Roth 401k Rollover

Submitted by MIKE KRUCHTEN on Tue, 2016-02-02 18:10

I have a client who has been contributing to their Roth 401k for 3 years and will be retiring this summer. The plan admin is worthless in trying to accurately explain what his options are regarding the Roth 401k portion since he has not met the 5 year holding period. I understand the regs to read the following; If he has no existing Roth IRA then after he rolls over the Roth 401k to it another 5 year hold period must begin. Essentially making the past 3 year holding period meaningless!!!!! However, if he has an existing Roth IRA and it’s 3 years old then he only has to wait 2 more years for the rolled over earnings to be tax free. To add more confusion, my client has no Contributory Roth IRA but has a Roth IRA which has been funded with conversions each year from his annual non deduct Trad IRA contribution. Does the IRS delineate the diff between a Roth Contributory vs. Roth Conversion IRA???

It seems the holding period at the employer is meaningless since upon Roth 401k rollover a new 5 year holding period has to start over if client has no existing Roth IRA. Am I missing something???



Submitted by Alan - IRA critic on Tue, 2016-02-02 18:43

  • You have it right. The Roth IRA 5 year holding period governs (plus age 59.5) with respect to when the Roth IRA and the funds rolled into it become qualified. That 5 year holding period starts 1/1 of the year client’s Roth IRA first received either a regular or conversion contribution, so client has a couple years head start. The 3 years in the Roth 401k do not count for the Roth IRA holding period.
  • That said, the 1099R for the Roth 401k rollover will show the amount client contributed in Box 5. That amount is treated as regular Roth IRA contributions once added to the Roth IRA and can therefore be distributed tax and penalty free. Client therefore needs to keep the 1099R and update the accounting on his Roth IRA as he now will have a balance of regular Roth IRA contributions equal to that Box 5. They come out first, then his conversions come out tax free. If these conversions were non taxable due to ND TIRA contributions being converted) then there is no 5 year holding period to distribute the conversions without penalty. In summary his Roth IRA could be distributed up to the total of the regular and conversion contributions (but not earnings) tax and penalty free.
  • While you said his Roth 401k includes gains, in the event he had losses his Box 5 contributions would be more than his direct rollover, but he would still get to treat the Box 5 amount as regular contribution basis in his Roth IRA.
  • One of the reasons that a clear explanation of a Roth 401k to Roth IRA rollover is lacking is because the IRS has not issued any clear guidance in any publication. You have to piece together info from different IRS Notices that are not at all user friendly.

Submitted by MIKE KRUCHTEN on Tue, 2016-02-02 21:58

In regards to conversions and the 5 year hold. I routinely advise clients to make the Non Deduct Trad IRA(assuming no other Trad IRA’s) then immediately convert to their Roth. This conversion can take a day or two depending on MF company. If their is a slight gain between days then clients realize they will have to claim some income on conversion. In your reply you mentioned no gain then no 5 year hold period. I assume then if a client makes a Non Deduct Trad IRA contribution then immedisately converts and value is unchanged then no 5 year holding period??? I was under impression that this conversion would require a 5 year hold regardless of earnings or account being flat from contribution to conversion. Going forward I would always contribute to the Money Marekt then convert to avoid a 5 yesr hold. Please confirm my hopes, lol…..

Submitted by MIKE KRUCHTEN on Wed, 2016-02-03 03:21

Should an employee contribute to the Roth 401k for 5 years then seperate and rollover the funds does he/she still have to follow another 5 year wait period if they don’t already have a Roth IRA?

Submitted by Alan - IRA critic on Wed, 2016-02-03 03:30

Yes, if they want the Roth IRA to become qualified. The Roth 401k itself is not qualified until both the 5 years and age 59.5 is reached. But under the Roth IRA ordering rules for taxing distributions, most of the money comes out tax and penalty free. Only after the Roth 401k contributions rolled over have been fully withdrawn do Roth 401k or Roth IRA earnings get distributed. Those earnings will be taxable until the Roth IRA is qualified and also subject to penalty prior to age 59.5. If the Roth 401k was itself qualified before the rollover (5 years and 59.5) then the entire amount of the rollover is treated as regular Roth IRA contributions and come out tax and penalty free, Only Roth IRA earnings actually earned in the Roth IRA have to wait until the Roth IRA itself becomes qualified.

