Author Topic: How to withdraw funds from your IRA and 401k without penalty before age 59.5  (Read 54197 times)

Westoftown

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Still likely better off taking the deduction now, but you aren't doing anything 'wrong' if you choose otherwise.  You can also split the contribution limit between a regular IRA & roth.  But if you have a 401k, or better, an HSA; put as much as they will let you into that and whatever extra you might have into a roth and you will have both taxable & non-taxable options available that will allow you to shoot or that elusive 0% effective tax bracket after FIRE.

I think maybe my question wasn't quite clear enough with my own personal story.

Are your only choices to start your Roth conversion ladder while still employed (thus paying at whatever tax rate you are while employed), use taxable accounts, or draw on Roth basis?


No, there are other useful tricks, but they depend upon doing things right.

Quote

For my own situation, I was asking post-401k maxing. We will still be in the 25% bracket after that, and worse (well, worse in context of making too much), still in the 25% bracket even after $11k in traditional IRA lowering AGI. In our case, I was considering a Roth to draw the basis (however, contributions would be at 25%), taxable accounts or cash prior to FIRE (also at 25%), or eating the 10% early withdrawal penalty plus whatever taxes would be (potentially lower than 25%?). After 5 years, we'd be able to use the laddered money.

It sounds like you're saying the difference between traditional and Roth is pretty miniscule and won't matter?

No, that is not what I'm saying.  I'm saying that the tax brackets are set up so that your 'last' income is taxed highest, and in the 25% tax bracket, you are almost certainly better off with the current deduction.  Also, while you may believe that you will still be in the 25% tax bracket after retirement, this will almost certainly not be the case after a few years.  So if the math looks like an even case between a traditional or Roth IRA, it's probably still favored to the traditional in practice.  But the 25% tax bracket is about where things are questionable anyway.

Still, there are too many factors to consider.  Myself, as an example, made $129K gross last year, with an AGI of $50K, and have been exempt at federal level for the past 3 years.  You really can set up your life to pay zero legally.

That is outstanding.  Can you detail how you made so much gross and no Federal?

MDM

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mathjak107

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the first question is does your company plan allow for periodic payments at 55 ?  most plans do not . in which case the age 55  requirement does not apply .

you can not just take penalty free withdrawals from a 401k because you are 55 and no longer working there unless the plan allows for  periodic payments .

very few plans want to get involved doling out money so they shy away from it .

if that is the case , you have to roll it over to an ira and do a 72t election the same as you would at any age since it remains at 59-1/2 for penalty free withdrawals except under certain circumstances ..

the age 55 ability to get penalty free withdrawals is quite mis-understood more often then not .
« Last Edit: August 08, 2016, 04:14:00 AM by mathjak107 »

MDM

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...you have to roll it over to an ira and do a 72t election....
Once the money is in the tIRA, one is not restricted to the 72t election in order to access the money without penalty.  The Roth Pipeline described in the OP for this thread is the suggested method.

dandarc

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the first question is does your company plan allow for periodic payments at 55 ?  most plans do not . in which case the age 55  requirement does not apply .

you can not just take penalty free withdrawals from a 401k because you are 55 and no longer working there unless the plan allows for  periodic payments .

very few plans want to get involved doling out money so they shy away from it .

if that is the case , you have to roll it over to an ira and do a 72t election the same as you would at any age since it remains at 59-1/2 for penalty free withdrawals except under certain circumstances ..

the age 55 ability to get penalty free withdrawals is quite mis-understood more often then not .
Source for the periodic payments requirement?  IRS indicates there will not be 10% additional tax on:

Quote
. . .
Distributions made to you after you separated from service with your employer if the separation occurred in or after the year you reached age 55 . . .

without further qualification here:

https://www.irs.gov/taxtopics/tc558.html
Link to my journal, so I can find it quickly - http://forum.mrmoneymustache.com/journals/dandarc's-journal/

MDM

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Source for the periodic payments requirement?  IRS indicates there will not be 10% additional tax on:
Quote
. . .
Distributions made to you after you separated from service with your employer if the separation occurred in or after the year you reached age 55 . . .
without further qualification here:
https://www.irs.gov/taxtopics/tc558.html

While it's true the IRS will not impose a 10% penalty, there is no law requiring an employer to provide periodic 401k withdrawals. 


mathjak107

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the 401k plan has to allow for the periodic payments and the majority do not . otherwise you can only take a lump sum .

if you take the lump sum and do not roll it over it is all taxed but with no penalty .

if you do roll it over in to an ira  you lose the ability to hit the money at 55 with no penalty .

then you can only 72t to get it out penalty free unless you do some roth conversions  but in that case it is taxed.

dandarc

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Maybe just semantics, but the practical requirement for the 55 rule is not strictly periodic payments - it is partial payments.  That or a small 401k balance such that withdrawing the whole thing in year 1 is no big deal.

The eTrade standard individual 401K, for example allows the following for payments:

Quote
You may choose to take your payment as a lump sum, in non-recurring partial payments, in installment payments, or in the form
of an annuity contract (other than a life annuity).

