ROTH 401(k)
Please correct me if I’m wrong. If a client has been contributing to a ROTH 401(k), retires, has the balance rolled into a regular ROTH IRA, the 5 year rule “clock” starts ticking. To get around this, the client should have had a ROTH IRA established 5 years ago. True?
Permalink Submitted by Alan Spross on Wed, 2009-07-15 00:04
Basically correct. For a non qualified Roth 401k transfer to a Roth IRA, the accounting in the Roth IRA adds the Roth 401k contributions to the Roth regular contribution basis, and the earnings to the Roth IRA earnings. The Roth IRA clock determines when the earnings become qualified for tax free treatment. Since the Roth 401k has only been around since 2006, there is no way the 5 year holding period could have been met, and the clock starts over based on the Roth IRA holding period. You are therefore correct that if you had the Roth IRA for 5 years upon receiving the rollover, the 5 year holding period would be considered met for the incoming funds.
Now fast forward to a year after 2010. By that time the Roth 401k funds may have been held for 5 years and if the employee is also 59.5, those funds are fully qualified. When rolled over to a Roth IRA, the entire rollover is added to the Roth regular contribution basis, meaning that it will never be taxed upon distribution.
Remember, for purposes of this discussion, all we are talking about is the earnings accrued in the Roth 401k. The actual contributions will not be taxed a second time in any event, but the earnings may have to wait longer to become tax free if the distribution is non qualified upon the date of rollover from the Roth 401k.