New and confused about Roth, rollovers and taxes

[hnzw_rui]

Hello! I'm a single 30-year-old still living with my parents. It's cheaper for all involved that way since we split the household expenses. I expect I'll probably still be living with and helping my parents when they retire. I plan to retire in 25 years at age 55. I work for the government so that's made easier since I can expect a pension (with COLA) and health benefits.

Our Section 457(b) Deferred Compensation Plan administrator recently released an online retirement calculator tool which I played with. Assuming a life expectancy of 100 years (45 years in retirement) and 3% rate of return, according to the calculator, I can expect to receive 130% of my income net of pension and deferred comp contributions thanks to a recent promotion. Pension will be able to cover 100% of net income while the deferred comp is pretty much just gravy. This has made me somewhat concerned about future taxes. At first, I was planning on just leaving the funds in the deferred comp account but then I learned you need to take RMDs starting age 70 1/2. Now, I'm left trying to diversify taxes on retirement savings both to try to minimize taxes now and in the future.

I've started maxing out my Roth IRA since that one's a no-brainer. Our 457b plan recently introduced a Roth option so for now I've split new contributions between Roth and non-Roth. I also started contributing $50/pay period to a taxable brokerage account last year and had planned on increasing it a little every year as I receive salary step increases over the next 4 years. Unfortunately, I don't have $18K a year to max out my deferred comp so I'm wondering if I'd be better off diverting contributions from the taxable account to the Roth 457b. Both the Roth 457b and taxable brokerage contributions will be after tax. However, Roth earnings will be tax free while earnings in the taxable acoount will be subject to long term capital gains. Disadvantage of Roth 457b is I can't touch the contributions and earnings until I retire (aside from loan).

TL; DR
On Roth IRA, you can withdraw contributions at anytime. My question is this: If you roll over funds from a designated Roth account, will the basis of the rolled over funds be considered part of your contributions that can be withdrawn anytime without penalty? Thanks!

 

[gauss]

You may wish to check out the calculator/optimizer over at Optimal Retirement Planner - Parameter Form if you have not done so already

It will allow you to model, over a lifetime, an optimal year by year strategy to maximize your net worth (especially w.r.t. taxes roth conversions etc.)

It is based on current law however, but they do tend to update it as the law changes.

On Roth IRA, you can withdraw contributions at anytime. My question is this: If you roll over funds from a designated Roth account, will the basis of the rolled over funds be considered part of your contributions that can be withdrawn anytime without penalty?

Rollovers are not contributions, they are handled very differently!

With regards to non-qualified Roth IRA withdrawals, as you correctly point out, your Roth contributions will not be taxed. There are ordering rules that determine which funds come out first (basically all the contributions, followed by all the conversions (and transfers from employer plans), followed by growth). IRS Publication 590 B has all the details. IRS Form 8606 line 22 and line 24 calculate this for your tax return.

Be sure to track your basis in any Roth Contributions and/or Roth Conversions/Rollovers separately. You will need them to fill out 8606 as described above. Also track the dates of the conversions/rollovers separately. A separate 5 year waiting period applies to each conversion/rollover in order for it to be withdrawn tax-free prior to age 59 1/2. It wasn't until I attempted to model taking large amounts out of my Roth IRA prior to age 59 1/2 by completing a pro-forma tax return (with software) that I became aware of all these requirements. I think that I will need 22 years of financial information to do this correctly when I start withdrawing conversions/rollovers before age 59 1/2.

Fortunately, you can get an IRS income transcripts for free that show all W-2s 1099 and 5498s for a given Social Security number. The IRS maintains the prior 10 years of these income transcripts. They can be accessed immediately online at http://www.irs.gov/Individuals/Get-Transcript.

It is a probably a good idea for everyone to register at this site to prevent identity thieves from registering before you do and accessing all of your information.

-gauss

 

[hnzw_rui]

You may wish to check out the calculator/optimizer over at Optimal Retirement Planner - Parameter Form if you have not done so already

It will allow you to model, over a lifetime, an optimal year by year strategy to maximize your net worth (especially w.r.t. taxes roth conversions etc.)

It is based on current law however, but they do tend to update it as the law changes.

Thanks. Played around with it a bit but the inflation-adjusted numbers tend to be too awe-inspiring. I'm gonna have to try it again with inflation at 0% but adjusting estimated yields and gains by -3% to account for inflation so I can see all numbers in "today's dollars".

