Question re: Roth 401k early withdrawal

[Earl E Retyre]

I have a simple question regarding Roth 401k early withdrawal.

My daughter has the option to invest in a Roth 401k through her 1st job and the company will do a 100% match up to 5% of pay. I recommended that she should max that out and let the money grow.

So, here is the question ... I believe in an absolute worst case scenario if she needs to withdraw the money, she only pays a 10% penalty and since the company matches 100% then she is way ahead of the game. Let's say she put $1,000 in her Roth and the company matched $1,000 so at the end of the 1st year she has $2,000. If she withdrew the money at the end of year 1 then she would get $2,000 minus a 10% penalty of $200 for a total of $1,800. With the company match she made an extra $800 when compared to not investing in the Roth. Please validate. Assuming my logic is correct then it seems silly for anyone in her situation to not invest in the Roth. Even if you need to pull the money out, you have earned a lot more due to the company match.

Thanks and Merry Christmas.

 

[ownyourfuture]

My daughter has the option to invest in a Roth 401k through her 1st job and the company will do a 100% match up to 5% of pay. I recommended that she should max that out and let the money grow

Absolutely the right advice. You simply cannot pass up a 100% return.

If she withdrew the money at the end of year 1 then she would get $2,000 minus a 10% penalty of $200 for a total of $1,800

That sounds logical, but even though it's a 401-k, due to the fact that she 'withdrew' the money, I'm thinking there might be some other tax consequences ?

 

[REWahoo]

There would be no penalty on the $1000 she contributed as those funds were already taxed.

If you are under 59½, you may withdraw the exact amount of your Roth IRA contributions with no penalties.

Roth IRA Withdrawal Rules

Not sure how the IRS views withdrawals of company matching funds, but if they haven't been taxed you can bet the IRS won't allow you to withdraw them tax free.

 

[REWahoo]

Follow up:

if an employee receives a company match on a Roth contribution, the company match is a pre-tax contribution. The funds that result from company matches and the associated growth will be subject to regular income tax when distributions are drawn at retirement.

https://www.smart401k.com/resource-center/retirement-strategy/roth-401k-vs-401k-contribution-taxes

Based on this, looks like she'd be taxed on the $1000 employer contribution plus a 10% penalty on any growth in the Roth.

 

[zinger1457]

It's my understanding that the company match will be deposited into the pre-tax 401K account, not the ROTH 401K.

 

[bingybear]

It's my understanding that the company match will be deposited into the pre-tax 401K account, not the ROTH 401K.

+1

 

[Earl E Retyre]

Thanks all for the replies. So based on:

"Contributions: Tax free in /tax free out - An investor can take out the exact amount of his or her Roth IRA contributions at any time, for any reason without having to pay any tax or penalty – with one big caveat. The earnings from your principal cannot normally be withdrawn prior to age 59½ without paying the 10% early withdrawal penalty. Earnings can generally be withdrawn without penalties after age 59½, provided you meet the five-year rule."

... it appears yet another scenario would be for her to withdraw the money she contributes to the Roth each year (if she needs it) with no penalty and let the company matched funds and any growth stay in the account.

 

[zinger1457]

... it appears yet another scenario would be for her to withdraw the money she contributes to the Roth each year (if she needs it) with no penalty and let the company matched funds and any growth stay in the account.

Do companies allow you to treat a ROTH 401K like a savings account where you can make withdrawals anytime you want? I didn't have the ROTH 401K option available when I was working but would be surprised if they didn't have some restrictions in place.

 

[pb4uski]

IIRC if you make a withdrawal from a company 401k then you are prohibited from making additional contributions (and getting the match) for a certain period of time (6 months to a year). The purpose if these restrictions is to prevent people from gaming the system and making temporary contributins to just get the match.

 

[DrRoy]

For early withdrawal of an untaxed contribution, you pay the 10% penalty plus all applicable income taxes. If you were in the 25% federal bracket and say 5% state, your total cost would be 40%.

 

[jazz4cash]

Since you are looking at "worst case scenarios", it's worth considering the 401k loan provisions of the plan. Even strong opponents of 401k loans might agree that a loan may be better than paying an early withdrawal penalty in some situations.

 

[Animorph]

"Many people either decide to retire before they reach 59 1/2 or simply end up needing retirement funds for other purposes earlier in life. If a withdrawal is made from a Roth 401(k) account that does not meet the above criteria, it is considered "unqualified" and incurs income taxes. However, taxes are only assessed on the earnings portion of the withdrawal. Since Roth contributions are made with after-tax dollars, you do not need to pay taxes on that portion again. To calculate the portion of the withdrawal attributable to earnings, simply multiply the withdrawal amount by the ratio of total account earnings to account balance. If your account balance is $10,000, comprised of $9,000 in contributions and $1,000 in earnings, then your earnings ratio is $1,000 / $10,000, or 0.10. Therefore, a $4,000 withdrawal would include $400 in taxable earnings, which would need to be included in the gross annual income reported to the IRS on your taxes."


What are the Roth 401(k) withdrawal rules? | Investopedia

Didn't say much about penalties. IRA's don't have penalties for early withdrawals of contributions, which are deemed to be withdrawn first, but I've never seen anything on Roth 401k's. Looks like you don't get the option of withdrawing just contributions from the Roth 401k. That would be a problem for older accounts.