refresher on 5 year rule for Roths
If an indiv age 60 rolls his 10 year old Roth 401k to a newly established Roth IRA, does the 5 year rule apply at all?…to earnings?…to basis?
Also, do the prorata rules that apply to distributions from IRAs (when separate pre and post tax IRAs exist) also apply to qualified distributions from Roth IRAs when a separate IRA exists?
Permalink Submitted by charles lore on Wed, 2009-01-07 03:52
1) yes but it is the Roth IRA that is looked at and not Roth 401K . IRA trumps the 401k for 5 yr rule purpose
2) Roth’s have ordering rules not pro rata.. The essence is that conversions first, then contributions and last is earnings.
Permalink Submitted by Alan Spross on Wed, 2009-01-07 05:32
I would like to expand on both the question and Chuck’s reply:
1) Perhaps a 10 year old Roth 401k is a potential future scenario, but since the Roth 401k first appeared in 2006, for the next two years at least all rollovers to Roth IRAs must be non qualified. The Roth IRA holding period will then apply, with the unqualified time in the Roth 401k essentially forfeited as Chuck indicated. However, the record keeping for the Roth IRA then becomes the IRA owner’s responsibility. For this purpose the contribution amount made to the Roth 401k are added to the Roth IRA basis of Roth IRA regular contributions, and any earnings would be added to earnings of the Roth IRA.
If the questions was for future illustrative purposes when an employee age 60 will also meet the 5 year holding period in the Roth 401k account, then the rollover is fully qualified and the entire amount will be added to the balance of regular contributions in the Roth IRA.
I can see that these accounting rules are going to cause massive confusion in the future for taxpayers, and probably the IRS also.
Once the Roth IRA becomes qualified, all this accounting work can end, however, I would not toss by records until the IRA custodian codes all distribution as “Q” on the 1099R.
In the event of a partial rollover of a Roth 401k to a Roth IRA, the amount that would be taxable is deemed rolled over first, another accounting requirement to be addressed.
2) Not totally sure what was meant here by the separate IRA, but a distribution from a Roth 401k is pro rated for tax purposes between basis and earnings like a TIRA. The Roth IRA ordering rules to not apply. But once the funds are all in the Roth IRA, the Roth IRA ordering rules totally replace the pro rate rules of the Roth 401k. This is why the new breakdown within the Roth IRA must be calculated and documented in case distributions are taken before the Roth IRA is qualified.
Before the Roth IRA is qualified, the ordering rules are first regular contributions including any basis from the Roth 401k, next conversions (no Roth 401k conversions can exist), and last the earnings from both the Roth 401k and Roth IRA. Once the rollover is integrated into the Roth IRA, there is no need to further track the breakdown from each source or credit losses from one against gains from the other.
It remains to be seen if the Roth IRA custodians will accept the IRA owner’s breakdown in order to code the 1099R properly.
Permalink Submitted by Thomas Ferry on Wed, 2009-01-07 15:15
Thank you both for your timely response. I apologize if my follow up question has already been answered by either of you.
Alan wrote
“If the questions was for future illustrative purposes when an employee age 60 will also meet the 5 year holding period in the Roth 401k account, then the rollover is fully qualified and the entire amount will be added to the balance of regular contributions in the Roth IRA.”
But, what if the Roth IRA is brand new at the time the qualified Roth 401k is rolled to it? Does this mean that the monies rolled from the qualified Roth 401k will now have to wait 5 years before they are qualified in the new Roth IRA? In this case, does the IRA holding period “trump” the 401k holding period?
If yes, our clients who currently earn too much to open a Roth IRA, but are funding Roth 401ks, need to convert regular IRAs to Roths in 2010. That is, the sooner they can start the 5 yr count down on a Roth IRA, the better.
Permalink Submitted by mk foss on Wed, 2009-01-07 18:13
If the Roth 401k is rolled over to a new Roth IRA, the five year period starts over again. The amount of time participating in the Roth 401k is disregarded. The solution, as you’ve guessed, is to start a Roth IRA in order to trigger the 5 year period.