1.402A-1. He has never had a Roth IRA. While rollovers of nonqualified distributions do not eliminate Roth 401(k) earnings, they do eliminate the cream-in-the-coffee rule. She also made a $10,000 conversion from a traditional 401(k) to her Roth 401(k) in 2014. And while you pay interest to yourself when paying back your loan, the interest will likely be below the return on investment you could have earned had you left your funds invested for your future. The earnings will go into the Roth IRA as earnings, and Lilly avoids the tax and penalty on the withdrawal. A qualified distribution from a Roth 401(k) is a withdrawal that occurs when the owner is age 59 ½ and has had that particular Roth 401(k) account for five years. Your Roth IRA withdrawals might be taxable if: You haven't met the five-year rule for opening the Roth and you're under age 59½. Thus, up to the amount rolled into the Roth IRA can be distributed tax and penalty free. If the rollover from the Roth 401(k) to the Roth IRA would qualify as a qualified distribution if taken directly, then the entire amount in the Roth 401(k) (IITC and earnings) goes into the Roth IRA as a contribution. If he keeps the amounts in the Roth 401(k), every dollar he takes out will be half recovery of IITC (tax-free) and half a withdrawal of earnings (taxable, but qualifies for a penalty exception). However, if you take gains out of your account before age 59 1/2, this is generally considered an unqualified or "early" withdrawal. Former college teacher. For those interested in seeing more information on distributions out of Roth IRAs after rollovers of Roth 401(k)s, please see Treasury Regulation Sec. While this reduces your taxable income now, you'll pay regular income tax when you withdraw the … It also shows that as long as the pre-age 59 ½ withdrawals will be less than the previous Roth 401(k) contributions, it is generally better to take the withdrawals from a rollover Roth IRA than from a Roth 401(k) penalty protected by the Rule of 55. However, the five-year rule supersedes that rule. Many like the Rule of 55, which is a rule that allows taxpayers to take amounts from workplace retirement plans such as 401(k)s without the early withdrawal penalty. She also made a $10,000 conversion from a traditional 401(k) to her Roth 401(k) in 2014. If, instead, James follows the “rollover then withdraw” strategy and rolls his Roth 401(k) to a Roth IRA, the first $100,000 he withdraws before age 59 ½ will be a return of contributions, and only if he exceeds $100,000 in withdrawals will he have ordinary income and a penalty. Unless the distribution qualifies as a “qualified distribution” (see below), amounts come out of Roth IRAs in layers. If a 401(k) … Taxpayers should exercise extra caution, and often consult with tax professionals, before moving money out of a Roth 401(k). Roth IRAs cannot be rolled into a designated Roth account, including a Roth 401(k). There are, however, strict rules, both to qualify for those tax-free withdrawals and to avoid penalties for early distributions. Recall that being age 59 ½ is a necessary, but not sufficient, condition to withdrawing Roth earnings tax free. While you are required to take required minimum distributions (RMDs) from a Roth 401(k), you may be able to get around this rule by doing a rollover from a Roth 401(k) to a Roth IRA. You generally have to start taking withdrawals from your IRA, SEP IRA, SIMPLE IRA, or retirement plan account when you reach age 72 (70 ½ if you reach 70 ½ before January 1, 2020). Example 4: Lilly has made five $6,000 contributions to her Roth 401(k) in previous years. If your account has a value of $10,000 -- $9,400 from contributions and $600 from investment gains -- and you take a $5,000 unqualified withdrawal, $4,700 is considered contributions and is not taxable, but that $300 of earnings is included in your income, and you are subject to taxes and penalties on that amount. And, of course, the rollover from the Roth 401(k) to a Roth IRA eliminates future RMDs. If you have a Roth 401(k) that is 5 years old but have never had any Roth IRA, and you are less than 5 years away from attaining age 59 ½, rolling into a Roth IRA could subject withdrawals of earnings (after age 59 ½) in excess of IITC to ordinary income taxation. Roth 401 (k) Withdrawal Rules There are three types of withdrawals from a Roth 401 (k): qualified distributions, hardship distributions and non-qualified distributions. Textbook contributor. In 2021, at a time when her Roth 401(k) is worth $60,000 and Lilly is 45 years old, she takes a $10,000 withdrawal from her Roth IRA. Thus, the entire distribution from the Roth IRA will be tax and penalty free. Here’s a quick example: Example 3: John is 60 years old. You also won't owe any penalties on it. The bottom line is that you need to understand the rules while considering your personal situation. As a result, Roth 401(k) to Roth IRA rollovers often make sense. The cream-in-the-coffee rule can be waited out. You should also have a broader choice of investment options available to you. As a practical matter, as long as the taxpayer does not plan on withdrawing more than the rolled over amount in the first five years, this nuance is not likely to be a gating issue in determining whether the Roth 401(k) should be rolled over to a Roth IRA. For more information on rollovers of distributions from Roth 401(k)s into Roth IRAs, please see Treasury Regulation Sec. Note that much of this post discusses withdrawals before age 59 ½. FI Tax Guy can be your financial advisor! She will not (generally speaking) be able to touch this Roth IRA without ordinary income tax and a penalty until age 59 ½. Quick Thought: I would be remiss if I didn’t insert the standard tax planner advice that rollovers from Roth 401(k)s to Roth IRAs are best accomplished through a direct trustee-to-trustee transfer. Sometimes, you just don't have a better option. He has had a Roth 401(k) with his employer for over five years. First, to avoid both income taxes and the 10% early withdrawal penalty, you must have held a Roth IRA for at least five years. One of the key benefits of a Roth IRA or Roth 401(k) is that, while contributions aren't tax-deductible, both contributions and earnings can be withdrawn tax and penalty free once you reach age 59½. So the question becomes, if you are in the 4.5 year Rule of 55 window (ages 55 to 59 ½) and you separate from service, should you leave a Roth 401(k) in the plan or roll it into a Roth IRA if you need to withdraw from it? All $10,000 will be a recovery of her previous contributions (leaving her with $30,000 remaining of previous contributions). Where such rollovers can be disadvantageous is the five year rule as applied to earnings. Roth IRAs are a type of Individual Retirement Account that allow investors to grow their money tax-free. There are three primary exceptions to the cream-in-the-coffee rule. Let’s see how that would affect Lilly: Example 5: Lilly needs $10,000 and has decided to access it from her Roth 401(k). You'll pay income taxes and a 10% penalty tax on earnings … She also made a $10,000 conversion from a traditional 401(k) to her Roth 401(k) in 2014. Taxpayers and practitioners alike are still learning its contours. If the taxpayer has never had a Roth IRA, he or she must wait 5 years (regardless of their age) to access later earnings generated by rollover contribution tax free. The Roth 401(k) goes into the Roth IRA as “contributions” to the extent of the IITC in the Roth 401(k), and as “earnings” to the extent of growth in the Roth 401(k). This blog post only presents an educational introduction to those rules. The partial rollover attracts earnings before attracting any IITC (see Treasury Regulation Section 1.402A-1 Q&A 5). Personal finance writer. Understanding Qualified Distributions. For a Roth 401 (k) distribution to be qualified, it must occur: After you have reached age 59.5 (or died or become disabled), and At least 5 years after the first day of the calendar year in which … You must use IRS tables to determine the minimum amount to withdraw from your account and are subject to a 50% penalty for any missed RMDs. 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