Good news from the IRS! (yes I know this is strange that I am excited about this news)
First a bit of background on after-tax funds in an IRA. Suppose you have an IRA worth $500,000 of which $50,000 is after tax funds. Any distribution from the IRA would be a portion of after-tax and pre-tax, whether that distribution is a withdrawal or Roth conversion. For example if the IRA owner took out $10,000, 10% or $1,000 would be considered after-tax. For all practical purposes the pre-tax and after-tax amounts cannot be separated just like cream in a coffee; every sip is a bit of cream and some coffee. Some people who have made after tax contributions to an IRA have mistakenly assumed that they can simply convert that IRA to a Roth tax free however this pro-rata rule applies because all IRAs of the owner are considered one for this purpose.
Ok so here's the situation with 401k's: Suppose instead of an IRA, you have a 401k plan with $500,000 of which $50,000 is after-tax funds same as above. Prior to 2009 it was common for the administrator of the 401k plan to issue two checks; one representing the after-tax funds and one representing the pre-tax funds. Then you would (assuming you were eligible at the time) convert the after-tax funds directly to your Roth IRA by simply depositing the after-tax check into the Roth account while depositing the pre-tax check in your pre-tax IRA. This strategy seemed to be a loop hole to the pro-rata rule above because IRA and employer plan rules while they seem similar do have notable differences.
Then in 2009, IRS issued some guidance on this common strategy (which I won't go into the details here) that basically indicated that the above loophole was not allowed, at least if you wanted to do this you had to go to great lengths to do it right (again I'll skip the details for now) which were essentially not practical thus the common strategy of getting the two checks to convert the after-tax funds directly to a Roth was not allowed. There remained some debate on the subject but most practitioners preferred to go the conservative route with clients and advise that this strategy was no longer allowed however many plans continued to offer the separate checks unaware of the IRS notice that went out in 2009.
Well 5 years later we finally have a definitive answer to this question from IRS notice 2014-54 which is an emphatic YES! This is really great news and makes things quite simpler for those who have after-tax funds in their 401k. It also opens up some planning opportunities that were not previously allowed which I will provide more detail on in the coming weeks after I myself learn more about this new ruling. Expect to hear more about this, and other topics after I attend the Ed Slott Master Elite IRA Advisor Group workshop in the first week of November.
If you have any questions on whether this may apply to you please feel free to contact me directly.
Do you ever wonder if you are taking the right amount of risk in your investment portfolio? Does your portfolio fluctuate more than you are comfortable with but your advisor doesn't seem to validate your concerns? Is your portfolio too risky, not risky enough, or is the risk you are taking just right? How do you know?
Most investors don't have a good sense of whether they are taking the appropriate amount of risk usually because of a lack of, or poor risk analysis tools available. For example, most traditional risk questionnaires ask questions such as how old you are, your time frame for when you need the money, and whether you are focused on growth, income, safety of principal, etc. Just because a young person may have 30 years until retirement doesn't mean he/she should take a lot of risk if they are uncomfortable with high risk. Just the same, just because a 60 year old may be nearing retirement doesn’t necessarily mean they should invest conservatively as there may be other factors involved that allow that person to take more risk than a similarly aged peer. It is these, and other fundamental flaws in traditional risk questionnaires that can result in a misalignment of risk comfort and portfolio design and ultimately taking on more risk or less risk than intended both of which can potentially knock a financial plan off course.
To solve this problem, Portnoff Financial has recently partnered with Riskalyze, a cutting edge technology build on the academic framework that won the Nobel Prize for Economics that pinpoints your acceptable level of risk with unparalleled accuracy to properly align your portfolio with your risk comfort zone.
So how does it work and why is it different?
For starters, the typical flawed questions in most risk questionnaires are either eliminated or carry much less weight. Also it is difficult to understand the impact of percentage based losses or gains without the context of portfolio size so the value of your portfolio is considered and the percentage based losses are translated into actual Dollars so that you can better visualize and understand the risk you are taking. Then Riskalyze will take you through a series of questions (fewer on the simple version and more on the detailed version) aimed at helping you determine just how much downside risk you are willing to expose your portfolio to for the chance to earn a potential gain.
If you want to know if your portfolio design is aligned with your risk comfort zone, take a free brief Risk Quiz at http://www.portnofffinancial.com/free-risk-analysis.phpto pinpoint your exact risk tolerance and receive your Risk Number. After completing the quiz, you will have the option to request a free portfolio review by Portnoff Financial to compare your Risk Number with the Risk Number of your portfolio. If there is a discrepancy between the risk level of your portfolio and your risk comfort zone, Portnoff Financial can re-engineer your portfolio to better align with your Risk Number and provide you with an Investment Policy Statement including a projection for potential gains and losses that you can expect from your re-engineered portfolio.
With Portnoff Financial and Riskalyze you can feel confident that the risk in your portfolio properly aligns with your comfort zone, investment goals, and expectations.
To learn more about your Risk Number, or to request the more detailed Risk Quiz, schedule a 15 minute Introductory Call or a complimentary Discovery Consultation at http://meetme.so/DiscoveryConsultationor call me directly at 732-226-3113(NJ) or 949-226-8342(CA).