Roth 401K Distribution and 5 Year Rule
Hello, I am trying to see clear on Roth 401K Distributions and 5 year Rule.
Client is separated from service and part of retirement plan is Roth 401k contributions of $40,000 with earnings of $10,000. Roth 401K plan money will be funded 5 years in September 2021. Money left in plan since separation of service back in 2016. Pre tax money is $600,000 and after tax money is $2,500 within 401K Plan. Former employee is age 58 in 2021.
On Roth money, options might be:
1.Rollover of Roth 401K to Roth IRA but this restarts 5 year clock.
2. Direct payment to former employee of Roth 401K Plan contributions and rollover to Roth IRA of earnings now. No tax or penalties?
3. Leave Roth 401K money in retirement plan until 5 year rule is met for all Roth money and then take distribution of Roth 401K plan funds direct to former employee. No tax or penalty?
Do I understand this right?
Would taking all the pre-tax money as rollover now to a Trad IRA, taking after tax direct to employee now and leaving the Roth money in the 401K Plan change the third option?
Thank you for your insights.
Permalink Submitted by Alan - IRA critic on Tue, 2021-07-06 13:50
Yes, this restarts the 5 year clock unless client had contributed to a Roth IRA earlier. But since 40,000 of the Roth 401k balance is contribution basis, that 40,000 can be withdrawn anytime from the Roth IRA without tax or penalty.
Yes, a distribution of the Roth 401k balance to client, who then rolls only the 10,000 of earnings to the Roth IRA will not be taxable, since the taxable portion of a Roth 401k distribution (10,000) is treated as the first dollars rolled over. The 40,000 would be tax and penalty free, just as Q 1 above.
No, if left in place a full distribution of the plan would not be qualified (tax free) until both 5 years and age 59.5 were attained. The 5 years were attained on 1/1/2021 (2016 counts as full year), but client also needs to reach 59.5. Before that the 10,000 of earnings would be subject to tax and penalty.
No, question 3 would not be affected by this. The 2500 of after tax money in the plan has likely generated some earnings on that 2500. Unless the earnings amount on the 2500 is small enough to accept as taxable income, client could do a split rollover where the 2500 went to the Roth IRA, and the earnings went to the TIRA along with the rest of the pre tax 401k balance. Such a rollover must be requested correctly as a split rollover per Notice 2014-54.
Client must update his Roth IRA basis accounting after these rollovers, since if he takes a Roth IRA Distribution before the Roth IRA is qualified (5 years and 59.5), he will have to report it on Form 8606 which requires knowing his regular contribution basis and conversion basis, if any. From the 401k plan, if these direct rollovers are done he would be adding 40,000 of regular Roth IRA contribution basis, and 2,500 of conversion basis, both of which are available tax and penalty free. The 2500 will be penalty free since it was not taxable when rolled out of the 401k after tax sub account.