Roth IRA Contributions Withdrawal Question

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strikefinder
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Roth IRA Contributions Withdrawal Question

Post by strikefinder » Thu Apr 26, 2018 7:05 pm

Hi all; I'm a long time lurker but first time poster...would appreciate your help in sorting out something I'm thinking about, and despite a few hours of Googling I haven't been able to come to a definitive answer.

We're a family of four, my wife and I late thirties, and in relatively good financial shape. We're currently maxing out the tax-sheltered contributions to my 401(k), her 403(b), and the state maximum for the two kids' 529 plans ($10,000), along with a decent 401(k) match for me (about 8%).

However, I think there's a non-zero chance that circumstances in my job will change in the next two years and I may have to make a jump to a lower-paying job (About 4/5 of our income is from my job). As such, I'm trying to reconfigure my savings so that if we need to draw on savings for a period, the money is as accessible as possible. However, the most likely outcome is that nothing will change...just trying to hedge my bets. My gut is that I should start bulking up the emergency fund balance just in case something goes sideways, but with current spending needs, I'd have to pull back the 401(k) contributions to add to the taxable account buffer.

I have a Roth IRA that's been open since 2010, which was just rolled over in a trustee transfer to a different provider. We incomed out a few years ago and haven't been able to contribute recently. My employer has a Roth 401(k) option, so my thought is this:
  • Stop contributing to the 401(k) ($18,500)
  • Contribute as much as possible (i.e. don't reduce take-home pay) to come as close to max to the Roth 401(k) as possible (let's say about $14,000), and at least enough to maintain maximum employer match
  • If nothing changes at my job, then reassess in a few years whether contributing to the 401(k) or Roth 401(k) is better, but otherwise maintain status quo.
  • However, if I have to leave my job and need cash, rollover Roth 401(k) after separation to Roth IRA and then withdraw principal as absolutely necessary (to avoid that split between earnings and contributions that I'd face a penalty on from the Roth 401(k)).
I have savings in laddered taxable accounts and the contributions to the existing Roth IRA to draw on, and, in a real bad case, the 529s first. But if all hell breaks loose, I'd be padding my retirement accounts with money that I could withdraw penalty free if absolutely necessary while keeping it sheltered if that doesn't happen and maintaining my company match. Any thoughts? Is this totally crazy logic? Am I missing anything?

ThriftyPhD
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Re: Roth IRA Contributions Withdrawal Question

Post by ThriftyPhD » Thu Apr 26, 2018 7:30 pm

strikefinder wrote:
Thu Apr 26, 2018 7:05 pm
I have a Roth IRA that's been open since 2010, which was just rolled over in a trustee transfer to a different provider. We incomed out a few years ago and haven't been able to contribute recently.
What does this mean? You make too much to contribute to a Roth IRA (MAGI > $199k)? If so consider a Backdoor Roth IRA. Takes a bit of reading to make sure you understand the mechanics, but it is an option so that you can get money into a Roth IRA.
strikefinder wrote:
Thu Apr 26, 2018 7:05 pm
the state maximum for the two kids' 529 plans ($10,000),

...

Contribute as much as possible (i.e. don't reduce take-home pay)
Lots of debate on the 529, but I'm in the camp that you should always ensure your own retirement savings before contributing to a 529.

Given that, assuming your income is high enough that you're in the 24%+ tax bracket, and you can't reduce your take home, I would:

1. Keep the max 401k/403b as pre-tax.
2. Drop the 529s and put the $10k into Backdoor Roth IRAs. If more money is available, max the Backdoor Roths, then go back to the 529s.

strikefinder
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Re: Roth IRA Contributions Withdrawal Question