Rollovers are not contributions, they are handled very differently!

With regards to non-qualified Roth IRA withdrawals, as you correctly point out, your Roth contributions will not be taxed. There are ordering rules that determine which funds come out first (basically all the contributions, followed by all the conversions (and transfers from employer plans), followed by growth). IRS Publication 590 B has all the details. IRS Form 8606 line 22 and line 24 calculate this for your tax return.

Be sure to track your basis in any Roth Contributions and/or Roth Conversions/Rollovers separately. You will need them to fill out 8606 as described above. Also track the dates of the conversions/rollovers separately. A separate 5 year waiting period applies to each conversion/rollover in order for it to be withdrawn tax-free prior to age 59 1/2. It wasn't until I attempted to model taking large amounts out of my Roth IRA prior to age 59 1/2 by completing a pro-forma tax return (with software) that I became aware of all these requirements. I think that I will need 22 years of financial information to do this correctly when I start withdrawing conversions/rollovers before age 59 1/2.

See, that's just the thing. I'm aware of the 5-year rule for conversions but I was reading Form 8606 (and Instructions), Form 5329 (and Instructions) and Publication 590-B. Here's an excerpt from the Instructions for Form 8606 Line 22:

Figure the amount to enter on line 22 as follows.

• If you did not take a Roth IRA distribution before 2014 (other than an amount rolled over or recharacterized or a returned contribution), enter on line 22 the total of all your regular contributions to Roth IRAs for 1998 through 2014 (excluding rollovers from other Roth IRAs and any contributions that you had returned to you), adjusted for any recharacterizations.
• Increase the amount on line 22 by any amount rolled in from a designated Roth account that is treated as investment in the contract.

and this from Publication 590-B

Distributions of conversion and certain rollover contributions within 5-year period. 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. You generally must pay the 10% additional tax on any amount attributable to the part of the amount converted or rolled over (the conversion or rollover contribution) that you had to include in income (recapture amount). A separate 5-year period applies to each conversion and rollover. See Ordering Rules for Distributions, later, to determine the re-capture amount, if any.

To me, this suggests the basis portion of rollovers from designated Roth accounts (Roth 401(k), Roth 457(b), etc) are exempt from the early distribution penalty and are treated the same as Roth IRA contributions. Of course, that's just based on my layman understanding. Any tax professionals or lawyers out there who can clarify?

Mind, from age 55 to 59 1/2, I can draw from the tax-deferred portion of the deferred comp account in case I need to supplement my pension. Only reason I'm asking this question is because I'm contemplating contributing to the Roth 457(b) account in lieu of a taxable account. Just seems a shame not to max out the tax advantaged accounts first before investing in taxable accounts.

Fortunately, you can get an IRS income transcripts for free that show all W-2s 1099 and 5498s for a given Social Security number. The IRS maintains the prior 10 years of these income transcripts. They can be accessed immediately online at Get Transcript.

It is a probably a good idea for everyone to register at this site to prevent identity thieves from registering before you do and accessing all of your information.

Very good advice. Will have the whole family do this.

 

[kaneohe]

You can ask your question about the Roth 457 rollover in the retirement forum at fairmark.com. Alan S. will know the answer.
Fairmark Forum

 

[hnzw_rui]

You can ask your question about the Roth 457 rollover in the retirement forum at fairmark.com. Alan S. will know the answer.
Fairmark Forum

Thank you very, very, very much for the link! Didn't even have to post a question. It's already covered in one of their articles regarding Roth accounts. It seems like yes, designated Roth contributions rolled over to a Roth IRA are treated the same as direct Roth IRA contributions. It's just that the account opening date doesn't carry over from the designated Roth account. And really, that only matters if you've had the Roth IRA shorter than the Roth 401k account and you're already age 59½ and need to make a qualified distribution.

Rollovers from Designated Roth Accounts - Fairmark.com Fairmark.com

Rolling to a Roth IRA

Money you withdraw from a Roth 401k or similar account can generally be rolled to a Roth IRA. (There are exceptions for certain kinds of distributions, such as a distribution you take to correct an excess contribution.) In this case you don’t have to use a direct rollover, although that approach is highly recommended to avoid potential problems. There’s an important hitch in these rules, however: the years of participation in the designated Roth account don’t count toward the five-year requirement to take tax-free distributions from a Roth IRA. That rule doesn’t make much sense, but for now at least we have to live with it.


