Roth IRA 5-Year Rules, Roth 401(k) Transfers Highlight Mailbag

By Marvin Rotenberg, IRA Technical Expert

Some of the trickiest IRA situations involving the Roth IRA 5-year rules. We receive questions about them constantly with each situation just a little bit different than the others. In this week’s Slott Report Mailbag, we answer questions on the 5-year rules as well as an inquiry about Roth 401(k) transfer provisions.  As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.

1.



I have an individual 401(k) that has Roth provisions. Can I rollover some of the pre-tax portion to the Roth portion? My understanding was that contributions to either “side” were irrevocable. 



Thank you,

Roger Simard 




Answer:
If your company offers a Roth 401(k) plan, and the plan allows transfers (which have only been allowed by the tax code since 2010), you can transfer amounts that you are able to withdraw from the plan into the Roth 401(k). If you are transferring taxable amounts to the Roth 401(k) plan, you will have to include them in your income for the year of the transfer.

2.


I had a mixture of after-tax and pre-tax money in my 401(k). When I retired at age 57, I rolled the pre-tax money into a traditional IRA and the after-tax money into a Roth IRA. Can I take the after-tax money out of my Roth without receiving a penalty if it is within 5 years? This is money I contributed, not earnings.

Thanks,


Michael 



Answer:
You can always withdraw your basis without penalty, however there are ordering rules for Roth IRA distributions.
 

1. Contribution amounts are distributed first. These distributions are not taxable or subject to the early distribution penalty, even if made before five years or before age 59 1/2.
2. Converted amounts are distributed next, first in, first out. If the conversion had both pre- and after-tax amounts, the pre-tax amounts are distributed first. Converted amounts are not taxable. Pre-tax amounts are subject to the 10% early distribution penalty if the account owner is under age 59 1/2 at the time of the distribution and the conversion was less than five years ago.
3. Earnings are distributed last. They are not subject to tax if the distribution is made after the account owner has had any Roth IRA account for five years and is over the age of 59 1/2, or is dead, disabled, or is taking the funds for a first time home purchase. If the account owner is under the age of 59 1/2 at the time of the distribution, it is also subject to the 10% early distribution penalty.

For the ordering rules, all Roth IRAs are considered one. If the funds being withdrawn from the Roth IRA were originally after-tax funds, there is no penalty – the penalty is only assessed on amounts that were taxable at the time of the conversion.

3.

Hi Ed,

I understand that IRA is an acronym for Individual Retirement Agreement, not account. An IRA can contain numerous separate accounts. I established my Roth IRA back in 1998. I’m considering opening a second Roth IRA account and initially funding it with a partial direct tax-free rollover from the 1998 account.

After that, I intend to do additional funding with after-tax conversions from my 401(k). Once the new Roth IRA account is established, will the rules for withdrawals from that new account be the same as my originally established account back in 1998? That is, will both Roth accounts be considered to have met the five-year holding rule since they are part of the same Roth agreement? I’m older than 59.5 so no penalties for early withdrawal would apply to either account.

Thanks,

Jerry Zacke

Answer:
You are correct. IRA stands Individual Account Agreement. An IRA doesn’t contain separate accounts. It could, however, contain separate investments. In your case, the five-year clock started in 1998. So you can open a new Roth IRA each year and not have to satisfy the five-year rule for any of those new accounts. There is a separate five-year rule for each conversion and the 10% early distribution penalty, however this will not apply to you because are over age 59 1/2.