401k vs. Roth 401k distributions
I’m trying to understand the differences in distributions from a 401k and Roth 401k.
Assume a traditional 401k that allows both pre-tax and after tax contributions. When a withdrawal is made from the Roth 401k, the entire amount is excluded from taxable income, but the traditional 401k has a mix of pre-tax and after–tax contributions and earnings. My understanding is that any withdrawal is a proportional mix of these three elements. I am getting that from my reading of Pub 575, but it does not get to that level of specifics, so I’m looking for clarification.
The example I would pose is a retiree that needs $20,000, (say for a grandaughter’s wedding,) could access the Roth and withdraw the entire amount without tax consequences. The same withdrawal from a traditional IRA would have tax consequences for the portions withdrawn from pre-tax and earnings, but not the after-tax contributions. So while that mix does provide some excluded income, the difference is in the flexibility in accessing the account. Does that seem correct?
Permalink Submitted by Alan Spross on Thu, 2011-04-14 22:15
Not exactly correct.
A Roth 401k account is kept totally separate from the pre tax 401k account. However, distributions from the Roth 401k are taxed differently from a Roth IRA distribution. Until that Roth 401k is qualified and totally tax free, any distributions come out proportionately between contributions and earnings. There are no ordering rules like the ones that apply to Roth IRAs. In this respect, distributions from a non qualified Roth 401k are taxed in a similar manner to pre tax 401k distributions, although the Roth would generally have a much lower pre tax balance since the only pre tax amounts are the earnings. Any company matching funds must go into the pre tax account.
If the retiree is at least 59.5 and first contributed to the designated Roth account in 2006 (the first year they were offered), the account is now qualified and fully tax free. Otherwise the earnings are pro rated with the contributed amount.
Permalink Submitted by gerard noronha on Thu, 2011-04-14 22:27
a different question for alan…married filing jointly…husband and wife…agi 55000…with roth conversion approx. 120 K..how does this affectthe AMT….is there a dollar figure for AMT not to go above…please respond…gerry
Permalink Submitted by Alan Spross on Thu, 2011-04-14 22:45
Sorry, but AMT is too complex to draw simple conclusions. It is a totally separate parallel tax system and includes some deductions while excluding others. It includes some tax free income and excludes others. The only way to be sure it to get tax software and run scenarios with different converted amounts to see if the AMT ever kicks in. Of course, a 2010 conversion can be split between 2011 and 2012, so AMT would not be affected at all by the conversion in 2010 unless the entire conversion was reported then. Splitting the conversion makes AMT less likely to apply.
But no way to throw out a particular taxable income number.
Permalink Submitted by Mark Eckman on Fri, 2011-04-15 02:01
Alan – not the question I’m asking.
Compare the Roth 401k and the traditional 401k distributions. Assume everything is qualified, as this is totally hypothetical for longer term planning.
When removing funds from the traditional 401k, each distribution has pre-tax and after tax (assuming there is a mix) in the withdrawal. No choice in that selection. If I want $10,000 I have to withdraw more from the traditional account to get $10,000 after taxes are paid. What happens to a withdrawal from a Roth 401k? It there the same sort of required mix of pre-tax, after tax and Roth funds, or can the participant direct the withdrawal to come exclusively from the Roth funds so a $10,000 withdrawal is $10,000 after tax?
Permalink Submitted by Alan Spross on Fri, 2011-04-15 02:51
Initially you indicated a retiree, so let’s eliminate the separate issue of in service distributions.
The key issue in your latest post is that the Roth 401k is qualified, ie employee is 59.5 and first contributed to the account prior to 2007 (these were first available in 2006). Since the ROth 401k is qualified, the entire balance is tax free, so irrespective of how much is distributed, the distribution is tax free. If a distribution is rolled over to a Roth IRA, it is all considered basis in the Roth IRA, ie regular contributions to the Roth IRA, so that balance can continue to be distributed from the Roth IRA tax and penalty free.
The retiree and request distributions from either the pre tax 401k or the Roth option, although the employer can still require a lump sum distribution from both of them. There is no pro rating between the pre tax account and the Roth account. A separate 1099R must be issued for distributions from each plan option. If the plan allows partial distributions, the taxpayer can choose between the pre tax account and the Roth account.
There is also a segment of the pre tax account that can be isolated, and that is any pre 1987 after tax contributions. These can come out separately without any prorating, but the rest of the pre tax account balance must be pro rated as you indicated between pre tax and after tax balances.
Note that we also have in plan conversions since last September, where balances from the pre tax account can be converted to the Roth 401k account. More complexity since the Roth 401k still does not have ordering rules so conversions would come out along with regular contributions and pro rated with earnings until the Roth was qualified. Then it is easier since the entire Roth account is tax free from then on.
Have I got to your question yet?