Distribution question from Roth IRA funded by 401k conversion to Roth IRA

Submitted by Joe Advisor on Tue, 2023-12-12 17:42

Client age 56 converted 2 older pre-tax 401k accounts (employee match and employer match) this year to her Roth IRA of about 25k. She said she had the funds in savings for the taxes and had not planned to withdraw any funds from the Roth IRA for at least 5 years, but now she says she needs to withdraw from the Roth IRA to pay for the taxes on the conversion. About 12k was her own personal contributions to the original pre-tax 401k before earnings- can she withdraw that amount from the Roth IRA without the 10% penalty?



Submitted by Alan - IRA critic on Tue, 2023-12-12 18:12

For a non qualified Roth IRA distribution, the taxpayer must keep track of their Roth IRA regular contribution basis and conversion basis in order to report the distribution on Form 8606. If client had no prior Roth IRA balance, only these rollover contributions of pre tax funds from the 401k, then the distribution will obviously come from the rollovers. The Roth IRA distributions will not be taxable, but client will owe the 10% penalty because these rollovers were not held 5 years and client is not 59.5. The penalty will be reported in Part I of Form 5329 and on line 8 of Sch 2 of Form 1040. It’s possible that client will qualify for a penalty exception other than being 59.5, so should check the list of penalty exceptions to see if they apply to her. She might consider not taking the Roth distribution in January to avoid reporting it this year, especially if she might qualify for a penalty exception next year. Having to take a Roth distribution degrades the benefit of doing these rollovers.

Submitted by Joe Advisor on Tue, 2023-12-12 18:46

First, thank you Alan.  My followup question is, would it would be a different scenario if the voluntary contributions had been made to a Roth 401k versus a pretax 401k plan, and the Roth 401k was then rolled over to the Roth IRA?  Would those voluntary contributions then count as basis, and could the individual then withdraw those voluntary contributions as basis in the Roth IRA without the 10% tax penalty?  I understand they would come out of the Roth 401k prorata for distributions, could they be rolled over to the Roth IRA and then just withdraw the voluntary contributions penalty free without touching the gains?

Submitted by Alan - IRA critic on Tue, 2023-12-12 19:16

Yes, regular Roth 401k elective deferrals (what you describe as voluntary contributions) would be treated as regular Roth IRA basis once rolled into a Roth IRA and would come out of the Roth IRA first both tax and penalty free. This amount would be shown in Box 5 of the 1099R reporting the direct rollover to a Roth IRA.

Submitted by Joe Advisor on Tue, 2023-12-12 19:53

Thank you!

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