How the 5 year rule is impacted on Roth 401(k) rolled over to a new Roth IRA
First question, Client has an existing 401(k) plan through his current employer that has a Roth 401(k) within it. The employee is 64 years old. The employee started contributions to the Roth 401(k) on May 30, 2007, over 16 years ago. He is interested in doing an in-service direct rollover of his Roth 401(k) to a NEW Roth IRA.
For purposes of the 5-year rule for qualified distributions for the Roth IRA that received all its funds directly from the Roth IRA, Would the Roth IRA’s 5-year rule be considered to start in May of 2007 or when the Roth 401(k) funds arrive at the Roth IRA in 2024?
Second question. If the same person above also had opened and contributed to an existing Roth IRA on January 1, 2021, would that change the start date on the 5-year rule for the above NEW Roth IRA?
Thank you.
Permalink Submitted by William Marton on Mon, 2024-04-01 20:11
The five-year rule for Roth IRAs cannot be met through a Roth 401(k), i.e., even though the contributions to a Roth 401(k) began over five years ago, this is not credited to the required five year holding period for a Roth IRA . This is from the IRS website (I emphasized the relevant text):
“When you roll over a distribution from a designated Roth account to a Roth IRA, the period that the rolled-over funds were in the designated Roth account does not count toward the 5-taxable-year period for determining qualified distributions from the Roth IRA. However, if you had contributed to any Roth IRA in a prior year, the 5-taxable-year period for determining qualified distributions from a Roth IRA is measured from the earlier contribution. So, if the earlier contribution was made more than 5 years ago and you are over 59 ½ a distribution of amounts attributable to a rollover contribution from a designated Roth account would be a qualified distribution from the Roth IRA.”
So if the owner of the Roth 401(k) did not establish a Roth IRA prior to the rollover, withdraws are not qualified until five tax years after the rollover. (Note that the five year clock is tax years not calendar years–a rollover in December 2024 would count as starting at the beginning of the tax year, January 1, 2024, even though the actual time that the Roth IRA was held was for a much shorter period of time; you always get credit for holding the Roth for the entire tax year in which it was established.)
Re. the second question: a rollover into either the Roth IRA first established January 1, 2021 or a completely new Roth IRA would be qualified on January 1, 2026 (five years after the 2021 tax year). In the second case (rollover to a new IRA), it doesn’t matter if the Roth IRA first established January 1, 2021 still exists. The only thing that matters is that five tax years have passed since any Roth IRA was first established.
Permalink Submitted by Alan - IRA critic on Tue, 2024-04-02 03:57
In this situation, because the Roth 401k was qualified when rolled over to the Roth IRA, the entire balance of that rollover will be treated as regular Roth IRA contribution basis, which can be distributed at anytime from the Roth IRA tax free.