The Rule of 55 and a ROTH 401k

[armor99]

I found myself wondering about this. And I figured many others might find themselves in this situation, so I thought I would post about this to the group. Surprisingly, this information was difficult for me to find.

So the Rule of 55 as it applies to a standard 401k is pretty simple. In the year you turn 55, if you retire, you can withdraw money from only your current 401k with no penalties. So it is a way you can get at your 401k money before 59.5 and avoid the early withdrawal penalty. Taxes still apply, but would apply after 59.5 as well.

The question becomes, so what if I have a ROTH 401k... then what? So after a LOT of searching... the answer seems to be this. You can withdraw from a ROTH 401k the same way... with no penalty. However, you will get hit with a pro-rated tax upon the amount you take out. This effectively nullifies the whole purpose of having a ROTH 401 k in the first place.

However, you CAN roll over your ROTH 401k to a ROTH IRA, with no taxes or penalties. And once there, at any age, you can withdraw what you have personally contributed without any taxes or penalties at all. (Provided that ROTH IRA account has existed for at least 5 years).

This is what I plan to do. I am thinking by the time I am 55, I will have personally contributed enough to my ROTH 401k(and Roth IRA), to get me to 59.5 without a problem.

 

[gwraigty]

I disagree that the whole purpose of having a Roth 401k is to be able to get at the money via a Rule of 55. At any rate, you correctly point out the workaround for this.

 

[jazz4cash]

I disagree that the whole purpose of having a Roth 401k is to be able to get at the money via a Rule of 55. At any rate, you correctly point out the workaround for this.

I didn’t think OP was making a point that “the whole purpose of having a Roth 401k is to be able to get at the money via a Rule of 55” at all. Maybe I missed that. The rules are waay too complex.

Anyway I just wanted to point out that some 401k plans don’t permit rollover to an IRA.

 

[travelover]

.......Anyway I just wanted to point out that some 401k plans don’t permit rollover to an IRA.

I've never heard that. Do you mean ever?

 

[gauss]

I found myself wondering about this. And I figured many others might find themselves in this situation, so I thought I would post about this to the group. Surprisingly, this information was difficult for me to find.

So the Rule of 55 as it applies to a standard 401k is pretty simple. In the year you turn 55, if you retire, you can withdraw money from only your current 401k with no penalties. So it is a way you can get at your 401k money before 59.5 and avoid the early withdrawal penalty. Taxes still apply, but would apply after 59.5 as well.

The question becomes, so what if I have a ROTH 401k... then what? So after a LOT of searching... the answer seems to be this. You can withdraw from a ROTH 401k the same way... with no penalty. However, you will get hit with a pro-rated tax upon the amount you take out. This effectively nullifies the whole purpose of having a ROTH 401 k in the first place.

However, you CAN roll over your ROTH 401k to a ROTH IRA, with no taxes or penalties. And once there, at any age, you can withdraw what you have personally contributed without any taxes or penalties at all. (Provided that ROTH IRA account has existed for at least 5 years
Actually you are talking about withdrawing a rollover - not a contribution. Each rollover to a Roth IRA has a separate 5 year waiting period before it can be withdrawn without penalty, so there is no loophole here.
).

This is what I plan to do. I am thinking by the time I am 55, I will have personally contributed enough to my ROTH 401k(and Roth IRA), to get me to 59.5 without a problem.

I adopted a similar strategy, but the funds were in Roth IRA only -- not Roth 401(k). With the pro-rata application of taxes/penalties before age 59 1/2 in a Roth 401(k), there is no obvious analogy to the Roth IRA where your yearly contributions come out first without taxes or penalties.

I rolled funds from traditional 401k(k) (partial ,in-service withdrawals) to the Roth IRA to build up a significant balance to fund my pre-age 59 1/2 penalty-free asset needs.

-gauss

 

[gauss]

I've never heard that. Do you mean ever?

Partial distributions and in-service distributions are not universally allowed.
Fortunately my employer allowed both of these as well as after-tax (not roth) contributions to the 401k of up to ~50K per year.

-gauss

 

[gwraigty]

I didn’t think OP was making a point that “the whole purpose of having a Roth 401k is to be able to get at the money via a Rule of 55” at all. Maybe I missed that. The rules are waay too complex.

Anyway I just wanted to point out that some 401k plans don’t permit rollover to an IRA.

Yes, you did miss it. OP said:

This effectively nullifies the whole purpose of having a ROTH 401 k in the first place.