In most cases this will not present a problem because the rules for Roth IRAs allow you to withdraw your basis tax-free even when you take a nonqualified distribution. Your basis is the amount you contributed to the designated Roth account if your rollover is a nonqualified distribution. If you roll over a qualified distribution, the entire amount of the rollover becomes basis in your Roth IRA.


Example: Over a period of six years you contribute $65,000 to a Roth 401k account. Then you leave that company and roll the entire account, worth $100,000, to a Roth IRA. Before this rollover, you didn’t have a Roth IRA.


Even though you’ve had the Roth 401k account more than five years, this is a nonqualified distribution if you aren’t over 59½ or disabled. In that case you would get $65,000 of basis in your Roth IRA. You would be able to withdraw up to $65,000 tax-free any time you want. To withdraw more than that amount tax-free you’ll have to wait five years (and be over 59½ or disabled).


If you’re over 59½ or disabled at the time the money comes out of the Roth 401k, you’re rolling a qualified distribution. The entire $100,000 is included in your basis for the Roth IRA, but you still don’t get to transfer the holding period from the Roth 401k. That means you can withdraw up to $100,000 from the Roth IRA tax-free any time you want, but you’ll have to wait five years before you can take a tax-free withdrawal of any additional earnings in the account.


Although you don’t get to count the years you held the Roth 401k before the rollover, you do get to count any time you held a Roth IRA. For example, if you held a Roth IRA three years before the rollover, you would only have to wait two years after the rollover to meet the five-year requirement.

 

[kaneohe]

Wow, I'm impressed.........you've been busy. Glad the link was helpful.
Would it be correct to say that a rollover from a Roth 401K to a Roth IRA is
similar to a rollover from a Roth IRA (considered to be of 0 yrs age even tho it could have earnings) to another Roth IRA . Basis remains basis and it takes on the age of the other Roth IRA..........which could be 0 if you just opened it .
And no taxes on the earnings involved in the transfer?

 

[hnzw_rui]

Wow, I'm impressed.........you've been busy. Glad the link was helpful.
Would it be correct to say that a rollover from a Roth 401K to a Roth IRA is
similar to a rollover from a Roth IRA (considered to be of 0 yrs age even tho it could have earnings) to another Roth IRA . Basis remains basis and it takes on the age of the other Roth IRA..........which could be 0 if you just opened it .
And no taxes on the earnings involved in the transfer?

As far as I'm aware, age of your Roth IRA is just the age of your oldest account. With the Roth 401k to Roth IRA rollover, say you've had the Roth 401k for 6 years while your oldest Roth IRA is just 3 years old, the 6 years you've had the Roth 401k doesn't carry over. Your Roth IRA is still considered to be just 3 years old.

That said, yes, it seems basis remains basis so you do need to keep track of your Roth 401k contributions. Need to read up on whether the basis will be pro-rated in case of a partial rollover. And yes, no taxes on earnings rolled over as long as you satisfy the 5-year account and 59 1/2 age minimum for qualified distributions.

 

[kaneohe]

And yes, no taxes on earnings rolled over as long as you satisfy the 5-year account and 59 1/2 age minimum for qualified distributions.

Not sure you're answering the question I asked since your answer sounds like what happens if you withdraw earnings from a Roth IRA.

I was asking if ,when you transferred the Roth 457 basis and earnings from the Roth 457 to the Roth IRA, the earnings were taxed. If you transfer one Roth IRA to another, there are no taxes (regardless of age of acct or owner) so I would think the same thing would be true for Roth 457 to Roth IRA.

 

[hnzw_rui]

Not sure you're answering the question I asked since your answer sounds like what happens if you withdraw earnings from a Roth IRA.

I was asking if ,when you transferred the Roth 457 basis and earnings from the Roth 457 to the Roth IRA, the earnings were taxed. If you transfer one Roth IRA to another, there are no taxes (regardless of age of acct or owner) so I would think the same thing would be true for Roth 457 to Roth IRA.

Earnings are not taxed during rollover. It's pretty much almost like doing a Roth IRA to Roth IRA rollover.

By the way, designated Roth accounts are subject to RMD same as regular 401k and 457b plans so it's probably a good idea to roll it over to Roth IRA for longer tax free compounding. Unlike a Roth conversion, you don't have to pay any taxes in order to roll over from Roth 401k/457b to Roth IRA, anyway.