Making Sense of the Roth 401(k)-to-Roth IRA Rollover Rules
One of the most common retirement account transactions – rolling over Roth 401(k) funds to Roth IRAs – is also one of the most complicated tax-wise. That’s because the rollover involves two five-year holding periods, one for the Roth 401(k) distribution/rollover and the other for the eventual Roth IRA distribution.
When you withdraw from a Roth IRA that contains dollars previously in a Roth 401(k), there are three pieces to consider:
- Roth 401(k) contributions that were rolled over;
- Earnings on Roth 401(k) contributions that were rolled over; and
- Earnings on the rolled-over amounts that were generated after the rollover.
Rolled-Over Roth 401(k) Contributions
The Roth contributions you make to your 401(k) are funded with after-tax salary. So, it would be unfair (even for the IRS) to tax you again when you withdraw those funds from your Roth IRA after a rollover. That’s why the rolled-over contributions (but not necessarily earnings on those contributions) are always available for withdrawal from your Roth IRA without tax or the 10% early distribution penalty.
Earnings on Roth 401(k) Contributions That Are Rolled Over
This is the sticky part. Earnings that you rolled over may also be available for withdrawal from your Roth IRA at any time without tax or penalty if the Roth 401(k) distribution met two conditions. First, you must have been at least age 59½ (or disabled) when you received the distribution. Second, you must have satisfied a five-year holding period for that particular 401(k) plan, starting on January 1 of the year of your first Roth 401(k) contribution (or in-plan Roth conversion).
If you didn’t satisfy both of these conditions, then the rolled-over earnings can be withdrawn tax-free from your Roth IRA only if your eventual Roth IRA distribution meets two slightly different conditions. The first is that you must be at least age 59½ (or disabled or using the funds for first-time homebuyer expenses) when you receive the Roth IRA distribution. The second is you must satisfy a five-year period that begins on January 1 of the year you made your first contribution (or Roth conversion) to any Roth IRA. Note that the period when you made Roth 401(k) contributions cannot be credited towards the Roth IRA five-year clock. Getting the Roth IRA clock running is why it’s so important to open a Roth IRA (even with a small amount) as soon as possible. (Withdrawals of rolled-over earnings won’t be penalized if you’re at least 59½ or qualify for a penalty exception.)
Earnings on the Rolled-Over Amounts Generated After the Rollover
What about earnings that are generated after the rollover? They can always come out of the Roth IRA tax-free if both conditions described in the preceding paragraph (being 59½, disabled, or a first-time homebuyer and having a Roth IRA holding period of at least five years) are satisfied. (They can come out penalty-free if you’re 59½ or older or you qualify for an exception.)
The bottom line: If you want to withdraw from your Roth IRA, you can always get your rolled-over Roth 401(k) contributions out first without tax or penalty. But you may have to wait some time before the earnings you rolled over (and the earnings generated after the rollover) are available free and clear of tax and penalty. Getting help from a competent financial advisor is essential.
By Ian Berger, JD
IRA Analyst
Ed Slott and Company, LLC
Interested in reading more of our library of articles on topics like this and more? Click here to browse our selection of financial articles.
If you have additional questions regarding rollovers, click here to schedule a complimentary 20-minute Q&A with a licensed financial advisor who can help you start on the right path.
Christian Cordoba, founder of California Retirement Advisors, has been a member of Ed Slott's Master Elite IRA Advisor Group since 2007. Click the title of the group or logo below to learn what that could mean for your retirement plan.