Post by strikefinder » Thu Apr 26, 2018 7:38 pm

ThriftyPhD wrote:
Thu Apr 26, 2018 7:30 pm
What does this mean? You make too much to contribute to a Roth IRA (MAGI > $199k)? If so consider a Backdoor Roth IRA. Takes a bit of reading to make sure you understand the mechanics, but it is an option so that you can get money into a Roth IRA.
Yep, MAGI > $199k. The backdoor Roth would be tricky because I have a traditional IRA with about $200k in it. I think avoiding the pro-rata rule would be complicated.
Lots of debate on the 529, but I'm in the camp that you should always ensure your own retirement savings before contributing to a 529.
Totally agree. However, I'm already putting away $37,000 to the 401(k), along with a 401(k) match of about $12,000. I could go mega backdoor with my employer, but felt like balancing out the contributions (plus eligible for state income tax deduction) using the 529 seemed reasonable. I'm not sure how withdrawals would go from the mega-backdoor roth, either--since it was an after-tax 401(k) which is converted to a Roth 401(k), I don't know the rules that would apply.
Given that, assuming your income is high enough that you're in the 24%+ tax bracket, and you can't reduce your take home, I would:
1. Keep the max 401k/403b as pre-tax.
2. Drop the 529s and put the $10k into Backdoor Roth IRAs. If more money is available, max the Backdoor Roths, then go back to the 529s.
My only issue with this is that I'd need to rearrange the whole portfolio to avoid the pro-rata rule to use the Backdoor Roths. I'm reluctant to go that route, meaning the only tax-advantaged space I have is the Mega Backdoor route or the 529.

ThriftyPhD
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Re: Roth IRA Contributions Withdrawal Question

Post by ThriftyPhD » Thu Apr 26, 2018 7:50 pm

Can you roll the tradition IRA into your 401k? Does your wife have a traditional IRA? If not, she could do a Backdoor Roth.

If you are eligible to do a Mega Backdoor, do you have the option to roll the after tax out to a Roth IRA rather than an In Plan Roth Rollover (IRR)? If so, you might be able to direct contributions to Roth IRA, earnings to traditional IRA (which can often be rolled back into the pre-tax 401k). Then if needed, you can withdraw the contributions (not growth) tax and penalty free.

strikefinder
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Re: Roth IRA Contributions Withdrawal Question

Post by strikefinder » Thu Apr 26, 2018 10:18 pm

ThriftyPhD wrote:
Thu Apr 26, 2018 7:50 pm
Can you roll the tradition IRA into your 401k? Does your wife have a traditional IRA? If not, she could do a Backdoor Roth.
I'm reluctant (though considering) rolling the traditional IRA into the 401(k). I like being able to have greater control over the Traditional, but it would give me the space for the backdoor Roth. I hadn't considered my wife...I had assumed that the taxation would be on both of us, but she doesn't have a traditional IRA, so that could be an option.
If you are eligible to do a Mega Backdoor, do you have the option to roll the after tax out to a Roth IRA rather than an In Plan Roth Rollover (IRR)?
I don't think so, but I'll check.
If so, you might be able to direct contributions to Roth IRA, earnings to traditional IRA (which can often be rolled back into the pre-tax 401k). Then if needed, you can withdraw the contributions (not growth) tax and penalty free.
I was under the impression that you couldn't withdraw contributions on conversions for 5 years. Since the mega backdoor would be after-tax 401(k), then converted to Roth, I assume I couldn't touch the principal (without penalty) for 5 years...which normally wouldn't be a problem, but the whole issue is that I might need the cash on a 2-year timeframe. And, actually, isn't that true of the backdoor Roth (which is also a conversion) as well?

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Epsilon Delta
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Re: Roth IRA Contributions Withdrawal Question

Post by Epsilon Delta » Thu Apr 26, 2018 10:48 pm

strikefinder wrote:
Thu Apr 26, 2018 10:18 pm
I was under the impression that you couldn't withdraw contributions on conversions for 5 years. Since the mega backdoor would be after-tax 401(k), then converted to Roth, I assume I couldn't touch the principal (without penalty) for 5 years...which normally wouldn't be a problem, but the whole issue is that I might need the cash on a 2-year timeframe. And, actually, isn't that true of the backdoor Roth (which is also a conversion) as well?
You can withdraw Roth IRA contributions tax and penalty free at any time.