Submitted by MIKE KRUCHTEN on Thu, 2016-02-04 12:19

Would it not make sense to advise those who start contributing to a Roth 401k to also open a Roth IRA if not already owned? Even a $100 contribution to get the Roth opened and if their MAGI is to high then a back door Roth conversion to get the 5 year clock started. This topic is top of conversation in my office due to the sketchy info we are all trying to piece together. EXAMPLE  A 50 year old started to contribute to a Roth 401k then retired at age 58 and rolled over his Roth 401k to a Roth IRA and never previously owned a Roth IRA. I interpret the regs and your responses as; the Roth 401k would not be considered qualified since he is not 59.5 and upon rolling Roth 401k to his newly opened Roth IRA the 5 year clock would start all over again thou he has Roth 401k for 8 years. The entire rollover wouldn’t be treated as a contribution but broken down as contributions vs. earnings. He could take the contribution portion at any time to avoid taxes/penalty but the earnings would have to stay the additional 5 years. If I’m right so far then the client would be better off leaving the Roth 401k at employer plan until 59.5 to avoid the headache.One would think the IRS would have or will be giving better guidance on the Roth 401k as they continue to grow in popularity. I bet less than 2% of employees/advisors understand the additional 5 year component should they not already own a Roth IRA as they began the Roth 401k. 

Submitted by David Mertz on Thu, 2016-02-04 14:22

For the reasons you mentioned, opening a Roth IRA is an excellent suggestion to make to those who have Roth 401(k) accounts, but there’s no need to limit the suggestion to only those who have Roth 401(k) accounts.  I suggest that anyone who has eligible compensation and does not have a Roth IRA should open a Roth IRA to get the Roth IRA 5-year clock started.  There’s no good reason for a person not to have completed the 5-year period for Roth IRAs before age 59½.

Submitted by Alan - IRA critic on Tue, 2016-02-02 22:52

The 10% early withdrawal penalty only applies to the taxable portion of a conversion, and that is consistent with an early TIRA withdrawal. An early distribution from a TIRA with basis incurs the 10% penalty on only the taxable portion of the distribution. On a Roth conversion of 5510 after a 5500 non deductible contribution and 10 gain, the taxable portion of the conversion is only 10. If this conversion is distributed before 5 years, the taxable portion of 10 comes out first and a penalty of 10% is due. That is only $1. Then the 5500 comes out penalty free. As a result the 5 year holding period on such a conversion is almost meaningless since the taxable portion is so small. Also, paying the tax on the $10 of gains on the contribution prior to conversion is also very incidental to the overall benefit of getting 5510 into the Roth IRA. Of course, all this assumes that there is no other TIRA account balance, just the non deductible contribution being converted. This is the strategy of the so called “back door Roth” contribution or conversion.

Submitted by Alan - IRA critic on Fri, 2016-02-05 16:10

  • I want to correct an error I made in a prior post regarding the 1099R issued for a direct rollover of a Roth 401k to a Roth IRA. The IRS Inst. indicate that Boxes 5, 10 and 11 are not filled in reporting such a rollover. Therefore, these 1099R forms will be similar to those of a pre tax 401k to IRA direct rollover except they are coded H.
  • The IRS Inst go on to state that if the direct rollover is to the Roth 401k in another plan, the distributing plan must provide the Box 5, 10, and 11 equivalent data to the new plan administrator so that the new plan can correctly report any Roth 401k distributions. However, there is no corresponding guidance in assisting Roth IRA owners in knowing the composition of the Roth 401k funds. This means that the Roth IRA owner will need to secure this information separately from the distributing plan or from a closing Roth 401k statement. If there were IRRs done in the plan, the Roth IRA owner will also need to know the year, amount and the taxable/non taxable breakdown of each IRR done in the last 5 years, not just the total you would get from Box 10 of the 1099R.

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