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New IRS rule simplifies rollover of after-tax 401(k) funds

If you have recently changed jobs, one important step is to rollover retirement savings from a company sponsored 401(k) plan into an Individual Retirement Account or Roth IRA.

Last week, the Internal Revenue Service issued new rules that allow you to roll any after-tax money in your 401(k) plan into a Roth IRA. The benefit for doing this is that the money can grow tax-free. In many cases it will no longer be necessary to pay taxes on the distribution to account for the percentage of pre-tax money in the 401(k).

The new rules should make life easier for those changing jobs who want to keep all their retirement accounts in one place. In guidance issued on the new rules, the agency included an example. For instance, if you changed employers and asked for a distribution from a 401(k) account that included both pre-tax and after-tax dollars this is how it would work. If the account distribution was $50,000 and the after-tax amount was $10,000, you could place $40,000 into a traditional IRA and the remaining after-tax dollars into your Roth.

In the past, it was difficult to separate out pre-tax and after-tax dollars when doing a rollover. It usually required having cash on hand to pay income tax withholding or you would face a tax collection action.

Classifications of pre-tax and after-tax dollars have not changed, but the ability to allocate portions of the distribution is new. The distributions generally must occur at the same time.

While the rules technically go into effect on January 1, 2015, taxpayers can rely on them from the date they were issued, September 18, 2014. Those who used a more roundabout method to accomplish the same result may also receive relief through the “reasonable interpretation standard.”

Source: Forbes, "IRS Issues 401(k) After-Tax Rollover Rules," Ashlea Eberling, September 19, 2014

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