You can withdraw conversions tax free at any time. There is a 10% penalty on the taxable part of the conversion if withdrawn within 5 years. However the bulk of the conversion that is part of a normal or mega backdoor Roth is not taxable, and this non-taxable part of a conversion can be withdrawn tax and penalty free at any time.

The ordering rules mean that you need to take out any taxable part of each conversion first, so you probably can't get zero penalty. But if you do the backdoor Roth properly the taxable part of the conversion is only the few days earnings while the money was in the traditional IRA or 401(k) so the 10% penalty is only on a few tens of dollars and is negligible.

strikefinder
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Re: Roth IRA Contributions Withdrawal Question

Post by strikefinder » Thu Apr 26, 2018 11:17 pm

Epsilon Delta wrote:
Thu Apr 26, 2018 10:48 pm
You can withdraw conversions tax free at any time. There is a 10% penalty on the taxable part of the conversion if withdrawn within 5 years. However the bulk of the conversion that is part of a normal or mega backdoor Roth is not taxable, and this non-taxable part of a conversion can be withdrawn tax and penalty free at any time.
If I understand you correctly:

I put $5000 in the after-tax 401(k), and a week later convert it to Roth 401(k) through mega backdoor Roth. Let's say in that week it went up $100 to $5100. Now, two years later, the account is worth $7000, and I want to withdraw $3000 from it. I would have to withdraw the $100 difference and pay marginal income taxes on it + 10% penalty (so, more or less $34), and the next $2900 comes from the contributions without taxes or penalties. Is that correct? I wouldn't start to get into "earnings" until I hit $5100 of withdrawals, correct?

That all said, it doesn't entirely address my initial question one way or another. The bottom line is I have about $37,000 in pre-tax money and another $10,000 in after tax money to invest per year, and I want to maximize what I can make available in an emergency on a 2 year horizon. My original thought was to redirect the 401k contribution to a Roth 401k instead (adjusting for the tax burden) because the Roth 401(k) allows contribution withdrawals, whereas the 401k does not. Even if I redirected the 529 funds to the mega backdoor Roth, couldn't I further increase my available "emergency" funds by using the Roth 401(k) in lieu of the regular 401(k)?

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Epsilon Delta
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Re: Roth IRA Contributions Withdrawal Question

Post by Epsilon Delta » Fri Apr 27, 2018 12:30 am

strikefinder wrote:
Thu Apr 26, 2018 11:17 pm
Epsilon Delta wrote:
Thu Apr 26, 2018 10:48 pm
You can withdraw conversions tax free at any time. There is a 10% penalty on the taxable part of the conversion if withdrawn within 5 years. However the bulk of the conversion that is part of a normal or mega backdoor Roth is not taxable, and this non-taxable part of a conversion can be withdrawn tax and penalty free at any time.
If I understand you correctly:

I put $5000 in the after-tax 401(k), and a week later convert it to Roth 401(k) through mega backdoor Roth. Let's say in that week it went up $100 to $5100. Now, two years later, the account is worth $7000, and I want to withdraw $3000 from it. I would have to withdraw the $100 difference and pay marginal income taxes on it + 10% penalty (so, more or less $34), and the next $2900 comes from the contributions without taxes or penalties. Is that correct? I wouldn't start to get into "earnings" until I hit $5100 of withdrawals, correct?

That all said, it doesn't entirely address my initial question one way or another. The bottom line is I have about $37,000 in pre-tax money and another $10,000 in after tax money to invest per year, and I want to maximize what I can make available in an emergency on a 2 year horizon. My original thought was to redirect the 401k contribution to a Roth 401k instead (adjusting for the tax burden) because the Roth 401(k) allows contribution withdrawals, whereas the 401k does not. Even if I redirected the 529 funds to the mega backdoor Roth, couldn't I further increase my available "emergency" funds by using the Roth 401(k) in lieu of the regular 401(k)?
I have probably mislead you. I am certain of the rules for a Roth IRA withdrawals but not for Roth 401(k) withdrawals. So what I say stands for backdoor Roth IRA contributions and mega backdoor Roth contributions that are rolled into a Roth IRA, but not for in plan Roth Rollovers (IRR).

