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Financial Information for Senior Military Officers

401(k) Rollover Rule 2.75693

401(k) Rollover Rule 2.75693

O.K...the rule isn't really called 2.75693, but in a recent IRS Notice 2014-54 (trust me...you don't really want to read it) the IRS clarified the treatment of and perhaps even incentivized certain 401(k) contributions.

Some of you may be offered the option of contributing after-tax dollars to your 401(k) plan or 403(b) plan up to the annual Defined Contribution Limit of $52,000 (2014).  This is not a Roth Contribution but is more like a Non-Deductible IRA contribution.  So you could contribute $23,000 (if age 50 or older) in deductible dollars to your 401(k) and then IF your employer allows, make another $29,000 non-deductible contribution to the 401(k).  Why would you want to do this?

 

  1. Working Years.  You may be able to contribute more in non-deductible 401(k) contributions than you could to a non-deductible IRA.  As a reminder the non-deductible IRA contribution is $6,500 (if age 50 or older).  The earnings on these contributions will be tax deferred.  Tax deferral is a valuable benefit especially if your funds are invested in assets that produce high current income (see this earlier blog post for an article on the tax benefit of non-deductible IRAs).
  2. Post Employment.  This is the part the IRS clarified.  After you leave the company (either a new job or retirement), you have the option of rolling over the entire balance of your 401(k) and designating that the after-tax balance be deposited in a Roth IRA.  You would also designate that the tax-deferred balance would be deposited in a Traditional IRA.  In essence, you are doing a tax-free Roth Conversion.  Having funds in a Roth IRA gives you the option for tax free earnings and a Roth is also a very effective estate planning tool as Roth IRAs are not subject to Required Minimum Distributions.

What to make of it all?

  1. For most retired (or soon to be retired) Senior Military Officers, you will most likely want to contribute as much a possible to your pre-tax 401(k) as you are in a relatively high tax bracket
  2. You can obtain some tax rate "diversification" if you contribute after-tax money to your 401(k) and then roll-over to a Roth IRA (Remember...your employer is not required to offer a after-tax option in the 401(k) plan)
  3. Check out your 401(k) plan's Summary Plan Document (SPD) to see if you have this option...if not ask about it.

 

Tax laws and their interpretations are constantly changing and an important part of your Financial Plan.  While the tax-tail should never wag the dog, options such as this are worth considering.  With that said, the IRS is very unforgiving when it comes to mistakes with retirement accounts...make sure you know what you are doing or get competent advice.

 

*(Tip of the Hat to Michael Kitces who provides education to advisors.  His article inspired this post)

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