In 2014, the IRS issued a seemingly obscure Revenue Notice (2014-54) to clarify how retirement plan distributions may be allocated when they consist of both pre-tax amounts and after-tax contributions.
Now, some financial advisors say that, with this ruling, the IRS has implicitly blessed a potentially attractive new planning technique, as follows:
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If a 401(k) or 403(b) plan allows, the account owner makes after-tax contributions in excess of the annual elective deferral limit. This creates two accounts within the plan: pre-tax money (deferrals + all earnings) and after-tax contributions (excess contributions).
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At a trigger event, the account owner takes a full distribution of both accounts, transferring 100% to personal IRAs. All of the pre-tax money is allocated to a Traditional IRA. All of the after-tax money is transferred to a Roth IRA.
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Income tax can be deferred in the Traditional IRA until minimum distributions are required, and it can be deferred in the Roth IRA for life.
Thus, the strategy opens a back door to creating a Roth IRA for retirement.
Prior to the Revenue Ruling, each distribution had to be allocated pro rata into pre-tax and after-tax portions, with the after-tax portion ineligible for a transfer. The owner could have distributed the after-tax portion tax-free.
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