Normally you couldn't make a withdrawal from a Roth 401(k) while you remain employed. However you can often take a loan from a 401(k) which gives you access to the money.

If you separate from employment you can usually roll the Roth 401(k) into a Roth IRA. The rules for tracking basis and the 10% penalty in this situation lack the elegant simplicity :twisted: of the Roth IRA rules (i.e. I don't fully understand them).

One thing that is clear is that if you do not have any traditional IRAs you are better off using a backdoor Roth IRA contribution than an 401(k) inplan Roth Rollover. Similarly if the 401(k) plan allows any mega backdoor Roth is better rolled over to a Roth IRA. So i

chevca
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Re: Roth IRA Contributions Withdrawal Question

Post by chevca » Fri Apr 27, 2018 7:01 am

Why not just keep doing what you're doing and IF the job situation changes adjust your savings rate then? Keep it simple.

You seem to want to save or stash some money, so if there's a job change you could continue your exact same lifestyle and savings plan. If you went to a 4/5 income situation, you could afford you same lifestyle, right? Maybe just not save quite as much then? Maybe the 529 contributions go away then.

Alan S.
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Re: Roth IRA Contributions Withdrawal Question

Post by Alan S. » Fri Apr 27, 2018 11:20 am

strikefinder wrote:
Thu Apr 26, 2018 11:17 pm
Epsilon Delta wrote:
Thu Apr 26, 2018 10:48 pm
You can withdraw conversions tax free at any time. There is a 10% penalty on the taxable part of the conversion if withdrawn within 5 years. However the bulk of the conversion that is part of a normal or mega backdoor Roth is not taxable, and this non-taxable part of a conversion can be withdrawn tax and penalty free at any time.
If I understand you correctly:

I put $5000 in the after-tax 401(k), and a week later convert it to Roth 401(k) through mega backdoor Roth. Let's say in that week it went up $100 to $5100. Now, two years later, the account is worth $7000, and I want to withdraw $3000 from it. I would have to withdraw the $100 difference and pay marginal income taxes on it + 10% penalty (so, more or less $34), and the next $2900 comes from the contributions without taxes or penalties. Is that correct? I wouldn't start to get into "earnings" until I hit $5100 of withdrawals, correct?

No, not correct. Assuming your Roth 401k is not yet qualified, any distribution will include a pro rated amount of earnings. This is totally different than the ordering rules for Roth IRA distributions. Your distribution of 3000 is roughly 43% of the balance on the date of distribution, so you would receive 43% of your basis (.43*5100=2193 non taxable) + 43% of your earnings (.43*1900=817 taxable). You would owe the 10% penalty on the 817. In addition, you would also owe 10% on the taxable portion of the IRR (.10*100=10) because you did not hold the IRR (conversion) for 5 years before your distribution. Therefore, the total taxable income would be 817 reported on line 16b of Form 1040 plus a 10% penalty on (817+100) = 92 reported directly on line 59 of Form 1040.

Note that since the IRR was done using distributable funds from the after tax sub account, those funds would generally remain distributable whenever you wish from the Roth 401k. The Roth 401k would need to maintain separate accounting for IRRs from the after tax sub account vs IRRs you may do from the pre tax 401k, since those would not be distributable until a certain age or upon separation. While this is the general treatment, a plan could adopt specific restrictions and limit your in service non hardship distributions from the funds originally sourced to the after tax sub account.



That all said, it doesn't entirely address my initial question one way or another. The bottom line is I have about $37,000 in pre-tax money and another $10,000 in after tax money to invest per year, and I want to maximize what I can make available in an emergency on a 2 year horizon. My original thought was to redirect the 401k contribution to a Roth 401k instead (adjusting for the tax burden) because the Roth 401(k) allows contribution withdrawals, whereas the 401k does not. Even if I redirected the 529 funds to the mega backdoor Roth, couldn't I further increase my available "emergency" funds by using the Roth 401(k) in lieu of the regular 401(k)?

