Rule of 55 Rollover to a Roth IRA
When using the rule of 55 to take early withdrawals from a 401k, can these withdrawals be rolled over into a Roth IRA without the 10% penalty?
When using the rule of 55 to take early withdrawals from a 401k, can these withdrawals be rolled over into a Roth IRA without the 10% penalty?
Permalink Submitted by David Mertz on Fri, 2021-12-24 13:16
Presumably you have separated from service with this company and you are under age 59½. There is no need to apply the age-55 penalty exception to any portion of this distribution rolled over to a Roth IRA since amounts rolled over are already exempt from the 10% early-distribution penalty. If you do the rollover in indirectly, there is mandatory tax withholding and you’ll need to substitute other funds to complete the rollover of that portion. For any portion not rolled over you can use the age-55 exception to eliminate the 10% early-distribution penalty. You have 60 days to complete an indirect rollover by one or more deposits to the IRA.
To avoid mandatory tax withholding and the need to substitute other funds, you can request that the plan do a direct rollover from the 401(k) to the Roth IRA. Direct rollovers are not subject to mandatory tax withholding.
Permalink Submitted by Beth Alwin on Tue, 2021-12-28 12:43
Thank you! I am 58 and did a Roth conversion from the 401k to my Roth. I paid my taxes on this rollover using estimated taxes. I took the conversion in August and paid all of the taxes due on it in October. I think I’m going to be penalized because I didn’t pay by September. I’m not old enough to have taxes sent from my IRA, can I use the rule of 55 to take a distribution from the 401k and send it to the IRS to eliminate the penalty?
Permalink Submitted by Alan - IRA critic on Tue, 2021-12-28 16:22
You wouldn’t know if you will owe a penalty or not until you determine what your safe harbor amount is. If this is a former 401k, it apparently allows partial distributions since your Roth rollover was a partial distribution. While you might request another partial distribution with 99% withholding, that distribution will be taxable and would have to be grossed up to determine what additional taxes would be owed. The age 55 exception would eliminate the 10% penalty if you separated in the year you reached 55 or later.
That said, it is likely too late now to have this distribution completed by Friday and it must be completed by Friday 12/31 in order to have the withholding applied to 2021. It would also deplete your 401k and increase your taxes for 2021. The underpayment interest rate is only 3% annually and only applies to the shortfall for each quarter.
If you were to complete the withholding distribution by Friday, you could avoid both depleting your 401k and the additional taxable income if you were able to roll back other funds to your IRA (not the 401k) within 60 days. This rollover would not be subject to the one rollover limitation.