401k Roth

Submitted by Carrie Baeten on Tue, 2022-12-20 19:48

Hi,
I have a client age 54 who was let go at work. She has money in a Roth 401k at work. She would like to use some of this money. What do I need to inform her of regarding the tax consequences? Then, we are able to roll the remainder into an individual Roth IRA, correct?

Thanks much,
Carrie



Submitted by Alan - IRA critic on Tue, 2022-12-20 22:30

She needs to determine from her plan statements or from the plan administrator what her Roth contribution basis is. For example, if her Roth account is worth 40k and her contributions were 30k, then 75% of her distribution will be non taxable and 25% taxable and subject to the 10% penalty unless she turns 55 prior to the end of the year in which she separated from service. However, if she were to roll over a portion to her Roth IRA that amount rolled over is treated as the taxable earnings, which would leave her with the non taxable portion. The accounting is more complex if she ever did in plan Roth rollovers (IRRs). If she rolled over just the earnings amount to a Roth IRA, her Roth IRA basis would not be increased, but if she rolled over some of the non taxable portion as well, her Roth IRA regular contribution basis would be increased. She would have to update her Roth IRA basis to know how any future non qualified Roth IRA distribution would be taxed. Therefore, she needs to pencil this out to know what taxes would be due on the Roth 401k distribution and that depends on how much she rolls over.

Submitted by Carrie Baeten on Wed, 2022-12-21 17:29

Thank you for this.  I will explain the taxable part for whatever she withdraws.  We will then do a direct rollover for  the balance to her individual Roth IRA.  Whatever she rolls over though, would not be taxable correct?

Submitted by Alan - IRA critic on Wed, 2022-12-21 18:23

  • Correct, but the amount she keeps might be taxable depending on how much she rolls over. Since she is getting a distribution, the rollover to her Roth IRA would be a 60 day rollover, not a direct rollover.
  • There will also be mandatory 20% withholding on the taxable portion of her distribution. If she completes a rollover of the taxable portion, she will have to replace the 20% of that portion that went to federal withholding. She would recover that amount when filing her taxes because a full rollover of the taxable portion would eliminate any taxes on the distribution.
  • Therefore, mandatory withholding is another factor to consider in determining the amount of the distribution and the amount rolled to a Roth IRA.

Submitted by Carrie Baeten on Tue, 2022-12-27 16:22

Would she be better off calling the current 401k where the roth is being held, request whatever distribution amount she wanted from there and when that is completed, doing a direct rollover with the remainder of the money to her personal roth ira?

Submitted by Carrie Baeten on Tue, 2022-12-27 16:22

Would she be better off calling the current 401k where the roth is being held, request whatever distribution amount she wanted from there and when that is completed, doing a direct rollover with the remainder of the money to her personal roth ira?

Submitted by Alan - IRA critic on Tue, 2022-12-27 17:14

No, because the partial distribution will include some gains which will be taxed, and 20% withholding on the amount of gain. It would be better to do a direct rollover of the entire plan to her Roth IRA, then take a Roth IRA distribution of the amount she needs. She can decline withholding for the Roth IRA distribution, and any gains in the Roth IRA come out last, meaning that tax and penalty can be avoided unless she takes a large enough distribution that would exceed her Roth IRA basis. The amount she contributed to the Roth 401k would all become Roth IRA basis, available anytime without tax or penalty.

Submitted by ssel on Wed, 2022-12-28 06:15

  • I hadn’t realized that in a rollover to Roth IRA, the earnings would come out first.  I’d thought it was pro-rata. 
  • If the Roth 401k also holds some taxable and some nontaxable conversion amounts (from in-plan Roth rollovers) in addition to contributions, in what order would those come out?

Submitted by Alan - IRA critic on Wed, 2022-12-28 16:35

  • Put another way, the Roth 401k distribution includes a pro rated amount of gains, but any portion rolled over within 60 days to a Roth IRA applies the gains to the first dollars rolled over. If the portion rolled over is large enough, the amount left will be 100% basis and tax free.
  • The answer to this is quite complex. IRR amounts are all basis, and would be part of the pro rata calculation to determine how much gain is distributed. The complex part of this is the 5 year holding period for IRRs, each of which may have a taxable and non taxable component. After all the pro rating, to the extent taxable IRRs are distributed after all the pro rating, the 10% recapture tax will be due. If the client has this situation, I would consider doing a complete direct rollover to a Roth IRA, and then taking a distribution from the Roth IRA as needed. Any recapture tax due is reported on Form 5329.

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