Partial rollover requires pre-tax amounts to be rolled first

Partial or installment distributions from accounts of individuals in qualified plans that contain after-tax amounts Require a pro-rata distribution of after-tax and pre-tax amounts except for after-tax contributed prior to 1987 and except for partial direct rollovers.

A participant may make a direct rollover of some of the qualified plan assets and take a distribution of part. If a partial distribution is made to a participant and it is eligible for rollover, there is 20% mandatory withholding. Also, when there is a partial rollover, the rules require that pre-tax amounts are distributed and thus, rolled over before any after-tax amounts.

Example 1
Participant severs service with a balance of $70,000, of which the pre-tax amount is $62,000 and the post 1986 after-tax is $8,000.

The participant requests a distribution of $50,000 as a direct rollover to IRA. The $50,000 would all be pre-tax as pre-tax is rolled first.

The participant then requests $20,000 to paid to himself. Of the $20,000, $8,000 is after-tax, and not subject to withholding. The remaining $12,000 is a pre-tax amount and eligible for rollover, thus, 20% ($2,400) federal income tax withholding applies. Thus, the participant receives $17,600, of which $8,000 is after-tax, The Form 1099-R will reflect gross distribution of $20,000, Taxable amount of $12,000 and Federal Income Tax withholding of $2,400.

Example 2

A retiring plan participant has a $1,000,000 dollar balance which includes $80,000 in post-1986 after-tax dollars. The participant wishes to withdraw just the after-tax amount. The pre-tax amount is to be kept tax-sheltered, though it does not have to remain in the plan. Is there a way to get the participant just the after-tax money?

The Job Creation and Worker Assistance Act of 2002 (JCWAA) established an order for rollover amounts. Specifically, an individual is to roll over pre-tax dollars first. Once all pre-tax amounts are rolled over, the individual may directly roll over the after-tax dollars to another qualified plan or an IRA.

In this example, if the participant arranges for the pre-tax amount of $920,000 to be directly rolled into an IRA, the participant may then withdraw the remaining $80,000 after-tax (or directly roll it to an IRA). There would be no withholding on the $80,000, as it is after-tax money.

Rollover of property

In order to rollover property, the plan must permit in-kind distributions. A participant with both property and cash in a qualified plan who wishes to make an eligible rollover distribution from a plan with in-kind distribution provisions may directly roll:

• The property, all or part, or
• Part of the cash or all, or
• Any combination of the two

Of course, this is provided that the plan receiving the direct rollover accepts rollovers in-kind.

Further, the same property (or sales proceeds) must be rolled over. A participant who receives property in an eligible rollover distribution from a qualified plan cannot keep the property and contribute cash to a traditional IRA or qualified plan in place of the property. The individual must either roll over the property or sell it and roll over the proceeds, including gains.

Example 3

A participant is to receive a qualified plan eligible rollover distribution in the amount of $10,000 cash and $15,000 worth of property. The participant directly rolls the $10,000 of cash to a traditional IRA. Then, the property is distributed in-kind and kept by the individual. There is no withholding on the property as there is no cash being distributed. The individual may not rollover an additional $15,000 in cash representing the value of the property that the individual has kept, and not sold.

Example 4, Gain from Property Sale

• Sept. 4, 2007, Paul receives eligible rollover distribution of $50,000 in non-employer stock.
• Sept. 24, 2007, Paul sold the stock for $60,000.
• Oct. 3, 2007, $60,000 cash into traditional IRA.
• The $50,000 and $10,000 gain are tax-deferred.
• The entire $60,000 rolled over will be ordinary income when distributed from the IRA (and not capital gains). 
  (IRS Pub. 575)

Example 5, Loss from Property Sale

• Sept. 4, 2007, Paul receives eligible rollover distribution of $50,000 in non-employer stock.
• Sept. 24, 2007, Paul sold the stock for $40,000.
• Oct. 3, 2007, $40,000 cash into traditional IRA.
• Paul does not include $50,000 eligible rollover distribution in his income and does not deduct the $10,000 loss from the sale of the stock.

• The $40,000 rolled over will be ordinary income when he withdraws it from his IRA.
  (IRS Pub. 575)

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