What 401k plan doesn't permit rollovers to an IRA? Maybe in-service rollovers, but they can't force you to leave the money in the 401k plan after you leave their employment. Since OP is talking about the Rule of 55, it's not an issue.

 

[gwraigty]

However, you CAN roll over your ROTH 401k to a ROTH IRA, with no taxes or penalties. And once there, at any age, you can withdraw what you have personally contributed without any taxes or penalties at all. (Provided that ROTH IRA account has existed for at least 5 years
Actually you are talking about withdrawing a rollover - not a contribution. Each rollover to a Roth IRA has a separate 5 year waiting period before it can be withdrawn without penalty, so there is no loophole here.
).-gauss

You're making it difficult to determine who said what.

Regarding your words in red, the correct info is as follows:

The 5-year rule means that five tax years must pass from the date of the first contribution to any Roth IRA, or Roth 401(k), before a qualified distribution can be made from the retirement account. The 5-year rule is fairly straightforward in a Roth IRA. However, what many taxpayers may not realize, is how that 5 year rule is calculated when you rollover a Roth 401(k). If the rollover is to a Roth IRA, the holding period within the Roth 401(k) does not carry over. Which means, if you have an existing Roth IRA, once the Roth 401(k) distribution is in the account, it has the same holding period as the Roth IRA funds. If you have had a Roth IRA open for over 5 years, the funds rolled over into that Roth IRA will pass the 5 year test. However, if you did not already have a Roth IRA open, and you now open one to roll the funds from your Roth 401(k) into currently, the five-year period starts the year the Roth IRA was opened, despite the number of years you have been making contributions to the Roth 401(k).

The take away from this is, if you have a Roth 401(k) that you are contributing to, consider opening a Roth IRA now to start the 5 year rule. If you experience a job loss, you can roll the funds right into the already established Roth IRA, and if you qualify for early withdrawals, you won’t be held up by a new 5 year rule.

Roth 401(k) Rollovers: Beware the 5 Year Rule

 

[gauss]

You're making it difficult to determine who said what.

Regarding your words in red, the correct info is as follows:



Roth 401(k) Rollovers: Beware the 5 Year Rule

Mmm... Your quote seems to be in regards to Qualified Roth IRA distributions (ie generally over age 59 1/2 and the owner has established his/her first Roth IRA at least 5 years ago).

OP is concerned about non-Qualified Roth distributions. As such Pub 590-B gives the ordering rules and other info on how taxes/penalties may apply to non-qualified distributions.

The item of issues is that rollover/conversions from a traditional account to a Roth IRA must not be distributed in a non-qualified fashion within 5 years of the rollover/conversion, lest the 10% penalty will apply to the amount of the conversion that was taxable. Congress foresaw this loophole.

I don't mean to overly-complicate this (non-qualified Roth IRA distributions are complicated enough in their own right), but OP thinking that he/she can convert to a Roth IRA and then immediately withdraw the funds and avoid the 10% penalty is a grave mistake (assuming a non-qualified distribution).

-gauss

 

[armor99]

My apologies if something I said might have been incorrect or confusing.... all the rules I read were convoluted...

What I meant was, it is against the point of a ROTH 401k... to have to pay taxes on it. And that is what would happen if you tried to use the rule of 55.

From my understanding, once a ROTH 401k is rolled over to a ROTH IRA, you can get to your contributions tax and penalty free at anytime. Provided the ROTH IRA has been in existence for more than 5 years. I do not believe there is any additional waiting time. That would only apply if you did not have a ROTH IRA, never did, and was starting one at that moment...

 

[travelover]

...........Anyway I just wanted to point out that some 401k plans don’t permit rollover to an IRA.

Partial distributions and in-service distributions are not universally allowed.
Fortunately my employer allowed both of these as well as after-tax (not roth) contributions to the 401k of up to ~50K per year.

-gauss

Right, but that is not what he said.

 

[gwraigty]

I don't mean to overly-complicate this (non-qualified Roth IRA distributions are complicated enough in their own right), but OP thinking that he/she can convert to a Roth IRA and then immediately withdraw the funds and avoid the 10% penalty is a grave mistake (assuming a non-qualified distribution).

-gauss

It is complicated, to be sure. From the OP:

However, you CAN roll over your ROTH 401k to a ROTH IRA, with no taxes or penalties. And once there, at any age, you can withdraw what you have personally contributed without any taxes or penalties at all. (Provided that ROTH IRA account has existed for at least 5 years).

