Roth IRA RolloversOn any given evening, many people think about having dessert even before they have finished their dinner. Similarly, as highly compensated employee (HCE) 401(k) plan participants approach retirement, they may want to consider a potentially useful, tax-efficient IRA rollover technique. The IRS has specific rules about how participants can allocate accumulated 401(k) plan assets based on pretax and after-tax employee contributions between standard IRAs and Roth IRAs. (Note: This article does not address opportunities involving Roth 401(k) plans.)

The High Earner’s Decadent Dilemma

In 2016, the top pretax contribution that participants can make to a 401(k) is $18,000 ($24,000 for those 50 and older). Plans that permit after-tax contributions — about half of them do — allow participants to contribute a total of $53,000 ($35,000 above the $18,000 pretax contribution limit). While some highly compensated supersavers may have significant accumulations of after-tax contributions in their 401(k) accounts, the IRS income caps block the highest paid HCEs from opening a Roth IRA.

However, under IRS rules, these participants can roll dollars representing their after-tax 401(k) contributions directly into a new Roth IRA when they retire or no longer work for the company. Thus, they will ultimately be able to withdraw the dollars representing the original after-tax contributions — and subsequent earnings on those dollars — tax-free.

The IRS’ Sweet Standards

Participants who have contributed after-tax dollars and pre-tax dollars into a 401(k) plan can the funds into Roth and conventional IRAs on a pro rata basis. For instance, if a participant has $5 million in a 401(k) account and contributed 50% of her contributions as after-tax contributions, then $2.5 million could be rolled over into a Roth IRA account upon retirement. Of the $5 million in the 401(k) account, if 60% of that amount had been contributions, then $1 million of the $2.5 million rolled into the Roth IRA would be a result of earnings from the 401(k) plan and would be taxable the year it was rolled into the Roth IRA. The participant could choose to delay taxation on this $1 million until withdrawal from the IRA by rolling it into a conventional IRA instead of a Roth IRA. However, future earnings on the $1 million would be taxable if the money were in a conventional IRA.

CRI Can Help You “Whip Up” a Plan for Your Roth IRA Rollover

Contact CRI for guidance regarding how the IRS’ new rules for may affect you. We’ll be happy to help make your Roth IRA rollover process “a piece of cake.”