Again, this is not correct. If you make your elective deferrals to the Roth portion, these amounts cannot be distributed in service until age 59.5 at the earliest. So if you want access to these funds before that, doing the mega back door will provide a good chance for access, but as indicated in the above paragraph, always check with the plan. Of course, doing an IRR exposes you to the 10% penalty on the taxable portion of the IRR, but that would typically be very small if you can do the IRRs shortly after you make the after tax non Roth contributions.

strikefinder
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Re: Roth IRA Contributions Withdrawal Question

Post by strikefinder » Fri Apr 27, 2018 9:02 pm

chevca wrote:
Fri Apr 27, 2018 7:01 am
Why not just keep doing what you're doing and IF the job situation changes adjust your savings rate then? Keep it simple.

You seem to want to save or stash some money, so if there's a job change you could continue your exact same lifestyle and savings plan. If you went to a 4/5 income situation, you could afford you same lifestyle, right? Maybe just not save quite as much then? Maybe the 529 contributions go away then.
Unfortunately, my line of work is fairly specialized and I think that if I'm forced to leave my current job, it might be some time (3-5 years) before I'm able to recover more than 50% of my current salary. So I can't change my savings rate then--there likely won't be enough money to save anything, and more likely that I'll be drawing on savings to keep the ship running while the kids get through the daycare phase.

I don't intend to keep my same lifestyle per se, but it would take some time to make adjustments to spending that's already committed. I've got a net worth of upwards of $900,000, but the cash that's accessible without penalties or home sale is currently around $60,000. I'm looking at taking a $120,000 a year haircut (maybe more) if things go south for at least a few years, and the math on that clearly will be a challenge, even with significant adjustments in spending.

I get what you're saying about just bailing on the 529s and putting all that money in something safe and taxable. But I hate forgoing an opportunity to take advantage of a tax shelter when there's a good possibility that I won't need to make a transition...and then I end up with a pile of cash that I can't get back into the sheltered side of things. While I could, I maxed out the Roth IRA contributions because I figured it was a win-win; if I had an emergency, I could pull the contributions back out and I was barely any worse off than had I kept it in taxable, but if I didn't have an emergency (and I never did), then I just ended up with a pile of money in my Roth IRA. I'm fortunate enough that I'm running out of those types of options, I guess.

strikefinder
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Re: Roth IRA Contributions Withdrawal Question

Post by strikefinder » Fri Apr 27, 2018 9:09 pm

No, not correct. Assuming your Roth 401k is not yet qualified, any distribution will include a pro rated amount of earnings. This is totally different than the ordering rules for Roth IRA distributions.
Do you have a reference for how distributions are handled from Roth 401(k) accounts, specifically? When I do a Google search I get 400 articles on the distribution rules for Roth IRAs, but virtually nothing definitive and reliable about the Roth 401(k). I'm not doubting you, I just want to have a copy of the regulation so I can unscrew myself when I forget down the line.
If you make your elective deferrals to the Roth portion, these amounts cannot be distributed in service until age 59.5 at the earliest.
What if I separated from the job? Couldn't I roll the Roth 401(k) directly to my Roth IRA and then withdraw the contributions, since the Roth IRA has been open well more than five years?
Of course, doing an IRR exposes you to the 10% penalty on the taxable portion of the IRR, but that would typically be very small if you can do the IRRs shortly after you make the after tax non Roth contributions.
For what it's worth, I've done this to a small extent in the past and I always do the rollovers immediately after being paid, so the taxable portion has been pretty darned close to 0.

Alan S.
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Re: Roth IRA Contributions Withdrawal Question

Post by Alan S. » Fri Apr 27, 2018 9:42 pm

The taxation of designated Roth contributions are addressed in Q 3 of the following IRS Reg:

https://www.law.cornell.edu/cfr/text/26/1.402A-1

Re your Q 2, my comment referred to "in service distributions". You could of course roll out the Roth 401k balance immediately after separating from service to your Roth IRA. The character of the Roth 401k dollars is then integrated into the Roth IRA ordering rules, and all Roth IRA distributions then follow the Roth IRA ordering rules. So you could do a non taxable direct rollover to your Roth IRA and if your Roth IRA was already qualified, the Roth 401k money rolled into it would become immediately qualified as well.

