Tax treatment of Roth IRA withdrawals with ROTH 401k rollover

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passive_investor
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Tax treatment of Roth IRA withdrawals with ROTH 401k rollover

Post by passive_investor » Mon Feb 12, 2018 4:26 pm

Hi all,

I have tried to find the answer to this but haven't been able to. I know that the Roth IRA contributions can be withdrawn tax and penalty free any time. However, what if I contribute and max my Roth 401k with my employer and then convert it to Roth IRA when I quit. In that case, can all the contributions in Roth 401k rolled into the Roth IRA account be withdrawn penalty free and tax free or will the "pro-rata" rule come into picture in some shape or form.

For this situation, please assume that the Roth IRA account is already 5 year old (not sure if it matters for withdrawal of contributions). Any help in this regard will be really appreciated.


Thanks

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David Jay
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Re: Tax treatment of Roth IRA withdrawals with ROTH 401k rollover

Post by David Jay » Mon Feb 12, 2018 4:44 pm

Using your assumption that the destination Roth IRA has been open for more than 5 years (it does matter, if you had no Roth IRA and you opened your first one to receive the rollover, the 5 year clock starts over from zero):

1. All contributions from the rollover may be taken out tax free (note: Roth 401K Trustee must provide the documentation to the Roth IRA trustee of the cost basis of the rollover. Verify that this has been done.)

2. All earnings from the rollover may be taken out tax free after age 59.5
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

passive_investor
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Re: Tax treatment of Roth IRA withdrawals with ROTH 401k rollover

Post by passive_investor » Mon Feb 12, 2018 4:56 pm

Thanks! Is the 5 year rule applicable only for rollover contributions withdrawals? I thought you could withdraw contributions from Roth IRA anytime without any restriction on the account being more than 5 year old.

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David Jay
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Re: Tax treatment of Roth IRA withdrawals with ROTH 401k rollover

Post by David Jay » Mon Feb 12, 2018 10:00 pm

I found the info here - should have posted the link for your further research: https://www.investopedia.com/articles/r ... llover.asp
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

passive_investor
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Re: Tax treatment of Roth IRA withdrawals with ROTH 401k rollover

Post by passive_investor » Tue Feb 13, 2018 9:50 am

Thanks for the source and clarification. Appreciate your help!

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David Jay
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Re: Tax treatment of Roth IRA withdrawals with ROTH 401k rollover

Post by David Jay » Tue Feb 13, 2018 10:31 am

it's what we try to do at BH...
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

Alan S.
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Re: Tax treatment of Roth IRA withdrawals with ROTH 401k rollover

Post by Alan S. » Tue Feb 13, 2018 12:14 pm

David Jay wrote:
Mon Feb 12, 2018 4:44 pm
Using your assumption that the destination Roth IRA has been open for more than 5 years (it does matter, if you had no Roth IRA and you opened your first one to receive the rollover, the 5 year clock starts over from zero):

1. All contributions from the rollover may be taken out tax free (note: Roth 401K Trustee must provide the documentation to the Roth IRA trustee of the cost basis of the rollover. Verify that this has been done.)

With respect to reporting, this is true when a Roth 401k is transferred to another Roth 401k plan. However, for a direct rollover to a Roth IRA the only data the Roth 401k administrator reports is the 1099R form, which goes to the IRS and participant, not to the Roth IRA custodian. Tax accounting for the Roth IRA that now holds a Roth 401k rollover is entirely the responsibility of the Roth IRA owner. The Roth IRA custodian will leave box 2a blank when reporting a Roth IRA distribution. Most Roth IRA owners hopefully do not need to take distributions until their Roth IRA is qualified. If they do, they probably are not prepared to complete the Form 8606 properly.

Note that if the employee did an in plan Roth rollover (IRR) before rolling to the Roth IRA, the tracking of Roth IRA basis becomes more complex prior to 59.5 because the taxable portion of each IRR must meet a 5 year requirement before it can be distributed without penalty. More simply, you track it as if you did an ordinary Roth IRA conversion in that same year.


2. All earnings from the rollover may be taken out tax free after age 59.5

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David Jay
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Re: Tax treatment of Roth IRA withdrawals with ROTH 401k rollover

Post by David Jay » Tue Feb 13, 2018 12:54 pm

Alan S. wrote:
Tue Feb 13, 2018 12:14 pm
David Jay wrote:
Mon Feb 12, 2018 4:44 pm
Using your assumption that the destination Roth IRA has been open for more than 5 years (it does matter, if you had no Roth IRA and you opened your first one to receive the rollover, the 5 year clock starts over from zero):

1. All contributions from the rollover may be taken out tax free (note: Roth 401K Trustee must provide the documentation to the Roth IRA trustee of the cost basis of the rollover. Verify that this has been done.)

