Roth 401k to Roth IRA and TIRA rules

Submitted by Rene Nourse on Mon, 2016-12-12 06:45

My client has $1MM 401k, of which $326K is in the Roth 401k account: $207K represents her after tax contributions with the remaining $119K as earnings. She also has a $350K TIRA, consisting of all pre-tax dollars. What are the rules and tax implications of rolling over the Roth 401k funds into a Roth IRA and will it be subject to the pro-rata rule?



Submitted by William Tuttle on Mon, 2016-12-12 15:23

Some clarifications are necessary and then I will let someone else reply.:

  • I am assuming you are referring to Roth 401k deferrals and associated earnings. After IRS notice 2014-54, the term “after-tax contributions” is at best ambiguous. I prefer to use the term post-tax deferrals to clarify.
  • Are these assets rollover eligible. In other words, has the client separated from the employer of the plan involved? If not is the client >= 59.5 and the plan allows in-service rollovers. IRS regulations do not permit the in-service withdrawal/rollover of deferrals and their earnings < 59.5
  • A rollover of Roth 401k deferrals and earnings is not a Roth conversion and is not subject to the pro-rata rule. There is no taxable event associated with a Roth 401k -> Roth IRA rollover.
  • However, eventual withdrawals from the Roth IRA after rollover can be a little complicated. You mentioned a TIRA, does the client also have a Roth IRA and has it been/will it be 5 years since the year it was opened and contributions made? Also, will the client be >= 59.5 when withdrawals are made?

Submitted by Alan - IRA critic on Mon, 2016-12-12 20:32

If the Roth 401k balance is rollover eligible, once the balance is in the Roth IRA then Roth IRA tax rules apply. If there is an existing Roth IRA, then the rollover money must be integrated into Roth IRA accounting or ordering rules for Roth IRA distributions. If there is no prior Roth IRA, then the accounting is simple. In this case, the Roth 401k account is either qualified (5 years and 59.5) or it is non qualified. If qualified, then the entire 326k is treated as regular Roth IRA contributions, eligible for tax free distribution at anytime. However, earnings on the 326k generated in the Roth IRA are not qualified earnings until the Roth IRA has been held for 5 years. But those earnings come out last so for partial distributions from the Roth IRA no taxes would be due. Conversely, if the Roth 401k was NON qualified at the time of the rollover, only the 207k would be treated as regular Roth IRA contributions. The Roth 401k earnings would be treated as Roth IRA earnings, would come out last but would be subject to tax (and penalty if under 59.5) until the Roth IRA became fully qualified in 5 years. Note that Roth 401k distributions are pro rated with earnings if the distribution comes from the Roth 401k plan, but once rolled to the Roth IRA, this pro ration ceases and the more favorable Roth IRA ordering rules apply. Finally, client will not face RMDs once the balance is in the Roth IRA.

Submitted by Rene Nourse on Mon, 2016-12-12 22:13

Thank you for the clarificaiton.  The client is currently 57, however, will be separating from service after the first of the year.  So, once she is technically no longer employed, she will be eligible to rollover all of the Roth 401k contributions and earnings, correct?  She does not currently have a Roth IRA; one will be opened shortly to house those funds. I understand that the account will need to be in place for at least 5 years and that she must be 59.5+ before accessing these funds on a tax free basis. She does have however, a traditional IRA, which is all pre-tax fund and I plan to discuss converting all of those funds over time into the Roth IRA as well.

Submitted by Alan - IRA critic on Tue, 2016-12-13 02:49

Yes, she will be entitled to a direct rollover of the entire plan, not just the Roth portion. However, the full amount contributed to the Roth 401k (207k) will be eligible for distribution from the Roth IRA on day 1 tax and penalty free since it is treated as regular Roth IRA contributions. For the 119k of earnings plus any earnings AFTER the money is in the Roth IRA, she must wait until the Roth IRA is 5 years old (1/1/2022) before being able to distribute this earnings portion without tax or penalty. In addition, if conversion from the TIRA are done, the 5 year holding period for each conversion will expire upon reaching 59.5, so this conversion money will also be available without tax or penalty on the day she reaches 59.5.

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