Contributing after-tax dollars to a 401(k) might appeal to you if you’d like to be able to withdraw funds tax-free in retirement. Should you decide to leave your job you might be wondering if it’s possible to roll over an after-tax 401(k) to a Roth IRA. The good news? Yes, you can do a rollover of after-tax 401(k) money to a Roth account if you’re following IRS rules. Talking to a financial advisor can help you decide if it makes sense to roll over after-tax 401(k) funds to a Roth IRA.
What Are After-Tax 401(k) Contributions?
The IRS distinguishes between four different types of contributions that are allowed with 401(k) plans. After-tax contributions are contributions that employees make from their compensation that must be included in their income when filing a tax return. These contributions are not tax-deductible for the employee.
It’s important to be aware of what type of contributions are involved when rolling money from a 401(k) to a Roth IRA. The other types of 401(k) contributions include:
- Elective salary deferrals: These contributions are made using pre-tax dollars from the employee’s compensation. It’s up to the employee to decide how much to contribute, above any minimum amount required by their employer to participate in the plan.
- Designated Roth contributions: Designated Roth contributions can be included in an employee’s gross income for tax purposes, but they’re eligible for tax-free distributions in retirement. A 401(k) plan is not required to allow designated Roth contributions, but many plans give employees that option.
- Catch-up contributions: Catch-up contributions are amounts that you can contribute to your 401(k), above the regular annual contribution limit. Catch-up contributions are allowed for workers aged 50 and older.
If you’ve made different types of contributions to the same 401(k), that can affect what you’ll need to do when you’re ready to roll funds over.
What Is a Roth IRA?
A Roth IRA is a tax-advantaged individual retirement account. Roth IRAs are funded with after-tax dollars and qualified withdrawals are tax-free. Unlike a traditional IRA, your contributions are not tax-deductible.
Your ability to contribute to a Roth IRA depends on your income and tax filing status. It doesn’t matter if you’re covered by a retirement plan at work. For 2023, the maximum contribution allowed is $6,500 or $7,500 if you’re aged 50 or older.
Why contribute to a Roth IRA? It could make sense to add money to a Roth IRA if you expect to be in a higher tax bracket when you retire. Being able to take tax-free distributions wouldn’t add to your tax burden when it’s time to file your return.
How to Roll Over After-Tax 401(k) to Roth IRA
Rolling money from an after-tax 401(k) to a Roth IRA allows you to avoid creating taxable income if you’re doing a like-to-like transfer. However, the IRS has certain rules in place that govern rollovers of after-tax dollars into a Roth IRA. Your plan may also impose restrictions on when you can take money out.
Here are the options you might have when completing a rollover.
- Roll over the entire amount: The simplest way to complete a rollover from an after-tax 401(k) to a Roth IRA would be to move the entire amount out of your workplace plan.
- Roll over a partial amount: If your plan allows for partial withdrawals, you might be able to roll over some of the money in your 401(k) and leave the rest where it is.
Sounds simple enough but there are some special considerations to keep in mind if your plan includes both pre-tax and after-tax contributions.
If you choose the first option, then any after-tax contributions could be rolled into a Roth IRA. However, any pre-tax contributions and earnings would need to be rolled into a traditional IRA. So, you’d have two IRAs to manage going forward and once you get around to taking traditional IRA withdrawals, they’d be subject to your ordinary income tax rate.
What if your plan allows for partial withdrawals? In that scenario, you could roll over some or all of your after-tax contributions to a Roth IRA. Any pre-tax earnings associated with those contributions would still need to go into a traditional IRA under IRS rules.
Avoiding Tax Penalties With a 401(k) to Roth IRA Rollover
The IRS imposes a time limit on how long you have to complete a rollover transaction. If you’re withdrawing pre-tax contributions or earnings from a 401(k), with the intention of re-depositing the funds into an IRA, you have 60 days to do it.
If you miss the 60-day window, however, the IRS can treat the entire distribution as a taxable event. The simplest way to avoid that scenario is to request a direct rollover. With a direct rollover, your plan administrator handles the movement of funds between your 401(k) and IRA.
Keep in mind that you’ll need to open a Roth IRA if you don’t have one already. You’ll also need a traditional IRA if your rollover involves the transfer of pre-tax funds. Your financial advisor can help you find the right brokerage for opening a new IRA if you don’t have one already.
Do You Have to Roll Over 401(k) Money?
A 401(k) to Roth IRA rollover is optional, rather than mandatory. If you’re not ready to roll your retirement savings to a Roth IRA just yet, you have a few other options:
- Roll the money to your new employer’s plan
- Roll your savings over to a traditional IRA instead
- Leave it where it is
- Withdraw it
Rolling funds into your new employer’s plan may be preferable if you’d like to continue making 401(k) contributions and you’d like all of your savings in one place. On the other hand, you might decide to leave your plan where it is if you’re happy with the investment choices offered and the fees that you’re paying.
Rolling after-tax 401(k) contributions to a traditional IRA can have long-term tax consequences since withdrawals would be taxable later. However, the tax impact may be less than what you’d pay if you were to withdraw all of the money. In that case, you’d owe income tax on the withdrawal and a 10% early withdrawal penalty if you’re under age 59 ½.
The Bottom Line
Completing a rollover of after-tax 401(k) money to a Roth IRA could be a good move if you’re expecting to be in a higher tax bracket at retirement. Before making a move, it’s a good idea to get familiar with the rules for where pre-tax contributions, after-tax contributions and earnings need to go in order to avoid breaking any IRS rules.
Retirement Planning Tips
- Consider talking to a financial advisor about how to handle a rollover from an after-tax 401(k) to a Roth IRA. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- If you need to open a new Roth IRA, it’s helpful to know what options you have. Your bank might offer Roth accounts, but you could also compare different brokerages to see what’s available. When researching Roth IRAs, consider the range of investments offered and the fees you might pay.
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