If your Roth 401k was qualified but NOT your Roth IRA, the entire balance rolled over is treated as regular Roth IRA contributions.
If neither your Roth 401k or your Roth IRA is qualified, the regular Roth 401k deferrals are treated as regular Roth IRA contributions, IRRs are treated as Roth IRA conversions and the 5 year holding period is continuous, and Roth 401k earnings become Roth IRA earnings. You would generally roll your Roth 401k to your Roth IRA prior to the year you reached 70.5 to avoid RMDs on the Roth 401k.

Basically, after a Roth 401k rollover the tax accounting responsibility switches from the employer to the Roth IRA owner.

strikefinder
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Re: Roth IRA Contributions Withdrawal Question

Post by strikefinder » Sat Apr 28, 2018 6:06 am

So you could do a non taxable direct rollover to your Roth IRA and if your Roth IRA was already qualified, the Roth 401k money rolled into it would become immediately qualified as well.
The distribution won't be qualified, because I'm only 38. My Roth IRA has been open about eight years, though...so I'm guessing that I can withdraw the contributions to the Roth 401(k) from the Roth IRA once the rollover is completed. The conversions from 401(A) to Roth would have a rolling 5-year holding period before I could withdraw anything (if I understand correctly).

That's the crux of my thought process. If I put the money in a the regular 401(k), and I separate from my employer, then I don't have access to what I've contributed without penalty. However, if I put an equivalent amount in the Roth 401(k) (after adjusting for tax burden), and then I separate, I have access to the contributions if absolutely necessary without penalty.

The alternative to this would be to reduce contributions to the regular 401(k) and bulk up my taxable investments, but then while I'm covered in an emergency, in three years if everything stabilizes, I can't get all that money back into a tax shelter now that things have calmed down...and I risk losing the company match, which is substantial.

Once I fill up the Roth 401(k) and the 403(b), the next question seems to be 529 vs Mega Backdoor. The latter would have a five-year rolling period before I'd have access to contributions if I'm understanding correctly, rolled over or not. Same goes for the non-Mega backdoor Roth. I know that the 529 withdrawal rules would force me to pay taxes on a portion of earnings, but I'd otherwise have access to contributions, so from an emergency planning standpoint, that seems like my next step. If I can then max that out and still have cash left, I either bulk up on taxable or then move to the Mega Backdoor.

In a few years if everything stabilizes and I'm not concerned about a job transition, then I'm thinking I'll stop contributing to the 529s and switch back to the Mega Backdoor until I hit the limit. But for now, the 529s seem like they have better accessibility in an emergency, so I feel more comfortable using them as the next step in the ladder.

Appreciate all the thoughts...I think it's sharpened my thinking quite a bit.

Alan S.
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Re: Roth IRA Contributions Withdrawal Question

Post by Alan S. » Sat Apr 28, 2018 11:47 am

strikefinder wrote:
Sat Apr 28, 2018 6:06 am
So you could do a non taxable direct rollover to your Roth IRA and if your Roth IRA was already qualified, the Roth 401k money rolled into it would become immediately qualified as well.
The distribution won't be qualified, because I'm only 38. My Roth IRA has been open about eight years, though...so I'm guessing that I can withdraw the contributions to the Roth 401(k) from the Roth IRA once the rollover is completed. The conversions from 401(A) to Roth would have a rolling 5-year holding period before I could withdraw anything (if I understand correctly).
Correct, when neither your Roth 401k or Roth IRA are qualified, after a rollover to the Roth IRA your Roth 401k deferrals (amount shown in Box 5 of 1099R) are treated as regular Roth IRA contributions and can be distributed tax and penalty free anytime. Amounts allocated to IRRs done more than 5 years back can likewise be distributed without tax and penalty. If you did an IRR from your after tax contributions to the pre tax account, those IRRs will have a very small taxable amount. If you distribute these amounts from your Roth IRA, you will only owe the penalty on the small taxable amount of the IRRs under 5 years, and this penalty will also be very small unless you do IRRs from the taxable portion of your 401k, which is not likely.

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