After-tax 401k to Roth conversion rule - am I wrong?

[BrianB]

I thought I knew the answer to the following question, but I may be wrong:

DW's 401k was about 90% pretax & 10% after tax. We rolled it into a new Trad. IRA (the 90%) and her existing Roth IRA (the 10%). No problem.

Regarding the 10% that is now in her Roth:

Is this money treated as a contribution (can withdraw any time any reason no penalty no tax)

or

Is it treated as a rollover or conversion (5 year waiting period to withdraw without penalty if under 59.5) ?

I've looked at a number of web sources and even some IRS documents, but I haven't found a clear answer. It seems to me that if it was treated as a contribution there would be problems related to other IRS rules about contribution limits, etc.

If it is treated as a rollover or conversion then the waiting period applies for under 59.5 withdrawals?

Does anyone know a source with a reliable answer to this one?

 

[pb4uski]

Rollover as I recall but others will know for sure.

While I would have done what you did had I know about it at the time because it is a backdoor way to get money into a tax-free Roth, I guess the quid pro quo is the 5 year restriction on withdrawals if you are under 59 1/2 but to me that is a reasonable trade-off for tax-free growth.

 

[karluk]

There was a recent thread on a similar topic, which I remember well since I gave incorrect advice back then. Let's see if I can do better this time.

http://www.early-retirement.org/forums/f28/q-on-withdrawing-from-roth-75638.html

Animorph's post in the earlier thread gives a reference to IRS publication 590 that appears to answer your question:

If, within the 5-year period starting with the first day of your tax year in which you convert an amount from a traditional IRA or rollover an amount from a qualified retirement plan to a Roth IRA, you take a distribution from a Roth IRA, you may have to pay the 10% additional tax on early distributions.

I'm reasonably sure that a 401k is a "qualified retirement plan", so your 401k money is treated as a rollover, not a contribution, and would incur the 10% penalty if withdrawn within five years of the rollover (unless you satisfy one of the exceptions that allow penalty free withdrawals).

 

[karluk]

Keep in mind, though, that the rollover doesn't affect withdrawals of contributions. If you were eligible for penalty free withdrawals of your contributions before making the rollover, you are still eligible after the rollover.

 

[jim584672]

I believe there is a 5 year IRA rule. So if you had a Roth opened in 2000 (any Roth account will do, for any dollar amount) the rule would be satisfied and you could remove the after tax amount immediately without penalty.

I am not a tax adviser so don't trust what I say.

 

[BrianB]

Jim, what you said is where my confusion lies.

DW's Roth is more than 5 years old, but a conversion or rollover has a separate 5-year waiting time - thus the idea of a Roth conversion ladder.

Wouldn't the 5-year clock for this after-tax-401k-to-Roth IRA conversion start with the year of the conversion, unless one was over 59.5?

 

[jim584672]

I think since the after tax amount has already had taxes paid you should be able to get it out immediately. If it was a pre tax amount converted to Roth then a 5 year clock starts.

 

[kaneohe]

You might want to post your question at fairmark.com in the retirement forum.
Check for reply by Alan S.

 

[karluk]

You might want to post your question at fairmark.com in the retirement forum.
Check for reply by Alan S.

This is a good suggestion, and in fact I found the following link on fairmark.com which says that the rollover from a Roth 401k to Roth IRA inherits the five year clock of the Roth IRA. Based on this link, I am going to have to retract what I said in my previous post. If you've already owned your Roth IRA for five years, there is no new five year clock for the rollover amount.

Five-Year Requirement for Designated Roth Accounts - Fairmark.com Fairmark.com

Suppose you’ve had a Roth 401k for just a few years, but you’ve had a Roth IRA more than five years. In this case, you can satisfy the five-year test for all your money by rolling the Roth 401k to a Roth IRA.

 

[pb4uski]

I think since the after tax amount has already had taxes paid you should be able to get it out immediately. If it was a pre tax amount converted to Roth then a 5 year clock starts.

No, I don't think so because if you could just take out any conversions that had been taxed it would be a huge loophole to sidestep the 10% early withdrawal penalty.

 

[jim584672]

They already satisfied the first 5 year test by opening a Roth IRA more than 5 years ago.

 

[kaneohe]

This is a good suggestion, and in fact I found the following link on fairmark.com which says that the rollover from a Roth 401k to Roth IRA inherits the five year clock of the Roth IRA. Based on this link, I am going to have to retract what I said in my previous post. If you've already owned your Roth IRA for five years, there is no new five year clock for the rollover amount.

