Course: Retirement Planning
Lesson 7: Income Distribution Planning for Qualified Plans
Regarding the after-tax example: Wouldn’t the full $10,000 hardship come first from the $80,000 that was contributed pre-1987? Don’t you exhaust the $80,000 before concerning yourself with the exclusion ratio?
From the Course:
Once the pre-1987 after-tax contributions have been withdrawn, or if none existed, all other after-tax contributions are withdrawn on a pro rata basis. This is accomplished by determining the percentage of the total account balance that is made up of post-1986 after-tax contributions. That percentage becomes the exclusion ratio for the pre-retirement withdrawal. In other words, that percentage of the withdrawal is nontaxable.
Susan’s current balance in her Section 401(k) Plan is $100,000, of which $20,000 was attributable to post-1986 after-tax contributions. This year, she made a $10,000 hardship withdrawal. Since her post-1986 after-tax contributions of $20,000 were 20% of her $100,000 account balance, 20% or $2,000 was nontaxable.
Great question here. And a good example of something to be aware of on the CFP Board Exam – don’t make assumptions. In the example, we cannot assume any pre-1987 after-tax contributions. The fact pattern does not indicate so. The difference between the $100,000 current balance and the $20,000 in post-1986 after-tax contributions cannot be assumed to include any pre-1987 after-tax contributions. The implication for the question is that the $80,000 increase is tax deferred. We’re not told exactly what comprises the $80,000 increase but we do know the potential sources include participant pre-tax deferrals, employer-matching contributions, employer profit sharing contributions, employer reallocated forfeitures and portfolio returns.
Hope that helps. Let me know if you have other questions.