Roth 401(k) to Roth IRA Rollover

A Roth 401(k) to Roth IRA rollover is the process of moving funds from an employer's plan, usually a former employer's retirement account, into a personal Roth IRA account.

The transfer may be considered for various reasons, but most people do it because they are no longer an employee or will not be one in the future.

What Is a Roth 401(k)?

A Roth 401(k) is an employer-sponsored plan that means employees can designate some or all of their elective deferral contributions as after-tax Roth contributions.

The corresponding tax treatment allows for tax-free growth and withdrawals if certain criteria are met, making this type of retirement vehicle attractive to investors saving for retirement in their 40s and 50s when they are in a lower tax bracket

What Is a Roth IRA?

A Roth IRA is an individual retirement account that allows investors to save for retirement on an after-tax basis.

As opposed to a traditional IRA, which is tax-deductible, like a 401(k), the contributions are made with after-tax dollars.

The corresponding tax treatment results in distributions being tax-free if they meet the criteria, making this type of retirement vehicle attractive to investors saving for retirement.

Differences Between a Roth 401(k) and a Roth IRA Account

There are several differences between Roth 401(k) and Roth IRA, such as:

Contribution Limits

The maximum annual contribution you may make to a Roth IRA is $6,500 for 2023 and $7,500 for those over 50.

The maximum contribution for your 401(k) depends on the plan regulations and may be as low as $22,500 and as high as $73,500.

Tax Treatment

You fund Roth IRAs with after-tax income, meaning your withdrawals are not taxable retirement income. Conversely, you fund 401(k)s with pre-tax income. This makes your 401(k) withdrawals subject to taxation in retirement.

Age Requirement for Tax-Free Withdrawals

You must be 59 ½ to make penalty-free withdrawals from Roth IRAs. Withdrawals made prior to this age incur a 10% early withdrawal penalty.

This is not the case with Roth 401(k)s, but you are required to start taking withdrawals when you reach 70 ½ years old under the current tax code.

Tax-Free Transfers to a Roth IRA Account

If you leave your job, you can convert your 401(k) into a traditional IRA or a Roth IRA. If the choice is the latter, withdrawals will be tax-free if you are 59 ½ or older.

Steps in Rolling Over a Roth 401(k) to a Roth IRA Account

There are five steps to rolling over a Roth 401(k) account:

Ways to Convert a Roth 401(k) to a Roth IRA Account

Conversion of a Roth 401(k) into a Roth IRA may employ the following methods:

Direct Rollover or Trustee-to-Trustee Transfer

A direct rollover is the straightforward method for converting a Roth 401(k) to a Roth IRA account. This method transfers the funds directly from one account to another without ever being in your possession. 

You discuss the matter with the 401(k) provider for your workplace and request a rollover. The process could involve filling out a few forms that authorize the transaction.

Indirect Rollover

An indirect rollover, also called a 60-day rollover, involves withdrawing funds from your 401(k) account.

Afterward, you have 60 days to transfer the money to another qualifying retirement plan or open a Roth IRA. Failure to do so makes the withdrawal a taxable one. This means a penalty of 10% if you are younger than 59 ½.

Things to Consider for a Roth 401(k) to Roth IRA Rollover

Converting your Roth 401(k) to a Roth IRA requires several considerations. Here are some of the pros and cons:

Pros of a Roth 401(k) to Roth IRA Rollover

Withdrawal Flexibility

Prior to your retirement, you could have more freedom in terms of withdrawals from your Roth IRA. Converted Roth IRA balances may also be withdrawn tax-free or penalty-free if certain conditions are met.

You will have more control of your money as you manage it yourself.

Investment Options

You can pick and choose your investments from a wide array of options. The Roth IRA must be invested in accordance with IRS rules, but you may invest in almost anything offered by the mutual fund company of your choice.

You may invest in any stock, bond, or other assets with a Roth IRA, meaning you can diversify your retirement portfolio.

Required Minimum Distributions (RMDs)

If you have a Roth IRA, you do not have to take RMDs throughout your lifetime. As a result, unless you are still employed by the firm, you will have to begin making withdrawals from your retirement account once you turn 73, including any Roth contributions.

Downsides of a Roth 401(k) to Roth IRA Rollover

Costs

In certain cases, a Roth 401(k) program may charge less than an individual Roth IRA account. These reduced fees may result in a slightly higher retirement savings balance.

Contribution Requirement Before Withdrawals

Despite the fact that you have maintained a Roth IRA for more than five years, you may still be required to delay withdrawals if you just started contributing a few years ago. The five-year rule will be described in further detail in the next section.

The Five-Year Rule for Roth IRAs

Roth IRA withdrawals may be subject to a five-year waiting period before they are tax-free. 

This is known as the five-year rule, which states that you must be at least 59 ½ and have had an active Roth IRA for at least five tax years in order to withdraw earnings from the account without incurring tax or penalty obligations.

However, there are several exceptions to this rule that allow early distribution of Roth IRAs without incurring a penalty. These include:

1. If you intend to use it to cover the cost of health insurance premiums. You can take out money from an IRA, so long as you use the funds solely for medical costs. There is no minimum age for this exception.
2. If you and your spouse qualify as first-time homeowners, you may both take $10,000 from your IRAs without incurring the 10% penalty. Within 120 days of receiving the payout, you must utilize it to pay for the eligible purchase and closing charges.
3. If you are disabled to the point where you cannot work, your distributions from an IRA will not incur a 10% penalty. A physician must certify that your ailment will last an extended period.
4. Tax-free early withdrawals used to pay for eligible higher education costs, such as tuition or education supplies on behalf of you, your spouse, your children, or your grandchildren, are exempt from the 10% early withdrawal penalty.

For all the other exceptions, you can refer to the IRA early withdrawal penalty exceptions guide.

Final Thoughts

You may convert your Roth 401(k) to a Roth IRA account. However, this decision should take into account the advantages and disadvantages of doing so.

The benefits, such as tax-free earnings and no minimum distribution requirement, are undeniable, but there are also downsides.

Consult with a tax expert to help you make an educated decision before moving retirement assets.

FAQs 

1. What is a Roth 401(k)?

A Roth 401(k) is a retirement savings plan that allows employees to make contributions on a post-tax basis. Contributions made to a Roth 401(k) are not tax-deductible, but earnings grow without being subject to taxation.

2. What is a Roth IRA?

A Roth IRA is an individual retirement account (IRA) that permits eligible withdrawals on a tax-free basis without incurring an additional tax liability. Roth IRA contributions are not tax-deductible since they are made using after-tax money.

3. How can I convert my Roth 401(k) to a Roth IRA plan?

The process of transferring funds from a Roth 401(k) to a Roth IRA is known as a rollover, which can take place through a trustee-to-trustee transfer. Another option is withdrawing funds from your 401(k) account and redepositing the entire amount into your own Roth IRA account.

4. What would make me eligible for a rollover?

The most typical occurrence that triggers eligibility is when a person quits their previous company. Other possibilities include reaching the age of 59 ½, dying, or being disabled.

5. What are some exceptions to the additional 10% tax on early distributions?

Early distributions are not subjected to the additional 10% tax if used to pay for medical insurance premiums, health care coverage fees, education costs, or first homes.