December 27, 2023

Separating Post-Tax Money from a Traditional IRA, #181

12 minutes

Have you ever accidentally put post-tax money in with pre-tax when rolling over a traditional IRA? On this episode, I'm answering a listener's question about fixing this easy-to-make but frustrating mistake. We'll look at the definition of a rollover, why you should separate pre-tax and post-tax money, and how to correct this situation if it occurs.

You will want to hear this episode if you are interested in...

What is a rollover? [1:42]
Why you should separate pre-tax and post-tax money [4:42]
How to separate post-tax money from a traditional IRA [7:02]

Understanding the IRA rollover process

When transitioning jobs, your accumulated retirement benefits don't necessarily stay behind. You've got options: transferring to another retirement plan, cashing it in (with tax implications), or rolling it over to an IRA, commonly known as an individual retirement account. The allure of an IRA rollover lies in enhanced investment choices and potential fee reductions, particularly with brokerage firms like Charles Schwab, Fidelity, or Vanguard.

The process? Fairly straightforward. Establish your new traditional or rollover IRA with your fresh employer. If you lack one, reach out to your former employer's retirement plan provider and inquire about their rollover process, often doable via phone verification or a mailed PIN. Important tip: bolster security with two-factor authentication, utilizing your cell number for added protection. When specifying the rollover amount and payee for the check, remember, always make it payable to your new investment company for your benefit to keep it non-taxable. Veer off this path, and the money turns taxable, with a limited 60-day window for the rollover. This process can also uncover after-tax contributions, which need to be kept separate from pre-tax monies.

Keep it separate, keep it safe

It's crucial to keep pre-tax and post-tax money separate in your retirement accounts, and here's why: segregating these funds ensures you can leverage the benefits effectively. After-tax money, eligible for a Roth IRA rollover, offers tax-free growth for you and your beneficiaries upon withdrawal, provided you meet specific criteria. Failure to segregate these funds can result in several complications.

First, without separation, tracking after-tax withdrawals becomes complex, risking double taxation. IRA distributions with a mix of pre and after-tax money lead to prorated taxable amounts, complicating tax calculations. Moreover, beneficiaries might overlook the after-tax funds, leading to potential double taxation for them. Lastly, gains on after-tax money in a traditional IRA don't enjoy tax-free growth, unlike if transferred to a Roth IRA. Thus, separating these funds safeguards against taxation pitfalls and ensures optimal tax benefits for you and your heirs in retirement planning. If you've made the mistake of lumping all of your retirement contributions together, listen to this episode for a solution!

Resources Mentioned