With respect to reporting, this is true when a Roth 401k is transferred to another Roth 401k plan. However, for a direct rollover to a Roth IRA the only data the Roth 401k administrator reports is the 1099R form, which goes to the IRS and participant, not to the Roth IRA custodian. Tax accounting for the Roth IRA that now holds a Roth 401k rollover is entirely the responsibility of the Roth IRA owner. The Roth IRA custodian will leave box 2a blank when reporting a Roth IRA distribution. Most Roth IRA owners hopefully do not need to take distributions until their Roth IRA is qualified. If they do, they probably are not prepared to complete the Form 8606 properly.

Note that if the employee did an in plan Roth rollover (IRR) before rolling to the Roth IRA, the tracking of Roth IRA basis becomes more complex prior to 59.5 because the taxable portion of each IRR must meet a 5 year requirement before it can be distributed without penalty. More simply, you track it as if you did an ordinary Roth IRA conversion in that same year.


2. All earnings from the rollover may be taken out tax free after age 59.5
From the man, himself.

You are responsible to understand how much of the rollover is contributions, how much is growth.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

passive_investor
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Re: Tax treatment of Roth IRA withdrawals with ROTH 401k rollover

Post by passive_investor » Tue Feb 13, 2018 2:18 pm

If I start contributing to a Roth 401k, it will be thru Vanguard because they manage our employer plans. If and when I roll it over to a Roth IRA, it will be again into a Roth IRA managed by Vanguard. Will figuring out contributions from earnings still be difficult if I intend to withdraw the contributions in a few years?

Alan S.
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Re: Tax treatment of Roth IRA withdrawals with ROTH 401k rollover

Post by Alan S. » Tue Feb 13, 2018 2:56 pm

If you have a Roth IRA, you have to keep track of your basis anyway, unless you are very sure you will not need to take a distribution before 5 years and 59.5.

1) Your regular Roth IRA basis is the amount of regular contributions you made (less distributions you took). You can withdraw this amount tax and penalty free anytime.

2) Your conversion Roth IRA basis is the amount you converted (less distributions of conversions) and the year (because you must hold your conversions 5 years to avoid the 10% penalty up to age 59.5. For conversions under 5 years you also need to note how much was taxable and non taxable when you did the conversion. These conversions come out in order of oldest first.

At anytime the amount of your Roth IRA exceeds the amounts above, the excess are gains. They come out last and are subject to tax and penalty before your Roth is qualified.

Now when you roll over a Roth 401k, you have to incorporate the amounts into the above system by categorizing them correctly. The 1099R reporting your direct rollover from Roth 401k to Roth IRA will include an amount in Box 5 that shows your basis from contributions. You simply add that amount to category 1 above, treating it as regular Roth IRA contributions.

If you did any In plan Roth rollovers (IRRs) which are conversions from pre tax 401k to Roth 401k, you will incorporate those amount into your Roth conversions category 2 above.

You never have to track earnings because earnings are automatically whatever is left after you have withdrawn all of your basis. You can keep track of your Roth IRA status by a spredsheet or simple paper tally sheet. Once your reach 59.5 and 5 years for your Roth IRA, you no longer need any of this detail and will no longer have to file Form 8606 to report distributions.

passive_investor
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Re: Tax treatment of Roth IRA withdrawals with ROTH 401k rollover

Post by passive_investor » Wed Feb 14, 2018 9:56 am

Thank you Alan for the detailed response, it is very helpful. My situation is quite straightforward.

I have a Roth IRA for myself and my wife and I am maxing out both of them for last 5 years ($5500 x 5) in both the accounts. Both Roth IRAs also have earnings of about $5500 each.

I don't have a Roth 401k yet, I contribute to 401k and max it out. However, I am not a US citizen and plan to relocate to my home country i.e. India in 2-3 years. When I relocate, I will most likely either leave the 401k AS-IS or will do a phased withdrawal over 2-3 years to minimize the effect of penalty + taxes. That's because I will be exempt from paying any taxes in India for 2-3 years (called RNOR period) and all I need to worry about during that time is to minimize my tax liability in US.

That's why I was thinking of also switching my contributions from 401k to Roth 401k. The rationale was, I will withdraw the contributions from Roth 401k after rolling it over in Roth IRA (tax free in my home country) as well as what was contributed to Roth IRAs originally, and leave the earnings from Roth IRAs and the Roth 401k (rolled over to the Roth IRA) for them to grow.

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