IRS opens door to direct retirement assets to a Roth

IRS opens door to direct retirement assets to a Roth

For 401(k) participants with a mix of pretax and after-tax funds in their retirement plan, planning may be easier following a recent announcement from the Internal Revenue Service.

The IRS issued a notice in September that provides clarification on how to distribute these funds. Participants will be able to direct pre-tax funds to a traditional rollover IRA. After-tax funds can be taken as cash or directed to a Roth IRA tax free.

Prior to the notice, it was difficult for taxpayers to segregate the funds upon distribution.

Consider this example:

  • Plan participant has $200,000 in a 401(k) plan
  • Assets within the plan consist of $150,000 (75%) in pretax funds and $50,000 (25%) in after-tax funds
  • The participant could opt to roll over the $150,000 in pretax funds to a traditional rollover IRA while directing $50,000 to a Roth IRA

The IRS further notes that any partial distributions are deemed to consist of a pro-rata portion of pretax to after-tax dollars. Using the same example, let’s assume the participant chooses to roll over just $100,000 from his or her plan to an IRA. In this case, $75,000, or 75%, would be considered pretax and could be rolled over to a traditional rollover IRA, while $25,000, or 25%, could be directed to a Roth IRA.

This guidance opens doors for plan participants who may wish to fund more retirement savings to Roth accounts, particularly when the plan does not offer a Roth 401(k) option. Knowing that they are able to directly roll over after-tax retirement plan assets to a Roth IRA, participants may be more likely to use this option if it is allowed in their plan. And, unlike contributions to a Roth IRA, there are no income requirements limiting after-tax contributions inside a retirement plan.

Plan participants deciding the most efficient way to distribute their retirement plan assets should consult with an advisor or tax expert to determine an appropriate strategy.


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