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This Web site contains a compilation of more than a thousand consumer finance  columns written by Tony Novak from the 1980s through 2006, updated and reformatted for maximum usefulness today.  New material was added after 2010.

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401(k) rollover questions

originally posted: 10/10/2006  revised: 11/23/2010

Q: I have a 401k balance with my former employer that I am considering rolling over to an IRA.   For part of my tenure with my former employer, they required 100% of my 401k investment to be in company stock.  In addition, they also allowed after tax contributions to their plan, to supplement the pre tax contributions.  About $65,000 of my $400,000 balance is comprised of after tax contributions.

My questions are: 1) Is it permissible to roll the above into an IRA, where I would place the after tax component (which is in a loss position due to free fall of the stock) into a separate investment vehicle, since I would not wish to commingle the pre and post components for ease of tax and recordkeeping? 2) Since I would realize a long term capital loss on the sale of my after tax investment, is it possible to offset this loss against future income tax payments in the event I elect to convert gross balance into a Roth IRA during the 2010 “window” for all wage earners? I have already paid taxes on the after tax amounts at the much higher original basis.

A: Separating the rollover accounts based on your allocation of pre-tax / post-tax contribution has no effect on the taxes on withdrawals from either account. In fact making two separate accounts, it would make tax calculations more difficult. In other words, IRA does not recognize this logic. Taxes on all withdrawals are based on a ratio formula that accounts for the original after-tax contributions as a portion of the total withdrawal.

A rollover to a Roth IRA would account for all of the taxes in on calculation, so the previously mentioned method would no longer be required. Before starting the Roth conversion, you should resolve the treatment of the employer stock.

There is another possibility you should consider: a tax treatment method referred to as "Net Unrealized Appreciation" that is a seldom used option for handling employer stock within a qualified plan. It may or may not help you - especially considering the loss situation - but the complexity of this issue is beyond the scope of this free service. 

The size of your account indicates that a few hours of individual tax planning and research would be justified even if just to explore the tax treatment possibilities in this unusual circumstance. It seems likely that a multiple-step strategy adjusted considering multiple other personal financial factors and evolving over the period of your remaining working career will give you the best tax results.

In any event, the sooner you deal with these issues and complete an IRA rollover, the better. Leaving your money in a former employer's 401(k) gives you the fewest options. 

401(k) rollovers can become complicated; ask for independent professional tax help when necessary

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