Five-Year Requirement for Designated Roth Accounts - Fairmark.com Fairmark.com

Be careful here......it's my impression that aftertax account in a traditional 401K is different in some details than a Roth 401K....so your answer may be correct but not necessarily from your link. In school, you might get 1 pt for the right answer but -4 for methodology I believe OP was not asking about a Roth 401K which I think is a designated Roth account.

 

[pb4uski]

They already satisfied the first 5 year test by opening a Roth IRA more than 5 years ago.

That only applies to contributions, not to conversions or rollovers. Just because the account has been open for 5 years and the tax has already been paid does not mean it is available penalty free if one is under 59 1/2. It is much more complicated than that.

Besides, the taxes paid aspect you seem to be focused on would be true for all monies in a Roth IRA.

 

[pb4uski]

Also see below from Fairmark Forum :: Retirement Savings and Benefits :: Distributions from RIRA after TIRA transfer

I believe that in the OPs situation that the the amount converted into the Roth from the after-tax 401k would need to be in the Roth for 5 years before it could be withdrawn penalty free (even if the Roth account is over 5 years old). However, the OP could withdraw contributions without any withdrawal penalty and any withdrawals would be contributions first anyway.

Roth IRA Distribution Table

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD NOT MET

Contributions: Tax-No; Penalty-No
Conversions: Tax-No; Penalty-Yes (Taxable Portion)
Conversions: Tax-No ;Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-Yes

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD MET

Contributions: Tax-No; Penalty-No
Conversions: Tax-No; Penalty-No (Taxable Portion)
Conversions: Tax-No; Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-Yes

OVER AGE 59.5
LESS THAN FIVE YEARS SINCE OPENING FIRST ROTH IRA

Contributions: Tax-No ;Penalty-No
Conversions: Tax-No; Penalty-No (Taxable Portion)
Conversions: Tax-No; Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-No

OVER AGE 59.5
FIVE YEARS OR MORE SINCE OPENING FIRST ROTH IRA

All Distributions Are Qualified

No Taxes
No Penalties

 

[jim584672]

I think you are right, looks like each conversion has a 5 year window, even after tax funds which are not ordinarily subject to taxes could still get a penalty.

 

[pb4uski]

Yes, until you turn 59 1/2 and then the "clock" for each conversion instantly accelerates to five years... a bonus for turning 59 1/2!

 

[borrom2002]

It looks like any after tax money rolled into the roth would be tax and penalty free to take out.

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD NOT MET

It would fall under this one.
Conversions: Tax-No ;Penalty-No (Nontaxable Portion)

Here is a good way to think of it. If you put money into a roth IRA in any fashion, as long as the money is after tax and you don't pay taxes on the process to get it into the roth account you should be able to take it out tax free and penalty free at any time.

 

[borrom2002]

conversions are taxable events. rollovers are not. moving after tax to a roth is a rollover not a conversion.

 

[jim584672]

I am wondering if someone could at the time of the rollover get a check for the after tax amount and keep it? Would there be any penalty on it?

 

[borrom2002]

Here is an article about the most recent irs ruling to this process.

New IRS Rules on After-Tax 401(k) Rollover To Roth IRA | Bankrate.com

 

[kaneohe]

Also see below from Fairmark Forum :: Retirement Savings and Benefits :: Distributions from RIRA after TIRA transfer

I believe that in the OPs situation that the the amount converted into the Roth from the after-tax 401k would need to be in the Roth for 5 years before it could be withdrawn penalty free (even if the Roth account is over 5 years old). However, the OP could withdraw contributions without any withdrawal penalty and any withdrawals would be contributions first anyway.
.....................................

I love that table by kawill but again, be careful........it was meant for TIRA to RIRA conversions and did not have after-tax funds from a traditional 401K in mind. In fact, if you did attempt to use that table in this case, you might say
that this was a non-taxable conversion (since after tax funds involved) and the table says no tax or penalty.......I'm not sure that's the right answer.....Alan S.
would.

 

[karluk]

Be careful here......it's my impression that aftertax account in a traditional 401K is different in some details than a Roth 401K

You are right, so my post may not apply to OP's situation. He'll probably be along shortly to clarify what he meant by "after tax" money in his wife's 401k. But I'm glad to post the fairmark link in any case, since it should be helpful to people who do have designated Roth contributions in their 401ks

 

[pb4uski]

From the way it was worded, I'm assuming that the OP meant an after-tax 401k balance was rolled over, not a Roth 401k but your are right that it would be good for the OP to clarify.

It might be somewhat academic as well since under the ordering rules contributions would come out first anyway.