Nonqualified Roth 401k distribution

Submitted by Peter Thomann on Tue, 2016-08-30 04:16

Is a Roth 401k participant now permitted to do the following? Roth 401(k) account balance consisting of $80,000 after-tax contributions and $20,000 earnings. Participant requests a non-qualified distribution directing the $20,000 rolled to a Roth IRA and the $80,000 directly paid to him. Is this permitted? Would there be no tax/penalty incurred?
What would happen if the participant only requested a non-qualified distribution of $50,000? Could he rollover $10,000 to the Roth IRA and $40,000 paid to him?
Thank you.



Submitted by Alan - IRA critic on Tue, 2016-08-30 21:03

  • TD 9769 was released earlier this year to clarify that amounts distributed from a designated Roth going to different destinations can be considered as a single distribution rather than separate distributions. This brings designated Roth distributions under the same guidance as Notice 2014-54.
  • Therefore your first question can be done, ie the 20k of earnings can be directed to the Roth IRA with no current tax or penalty. However, this amount would not be treated as basis in the Roth IRA unless the Roth IRA is already qualified.
  • If 50,000 was distributed to the participant (a partial distribution), then the participant is receiving 40,000 in contributions and 10,000 in earnings (pro rate rules). The first dollars the participant rolls over to the Roth IRA are deemed to be the taxable amounts, ie 10,000. The 40,000 retained would be tax and penalty free.
  • https://s3.amazonaws.com/public-inspection.federalregister.gov/2016-11647.pdf

Submitted by Peter Thomann on Tue, 2016-08-30 21:43

Thank you Alan.  Sorry, two follow up questions:

  1. Must the plan sponsor/administrator offer to the participant the option to roll the taxable portion to a Roth IRA?  
  2. Couldn’t the participant just rollover the entire Roth 401k to a Roth IRA and then once in the Roth IRA have the ability to isolate the basis?   

Submitted by Alan - IRA critic on Tue, 2016-08-30 22:31

  1. Of course the participant must be eligible for distributions if still working. Elective deferrals can only be rolled out after age 59.5 at the soonest.  If separated, there is no choice and the plan must offer a direct rollover of the portion the participant wants rolled over.
  2. Yes, a direct rollover could be done with the same result if the participant then took a Roth IRA distribution. The Roth basis would come out first if the Roth IRA is not yet qualified. This would just require the extra step of a Roth IRA distribution.

Submitted by Peter Thomann on Tue, 2016-08-30 23:19

Thanks again, very helpful.

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