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Does the guidance in IRS Notice #2014-54 apply to Roth 401k rollovers?

Specifically, is it possible to do a out-of-service rollover on a Roth 401k such that:

  • The earnings are put in the Traditional IRA
  • The basis (original contribution) is put in the Roth IRA?

The goal of this is such that, if necessary, the balance in the Roth IRA is immediately withdrawable without tax or penalty, excluding any earnings on the basis.

In this case, what is the tax treatment of the Roth 401(k) earnings that are now in the IRA? Are they taxed upon withdrawal? I assume the earnings on the earnings are taxable upon withdrawal.

It's also my understanding that all amounts in the Roth IRA, regardless of source, are not taxable as a qualified distribution (age 59 1/2 + 5 year rule).

  • The question should be why you would want to do such a split? When a distribution occurs from a Roth IRA, the original contributions come out first, and only when they are exhausted do the earnings come out. So, rolling over the earnings in a Roth 401k into a Traditional IRA (hopefully as basis so that they don't get taxed on withdrawal) doesn't seem to gain you much. – Dilip Sarwate Aug 30 '15 at 2:11
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    Well suppose, hypothetically, that I have 15,000 in a Roth 401k, 10000 of which is basis and 5000 of which is earnings. My understanding is that if I were to roll that into a new Roth IRA, any distribution that I take would include the taxable portion (5000), subject to taxes + penalty, before the nontaxable portion (10000). For example, if I withdraw 1000 from the new Roth IRA, that would be subject to income tax + 10% penalty whereas if the earnings were sent to the traditional IRA and only the 10000 basis were in the Roth IRA, that 1000 would be tax and penalty free. – arcyqwerty Aug 30 '15 at 14:36
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The answer to your question is No. Roth 401k can only be rolled over into Roth IRA, never into Traditional. Traditional 401k (which the notice is about), on the other hand, can be rolled over into Traditional IRA or Roth IRA.

But, what you want to achieve is already achieved by a rollover into Roth IRA (and only Roth IRA) -- the contribution amounts in Roth 401k will be counted as contributions in Roth IRA, which can be withdrawn at any time (including immediately) with no tax or penalty; the earnings amounts in the Roth 401k will be counted as earnings in the Roth IRA. Contributions always come out first in a withdrawal, so you can withdraw (all or part of) the contribution amounts without any tax or penalty.

Furthermore, if your goal is to immediately withdraw the contributions from the Roth 401k, you don't even need to rollover the contributions amounts into the Roth IRA to do this -- you can just take all the money out of the Roth 401k, rollover at least the earnings part to the Roth IRA, and keep (all or part of) the earnings part yourself (as a withdrawal). The rollover to Roth IRA will automatically consist of earnings first, which means your withdrawal will consist of contributions, which means no tax or penalty.

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Not quite as you ask. You see, the earnings of a Roth 401(k) are intended to not be taxed, ever. So the Roth 401(k) rolls right to a Roth IRA with no tax consequence. Any employer match would be in a traditional 401(k) and therefore roll to a Traditional IRA.

  • How is the new Roth IRA balance treated with regard to contributions/earnings? Is any part of it withdrawable without tax or penalty, as contributions would be if they had been made directly to a Roth IRA? – BrenBarn Aug 29 '15 at 22:01
  • I believe the 'basis' is identified as such, and the growth is non-penalized only after age 59-1/2 – JoeTaxpayer Aug 29 '15 at 22:22
  • One other thing to keep in mind is that the Roth IRA starts its own 5-year clock and you don't get to inherit the clock from the Roth 401(k). – Dilip Sarwate Aug 30 '15 at 2:12
  • Yes, the main point of concern is as BrenBarn said: how are the earnings treated for nonqualified distributions? See my comment on the original question for clarification. – arcyqwerty Aug 30 '15 at 14:37
  • @DilipSarwate: The clock is separate for the Roth IRA, true, but it doesn't restart with a rollover. It started from the first time a Roth IRA was funded. This is one reason to open a Roth IRA early in life even if retirement savings are focused through an employer's qualified plan. – Ben Voigt Dec 15 '18 at 22:30

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