A credible source to back this up:

https://www.schwab.com/ira/roth-ira/withdrawal-rules

Age 59 and under

You can withdraw contributions you made to your Roth IRA anytime, tax- and penalty-free. However, you may have to pay taxes and penalties on earnings in your Roth IRA.

Withdrawals from a Roth IRA you've had more than five years.

If you're under age 59½ and your Roth IRA has been open five years or more,1 your earnings will not be subject to taxes if you meet one of the following conditions:

You use the withdrawal (up to a $10,000 lifetime maximum) to pay for a first-time home purchase.
You use the withdrawal to pay for qualified education expenses.
You're at least age 59½.
You become disabled or pass away.
You use the withdrawal to pay for unreimbursed medical expenses or health insurance if you're unemployed.
The distribution is made in substantially equal periodic payments.1

You can withdraw only the contributions, as far as I'm able to tell from various sources.

 

[gauss]

^ Contributions in this context are the annual IRA contributions only.

Rollovers from employer plans and Roth conversions are not considered contributions and are handled differently if under 59 /12 (or otherwise non-qualified).

Instructions 2019 IRS From 5329

Recapture amount subject to the
additional tax on early distributions.
If you converted or rolled over an
amount to your Roth IRAs in 2015
through 2019 and you received an early
distribution for 2019, the recapture
amount you must include on line 1 is the
amount, if any, of the early distribution
allocated to the taxable portion of your
2015 through 2019 conversions or
rollovers.
[stuff deleted]
For more information about the
recapture amount for distributions from
a Roth IRA, including how to figure it,
see Ordering Rules for Distributions
under Are Distributions Taxable? in
chapter 2 of Pub. 590-B. Also, see the
Example next, which illustrates a
situation where a taxpayer must include
a recapture amount on line 1.

-gauss

 

[gauss]

Right, but that is not what he said.

Agreed! I quoted you in that I thought you were the last entry on that topic, not that I was correcting what you said.

I will try to be more selective in my forum quoting going forward

Thanks

-gauss

 

[gwraigty]

^ Contributions in this context are the annual IRA contributions only.

Rollovers from employer plans and Roth conversions are not considered contributions and are handled differently if under 59 /12 (or otherwise non-qualified).

Instructions 2019 IRS From 5329



-gauss

The example in the IRA instructions that follows what you quoted is specific to a conversion from a traditional IRA to a Roth IRA. I'm not going to dig into this any further. Not my problem and not my intent to get into a huge debate over it.

 

[jazz4cash]

I've never heard that. Do you mean ever?

I mean for active employees. It happened to me but they eventually added a rollover provision. I think some short sighted employers and custodians with lousy plans do it to keep people from rolling out of the plan ASAP. Almost every reference for 401k rollovers refers to ex-employers. Here’s a reference that backs up my statement for active employees:
https://finance.zacks.com/roll-over-401k-still-working-8501.html

 

[armor99]

The example in the IRA instructions that follows what you quoted is specific to a conversion from a traditional IRA to a Roth IRA. I'm not going to dig into this any further. Not my problem and not my intent to get into a huge debate over it.

I was not trying to get anyone heated as part of this conversation. I was just wondering if I had it right? Looks like there are differences of opinion. At some point I will have to go ask a retirement person, just to make sure. I figure I have 10 years or so to go. If I cannot do this, I might have to investigate other things...

 

[gwraigty]

I was not trying to get anyone heated as part of this conversation. I was just wondering if I had it right? Looks like there are differences of opinion. At some point I will have to go ask a retirement person, just to make sure. I figure I have 10 years or so to go. If I cannot do this, I might have to investigate other things...

By all means, ask someone. I wasn't getting heated because of anything you said. As I've said, I believe your understanding is correct. It matches with what I've been able to find on the subject. I haven't been able to find any source that claims that Roth 401k rollovers to a Roth IRA aren't given the same tax treatment as direct Roth IRA contributions. Some people aren't given access to Roth contributions (or After-Tax) in their 401k and don't understand these things.

Here is a helpful, one page PDF:

Roth IRA Distribution Ordering Rules

 

[BigBob]

I retired 3 years ago at 55 and have withdrawn from my 401k during that time. My company will not allow me to roll my Roth 401k to my Roth it a without moving everything out. Ymmv.

 

[RxMan]

I have an existing Roth IRA I’ve been contributing to for over 5 years. My current job has a Roth 401k option that I am participating in for the last year. I’m hoping that when I leave/retire I will be able to roll over the Roth 401k directly into my existing Roth IRA and the 5 year rule will be satisfied.