June 2007 News Letter: ROTH 401k to ROTH IRA
I’m confused on the June news letter. In one part it states that the 5 yr holding period is “never” carried over to an individual ROTH IRA. The ROTH 401k funds will be governed b the 5 yr rule that applies to the ROTH IRA. In another spot it states (ex. 5) that the client is 62, has ha the ROTH 401k for 10 years, never had a ROTH IRA, and rolls the ROTH 401k dollars into a ROTH IRA. It states that her ROTH IRA will have to satisify a 5yr holding period before taking a qualifed distribution. Then comes the BUT….the rollover funds from the ROTH 401k are considered basis in the ROTH IRA since they were a qualified distribution from the plan. Under the ROHT IRA ordering rules, any distribution is considered t first come from her basis and distribution of basis will be income tax free. So, does this mean the 5 yr holding perod, can is some cases, carry over?? Help!
Permalink Submitted by Alan Spross on Fri, 2007-10-12 02:39
Your description of the designated Roth account rollover rules to a Roth IRA are correct. If the Roth 401k distribution is qualified, the entire amount is characterized as basis in the Roth IRA, which does preserve the earned tax free nature of the entire amount. However, a new 5 year rule must be satisfied by the Roth IRA in order for the earnings generated on the rollover to also attain qualified status for tax free distribution.
As you noted the ordering rules call for the basis of regular contributions to come out first, therefore in most cases the taxpayer would not be draining the Roth IRA within 5 years after which the earnings on the rollover would also be qualified. Therefore, this “hybrid treatment” of Roth 401k rollovers generally will not result in negative consequences.
Obviously, retirees should do their rollover ASAP after they reach the 5 years in the plan, so the Roth IRA clock can start to run sooner. They also need to get these funds rolled over eventually to protect them from the RMD requirement of the Roth 401k.
In summary, the 5 year aging benefit in the plan is preserved, but the actual years in the plan are not credited to the Roth IRA aging, which must start from scratch. Some taxpayers may already have a prior Roth IRA which would result in complete qualification coming sooner.