Calculating After Tax 401(k) Contributions and Withdrawals

Q: I’ve searched your website but can’t find information about whether or not a distribution of 401(k) after tax contributions is taxable in any way. I have about $10,000 in a 401(k) from a previous employer that includes about $5,000 in after tax contributions. I need about $5,000 to help purchase a car but I don’t want to pay taxes on a $5,000 distribution. If I request the provider to send me only the after tax monies, will I be subject to taxes? I am more than 59 1/2. Thanks, DH

A: DH, when I read your letter, I realized that I had never heard of after tax contributions to a 401(k). I’m much more familiar with Roth IRAs and even Roth 401(k)s. So, I turned to my buddy, Woody Alpern, CPA, for some tax guidance. Here’s what he had to say (with some minor editing changes):

Woody’s Answer

Thanks for your question. There is not much information on this on the web because after tax contributions are very uncommon now especially since the ROTH came into effect. Also, most plans don’t allow after tax 401(k) contributions because they can greatly complicate the plans matching contribution discrimination testing calculations, which is certainly beyond the scope of the question you asked.

Specifically, your company’s plan document will dictate how this after tax contribution has to be treated. At a minimum, the IRS will require that the distribution of $5,000 be pro-rated between pre-tax and after tax contributions and any earnings associated with those contributions. Let me illustrate below with a very simplified example.

Assume your total contributions in the plan since inception are $10,000, and there have been $2000 in earning on this through the date that your actual distribution of $5,000 takes place. Also assume that of the $10,000 contribution, $5,000 of it was with after tax contributions and $5,000 of it was with pre-tax tax contributions. Unfortunately, you would be required to do a proration to determine how much of the $5,000 is from the pretax contributions versus the after tax contributions. Also, an allocation of the earnings would have to be made, which is all taxable. The calculation would be as follows:

Total pre tax contributions = $5,000
Total earnings subject to tax = $2,000

Total contributions and earnings $12,000

Ratio of total pre tax contributions and earnings subject tot total contributions ($7,000/$12,000) = 58.3333 percent

Taxable portion of $5,000 distribution = $5,000 X 58.333 percent = $2,916.67 = taxable portion of distribution subject to ordinary income tax rates, but not penalty since age is over 59 1/2.

You will need to ask your administrator the specifics in their plan document to see if their plan document has language stating something different (more stringent, like all comes from pre-tax first) before being sure this would be the methodology.

I hope this helps.

Woody Alpern – CPA/PFS

Consider Using a Roth IRA Instead

If you qualify, you’re far better off stashing after-tax contributions in a Roth IRA rather than part of a 401(k). You might also be better off making a non-deductible contribution (if you qualify) to a non-deductible IRA. For more details, talk to your tax planner.