Take roth money now? Seems a no-brainer

Submitted by Dave Pattie on Thu, 2013-11-07 16:44

Father is 67 and retiring from corporate life (last week). Liquid Net worth of $930K made up of lump sum retirement ($500K being rolled into IRA), current IRA ($50K), and 401k ($350K traditional 401k, $30K Roth 401k). Essentially no money in taxable accounts and so no cash other than that in tax-deferred accounts above. Also $30K in credit card debt.

Made money this year (>100K so in a high tax bracket) but won’t make money next year or thereafter other than small social security.

Will need liquidity this year to live

Why not just take the Roth money now rather than roll over into Roth IRA???? He’s reluctant to take distributions from IRA because they’re taxable this year but probably won’t be next year. He’s thinking take the $30K Roth 401k money in cash, live and pay credit card debt down, live on IRA distributions next year and thereafter.

However, is nervous that he’s taking money out of Roth. Any catch?



Submitted by Alan - IRA critic on Thu, 2013-11-07 17:26

  • If he started Roth 401k contributions less than 5 years ago, the Roth 401k is not yet qualified and any earnings would be taxable. Earnings are pro rated with contributions in any partial distribution. Further, this 30k is the only Roth assets he has. He should look at his statement to see how much of the 30k is earnings (balance less his salary deferrals) if he does not have the 5 years, and if it is very small he could do as you suggest. Otherwise, it is not wise to pay taxes at a high rate on earnings that will be tax free in the near future.
  • Another option is to do direct rollovers of the 401k and Roth 401k to a TIRA and Roth IRA respectively. He can then remove money from the Roth IRA with earnings coming out last. So if his earnings are 5k from the Roth 401k, once it is rolled over to a Roth IRA, he can withdraw up to 25k without any taxes due. The earnings should stay in the Roth IRA until it is qualified and tax free. There is no 20% withholding on direct rollovers, as there is with 401k distributions to him.
  • If he does tap the Roth, he could gradually replace Roth assets by doing small conversions from his TIRA starting next year that would be taxed at a low rate.
  • Final option – do the direct rollovers of the 401k to a new rollover IRA and new Roth IRA. Take a single distribution from his current TIRA. Within 60 days of that distribution in January, take a similar distribution from his new rollover IRA and roll that back into his old TIRA, thereby erasing the taxation of his first distribution. The last distribution will be taxable in 2014. This will take some planning and execution to meet the 60 day rollover requirement, setting up the rollover IRAs and he cannot do any other indirect rollovers from these IRAs for the next 12 months.

Submitted by Dave Pattie on Thu, 2013-11-07 17:57

Alan,That’s fantastic info! – I didn’t realize there was a five year “waiting period” on Roth contributions.  We’ll look at his statement to get the mix of contributions/earnings.  So to clarify, he’s able to take “returns of contributions” in 2013 and take “earnings” later? (ie, he’s not forced to take earnings first?) 

Submitted by Dave Pattie on Thu, 2013-11-07 18:10

Sorry, you clearly said that partial distributions are pro-rata contributions/earnings.Does the five year waiting period apply to all contributions or is he ok (meaning he can take money out of his Roth IRA tax free) so long as he STARTED contributing more than five years ago? 

Submitted by Alan - IRA critic on Thu, 2013-11-07 18:44

The 5 year holding period starts on 1/1 of the year in which the first contributions are made. This is true of both the Roth 401k and a Roth IRA. It would be helpful to know when he first contributed to the Roth 401k to determine whether the Roth 401k is already qualified or not. If it is NOT, then a rollover to a new Roth IRA when he has never had a Roth IRA before will require that the 5 year period start over again for the Roth IRA. In other words, if he has 3 years in the Roth 401k and rolls it over he loses those 3 years and starts fresh in the Roth IRA. But he can still remove his contributions FIRST from the Roth IRA, and earnings come out last. The pro rating between earnings and contributions only applies to distributions from the Roth 401k. You need to find out if he had a Roth IRA before and also which was his first year in the Roth 401k.

Submitted by Dave Pattie on Thu, 2013-11-07 20:59

He looked and found that his first roth 401k contribution was in 2004, so ALL of it (even contributions and earnings that are recent) is non-taxable?  It’s worth $37K of which $32K is contributions and the other $5K is earnings. 

Submitted by Alan - IRA critic on Thu, 2013-11-07 21:59

2004 cannot be correct because designated Roth accounts first became available in 2006. If his first Roth 401k contributions were anytime prior to 1/1/2009 the account is fully qualified (ie no earnings would be taxed). As of 1/1/2014 a first contribution prior to 1/1/2010 will result in the account being qualified. That will give you an idea when the 5k of earnings will become tax free if the funds are still in the Roth 401k.

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