includes after-tax contributions. Your plan administrator will cut two checks to facilitate the rollover of after-tax 401(k) funds to a Roth IRA: one for the after-tax contributions and one for the pre-tax money. You can direct that the after-tax contributions go right to a Roth IRA account while the pre-tax money gets rolled into a traditional IRA. You would designate the appropriate account for each respective contribution type on your 401(k) distribution paperwork.
The Penalty if You Deposit to the Wrong Account
You have 60 days to deposit the funds into the appropriate account when you receive a rollover check. Your rollover won’t count as a rollover if you miss the 60-day deadline. It will become taxable. Exceptions to the 60-day rollover time frame are hard to come by unless your financial services company makes a gross error. It’s important to have a clear plan for where your rollover funds are going and to make sure your financial advisor or plan administrator knows exactly where to put the money.
Avoiding Rollover Mistakes
Make sure you follow all of the rollover rules at retirement so you don’t encounter any unpleasant tax surprises. Read all paperwork carefully before you submit it to your plan administrator, and double-check account numbers before you make deposits. You can look at your most recent 401(k) statement to see how much should be in after-tax funds. Make sure the check amount you’re depositing to your Roth is approximately that same amount.
Other Rollover Options
You have other options besides a Roth IRA if you’re retiring or separating from a company. You could roll the funds into a traditional IRA, move them into a new company’s 401(k) plan, or leave them where they are. You don’t have to do anything with the money until you’re ready because 401(k) plans are portable. The 60-day clock doesn’t start ticking until you begin the transfer process. Take your time, talk to a financial advisor, and figure out the best way to roll the funds over before you start the process. There’s no need to do it as soon as you separate from the company, especially if you have a high balance.
