5 Year Rule – Traditional 401(k) Conversion with other accounts
Client is 58 years old. Client has a ROTH 401(k) and has had it longer than five years. Client does a trustee to trustee transfer to ROTH IRA in year 1. The ROTH IRA has a carryover five year holding period. Client has a traditional 401(k) and does a conversion to a new ROTH IRA account in year 2. Does the five year holding period of the transferred ROTH cover the traditional 401(k) conversion or does the converstion start a new five year holding requirement? Does the answer change if the client waits until he is older than 59 1/2?
Permalink Submitted by Alan - IRA critic on Fri, 2019-05-03 17:33
The Roth 401k rollover does not affect the holding period for purposes of the 10% penalty on the conversion. The conversion holding period ends at 59.5. If client takes a non qualified Roth IRA distribution before reaching 59.5, the Roth IRA ordering rules determine what amounts are being distributed. Regular Roth IRA contributions and Roth 401k contributions come out first tax and penalty free. Next out are conversions, so if the 401k to Roth IRA conversion was distributed before 59.5, client would owe the 10% penalty since the conversion was not held 5 years. If client went through all regular and conversion amounts, any earnings would be subject to tax and penalty, but upon reaching 59.5, the entire Roth IRA will be qualified, tax and penalty free. Until that time the Roth IRA has been funded by at least 3 different souces (Roth IRA, Roth 401k rollover, and pre tax 401k rollover), and client must keep tabs on the composition of the Roth IRA in order to be able to properly report any distributions on Form 8606. But after 59.5 everything is qualified and Form 8606 is no longer needed to report Roth IRA distributions.