As retirement account questions go, this is the shortest inquiry with the longest answer. When asked what factors to consider and what 5-year clocks apply with a Roth 401(k) to Roth IRA rollover, I take a big breath and say, “Pull up a chair.” There are a number of variables to determine. Probing questions must be posed before any guidance can be given.
First, we must determine if this is a “qualified distribution” or not. A qualified distribution from a Roth 401(k) means the person had the Roth 401(k) for 5 years AND is age 59 ½ or older. If either of these hurdles come up short, then we have a NON-qualified distribution. Assume a person meets the requirements for a qualified distribution. In that case, upon rollover, all former Roth 401(k) dollars go into the Roth IRA as basis and are available for immediate distribution tax-free. Essentially, all dollars go into the Roth IRA as one big contribution, and a person always has access to their contributory Roth IRA funds.
What about the 5-year clock? The 5-year holding period is the period applicable to the Roth IRA. So, even if this was the first Roth IRA a person ever had and it was just opened to receive the Roth 401(k) dollars, a qualified distribution from the plan means all dollars rolled into the Roth IRA are available. If this was a brand-new Roth IRA and the person never had a Roth IRA before, there would be a 5-year wait for any subsequent EARNINGS to be tax-free, but the rollover dollars are accessible.
What if a Roth 401(k) participant could NOT check both boxes – meaning they were either under 59 ½ or did not have the Roth 401(k) for 5 years? Then it would be a non-qualified distribution. With a non-qualified distribution, former Roth 401(k) dollars “maintain their same character” when they roll into the Roth IRA. Salary deferrals into the plan will dump into the Roth IRA “contribution bucket” as basis, and Roth 401(k) earnings will dump into the Roth IRA earnings bucket. As with a qualified distribution, the 5-year holding period will be the period applicable to the Roth IRA.
Qualified vs. non-qualified distributions from a plan is an important distinction. If a plan participant held their Roth 401(k) for only four years (non-qualified), but elected to roll the Roth 401(k) into a brand new Roth IRA (and this person never had a Roth IRA before), then they would lose the 4 years…because the Roth IRA clock takes precedence. On the flip side, if this same person already had a Roth IRA for 5 years, then the former Roth 401(k) dollars would essentially zoom forward and adopt the more advanced 5-year Roth IRA period. Upon rollover, the Roth IRA 5-year clock takes precedence, whether that is beneficial or not.
In summary, when rolling Roth 401(k) dollars to a Roth IRA, the following variables must be considered:
- Is this a qualified distribution (age 59 ½ AND 5 years in the Roth plan), or is it non-qualified?
- How long was the Roth IRA held? (The Roth IRA clock will take precedence.)
- A qualified distribution means all plan dollars come over as basis.
- With a NON-qualified distribution, the rollover dollars “maintain their character” when dumping into the Roth IRA contributions and earnings buckets.
By Andy Ives, CFP®, AIF®
IRA Analyst
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