How Are Roth 401(k) Distributions Taxed?
Roth 401(k) plans have become more common in employer retirement offerings. At the same time, Americans are changing jobs more frequently, leading to a rise in 401(k) withdrawals. If you participate in a Roth 401(k), it’s critical to understand how distributions are taxed—especially to avoid penalties or unexpected tax bills.
A Roth 401(k) allows employees to contribute after-tax income. Unlike a traditional 401(k), the tradeoff is that qualified withdrawals can be entirely tax-free—including investment earnings. However, this only applies when the IRS conditions for a qualified distribution are met.
Establishing a well maintained Roth can act as a tax free money base, as long as you counter dis-qualifications.
What Makes a Roth 401(k) Distribution Qualified?
The IRS requires two conditions to treat a Roth 401(k) withdrawal as qualified and tax-free:
1. Age or Event Requirement
You must be age 59½ or older at the time of the withdrawal. Exceptions exist for those who are disabled or for distributions made to beneficiaries after the account holder's death.
2. The Five-Year Rule
You must have maintained the Roth 401(k) account for at least five tax years. The five-year period starts on January 1 of the year when you first made Roth contributions to your employer's plan. Contributions made to a different employer’s Roth 401(k) plan do not apply unless you rolled over those funds into your current plan.
Important Note: Contributions to a Roth IRA do not count toward the five-year requirement for Roth 401(k) plans.
Example: Applying the Five-Year Rule
Denise contributed to the Roth 401(k) at Alpha Company from 2012 to 2018. In 2018, she switched to Beta Company and started Roth contributions on July 1, 2018.
In 2022, Denise turns 60 and decides to take a distribution from her Beta Roth 401(k). While she meets the age requirement, she fails the five-year rule—because the five-year holding period at Beta doesn’t end until December 31, 2022.
Unless Denise rolls over her Alpha Roth 401(k) funds into the Beta plan, her distribution in 2022 will not be qualified. That means part of her earnings will be subject to tax.
What Happens If a Distribution Is Not Qualified?
When a Roth 401(k) distribution is not qualified, the IRS requires you to pay taxes only on the earnings portion of the withdrawal. Your original contributions come out tax-free since you already paid income tax on them when contributed.
To figure out how much is taxable, use the pro-rata rule.
How to Calculate Taxes on Non-Qualified Roth 401(k) Withdrawals
Follow these three steps to calculate the taxable portion of a non-qualified distribution:
Step 1: Divide your total Roth 401(k) contributions by your entire Roth 401(k) balance (contributions + earnings). This gives you the percentage of your distribution that is not taxable.
Step 2: Multiply that percentage by your withdrawal amount to determine how much is tax-free.
Step 3: Subtract the tax-free amount from the total withdrawal. The result is your taxable income.
Example: Roth 401(k) Withdrawal Tax Calculation
Denise's Beta Roth 401(k) account has:
- $35,000 in contributions
- $15,000 in earnings
- Total balance = $50,000
She withdraws $20,000 before meeting the five-year rule.
- Step 1: $35,000 / $50,000 = 70%
- Step 2: $20,000 × 70% = $14,000 tax-free
- Step 3: $20,000 - $14,000 = $6,000 taxable earnings
Denise must report $6,000 as taxable income on her return.
Can You Avoid Taxes on Roth 401(k) Earnings?
Yes. If you:
- Wait until you're at least 59½
- And satisfy the five-year holding rule
Then your Roth 401(k) distribution is fully tax-free—including earnings.
Also, if you’re changing jobs, rolling over your Roth 401(k) into a new employer’s Roth 401(k) or a Roth IRA can help preserve your tax advantages. Just ensure you follow IRS rollover timelines to avoid penalties.
FAQ: Roth 401(k) Distribution Taxation
How are Roth 401(k) withdrawals taxed after age 59½?
If you are at least 59½ and have held the account for at least five years, your Roth 401(k) withdrawals are tax-free, including earnings. Otherwise, the earnings may be taxed.
What is the 5-year rule for Roth 401(k) distributions?
The IRS requires that your first Roth 401(k) contribution to a specific employer plan must be at least five tax years old for the distribution to be considered qualified.
Are Roth 401(k) contributions taxable when withdrawn?
No. Since you contribute with after-tax dollars, Roth 401(k) contributions are not taxed again when withdrawn.
What if I withdraw from my Roth 401(k) early?
If you withdraw earnings before age 59½ or before meeting the five-year rule, the IRS may tax the earnings and apply a 10% early withdrawal penalty unless an exception applies.
Can I roll over a Roth 401(k) to a Roth IRA?
Yes. You can roll over a Roth 401(k) into a Roth IRA without tax consequences, and it may help consolidate your retirement savings under one five-year rule (specific to Roth IRAs).