New Roth 401(k) at age 62 – 5 year waiting period
Hi,
My father wants to setup and contribute to a new Roth 401(k) through his LLC. (I will probably help him set it up through E*Trade.)
He is 62 years old, so he is definitely past 59.5.
Does he still have to wait 5 years to withdraw any of the contributed money without penalty? If not 5 years, what is the limit?
This is not his first Roth account but it IS his first Roth 401(k).
Thanks.
-Clay Hebert
Permalink Submitted by Alan Spross on Tue, 2008-11-11 22:54
Since he is past 59.5, there would be no penalty involved in any distribution. However, there may be taxes if he is able to take a distribution before the 5 year holding period is met.
Unlike Roth IRAs, where contributions come out first, a non qualified Roth 401k contribution is composed pro rata of contributions and earnings. If he has 8,000 of contributions and the account is worth 10,000, then his earnings are 20% of any distribution is takes. The earnings would be taxable, but no penalty.
The aging rules of a Roth IRA govern when a Roth 401k is rolled over. In other words, if he rolled over the Roth 401k after 3 years, but his Roth IRA goes back 6 years, then the Roth IRA aging of 6 years will result in all Roth IRA distributions being qualified and tax free. However, if he did not have the prior Roth IRA, the aging would have to start over after a rollover of the Roth 401k.
Also, the Roth 401k is subject to RMDs at age 70.5 since he is more than a 5% owner, even if still working. Therefore, if he wants to avoid RMDs from the Roth 401k, he should try to roll it over prior to the year he reaches 70.5.
Permalink Submitted by Clay Hebert on Thu, 2008-11-13 16:21
Thanks for the reply, Alan. I wanted to clarify a few things.
1) I didn’t understand your first paragraph:
“Unlike Roth IRAs, where contributions come out first, a non qualified Roth 401k contribution is composed pro rata of contributions and earnings. If he has 8,000 of contributions and the account is worth 10,000, then his earnings are 20% of any distribution is takes. The earnings would be taxable, but no penalty.”
a) What do you mean “Unlike Roth IRAs, where contributions come out first”?
b) Why would it be a “non qualified Roth 401k contribution”? I know what a non-qualified distribution is. What is a non-qualified contribution?
c) And why would any earnings be taxable in a Roth 401k?
2) His whole reason for doing this is that he wants to convert a larger chunk of the money he has in Traditional IRA(s) to his Roth IRA(s). He was going to use the Roth 401(k) as the vehicle to accomplish that goal, since there is a larger contribution limit per year.
I did some more research this morning and found that the limits (for Roth IRA and Roth 401k) apply only to contributions, not to conversions. So if, in tax year 2008, he is able to make a regular $6,000 contribution to his Roth IRA AND convert as much as he wants, from Traditional to Roth (and pay the necessary taxes), then there is no need to use the Roth 401k vehicle.
Can you confirm that the limits apply to contributions and not to conversions?
Thanks, Alan.
Permalink Submitted by Alan Spross on Fri, 2008-11-14 06:14
a) For Roth IRAs, until distributions are fully qualified, all distributions come out under “ordering rules”. The order is first all your regular contributions, then your conversions, and last the earnings. This is not true for Roth 401k accounts.
b) Sorry, that was a typo – I meant DISTRIBUTION, not contribution.
c) Only if they were taken out before the account was qualified. That applied to your post because the 5 year holding period for qualification had just started. After qualification is attained, all distributions are tax free.
Yes, there is no limit on the amount of conversions or the number of conversions in a given year. However, converting too much may inflate the tax bracket that applies to the converted amount.
And, of course the income limits apply to conversions until 2010, although they do not to Roth 401k contributions. They may be one reason to consider the Roth 401k, if he wanted to get funds into a Roth and could not convert due to income and perhaps not even make a regular Roth IRA contribution due to that income limit.
But there are no dollar limits on conversions.
Now, this is not logical, but you should know that due to a glitch in the tax legislation, the modified AGI limits also apply to transfers from a Roth 401k to a Roth IRA, even though the funds are already in a Roth vehicle. This is supposed to be corrected when Congress gets around to it, but in any event would be gone in 2010, just 14 months from now.