You could have a plan that allows lump-sum and partial lump-sum but not periodic payments, and the 55 rule still works.  For example, the Summary plan description for Freescale SemiConductor (http://www.nxp.com/files/company_information/benefits/2013_RetireeBenefitsBook.pdf only offers installment (periodic) withdrawal to folks who were hired before 1996 and retired after age 55, but non-recurring partial distributions are available to anyone.
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Mother Fussbudget

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Re: How to withdraw funds from your IRA and 401k without penalty before age 59.5
« Reply #108 on: November 07, 2016, 05:27:28 PM »
I get that this thread is primarily regarding the building of a Roth Conversion Ladder - convert tIRA dollars to Roth IRA over a period of years, having them 'age' in the Roth account for 5 years, and then withdraw those conversion dollars from the Roth to cover annual expenses.  Furthermore, I get that the majority of people who are pursuing FIRE are younger than the norm (aveage age 22-to-30).  I often interact with people who (like me) are in the 'not-so-early... early-retirement' camp - those who got a late start in their 40's or 50's.

There is ANOTHER WAY to withdraw funds from a 401k or 403b ("company retirement plans") and avoid the 10% early withdrawal penalty (from IRS Publication 575) specifically for people starting FIRE in the calendar-year they turn age 55 (or older, or age 50 for qualified public safety employees).  Generally referred to as the 'Rule of 55': (quote below from http://www.401khelpcenter.com/401k_education/Early_Dist_Options.html#.WCEQlPkrLIX)
NOTE:  this does NOT apply to ALL retirement savings plans - specifically it does NOT apply to IRA & Roth IRA accounts.

Leaving Your Job On or After Age 55

The age 59˝ distribution rule says any 401k participant may begin to withdraw money from his or her plan after reaching the age of 59˝ without having to pay a 10 percent early withdrawal penalty.

There is an exception to that rule, however, which allows an employee who retires, quits or is fired at age 55 to withdraw without penalty from their 401k (the "rule of 55").
There are three key points early retirees need to know.

First, this exception applies if you leave your job at any time during the calendar year in which you turn 55, or later, according to IRS Publication 575.

Second, if you still have money in the plan of a former employer and assuming you weren't at least age 55 when you left that employer, you'll have to wait until age 59˝ to start taking withdrawals without penalty. Better yet, get any old 401k's rolled into your current 401k before you retire from your current job so that you will have access to these funds penalty free.

Third, this exception only applies to funds withdrawn from a [company sponsored retirement plan - a 401k or 403b]. IRAs operate until different rules, so if you retire and roll money into an IRA from your 401k before age 59˝, you will lose this exception on those dollars.


IRS Publication 575 (p.35) goes on to define 'qualified public safety employees' as:
"You are a qualified public safety employee if you provided police protection, firefighting services, or emergency medical services for a state or municipality, and you separated from service in or after 
the year you attained age 50."  Qualified public safety employees also includes:  Federal law enforcement officers, Federal customs and border protection officers, Federal firefighters, Air traffic controllers, Nuclear materials couriers, Members of the United States Capitol Police, Members of the Supreme Court Police, and Diplomatic security special agents of the United States Department of State.

In practice, using the "Rule of 55" might look like this:
Sam will turn 55 in December.  In August of that year, s/he quits, is fired, or retires from his/her job at WidgetSoftware, LLC.  They can request a distribution from WidgetSoftware's 401k plan, and avoid paying 10% early withdrawal penalty.  They would continue to make distributions from their WidgetSoftware 401k plan to pay expenses during the following 5 years until reaching age 59-1/2 at which point they could begin taking withdrawals from their IRA and Roth IRA accounts.  At the same time, while withdrawing annual expense amounts from their 401k, Sam *might* also begin converting his/her IRA to a Roth IRA - not with the goal of building a Roth IRA ladder to be used prior too age 59.5, but with the goal of converting ALL their IRA funds into Roth IRA funds prior to age 70 to avoid annual required minimum distributions.

The "Rule of 55" discussion may not belong in this discussion of  Roth Conversion Ladders, and if that's the case, I will happily remove this response.
However, I have read very few references to the rule of 55 mentioned anywhere else in the forums, and know there are a lot of people who are unaware of this exception to the 59-1/2 age limit for penalty free 401k withdrawal.



markbike528CBX

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Re: How to withdraw funds from your IRA and 401k without penalty before age 59.5
« Reply #109 on: November 07, 2016, 09:17:00 PM »
I am Sam

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Indecision may or may not be my problem.

seattlecyclone

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Re: How to withdraw funds from your IRA and 401k without penalty before age 59.5
« Reply #111 on: November 07, 2016, 09:55:11 PM »
Thanks for that, Mother Fussbudget.

The age 55 rule has been mentioned several times here, but it's always good to provide a reminder for those who are planning to retire between 55-60.

Do be sure to check your employer plan's rules before you count on being able to rely on the age 55 rule. While the law does allow these withdrawals with no early withdrawal tax, many employer retirement plans do not allow partial withdrawals. These employers don't want to deal with the administrative cost of dealing with retirees who are getting monthly checks from the plan. They'd rather you roll your money into an IRA so they don't have anything to do with you anymore. Therefore they put a provision into the plan rules saying that former employees who make a withdrawal must withdraw their entire balance all at once. If this applies to you, you obviously won't be able to make periodic withdrawals from your workplace retirement plan to bridge the gap between 55 and 59˝.

Of course this doesn't apply to every plan. Many employers are just fine with their retired employees keeping their money in the plan while they make withdrawals to fund their retirement. Just be sure to check what the rules are for your particular employer before you plan to rely on the age 55 rule.
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TomTX

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Re: How to withdraw funds from your IRA and 401k without penalty before age 59.5
« Reply #112 on: November 08, 2016, 06:47:54 AM »
Thanks for that, Mother Fussbudget.

The age 55 rule has been mentioned several times here, but it's always good to provide a reminder for those who are planning to retire between 55-60.

Do be sure to check your employer plan's rules before you count on being able to rely on the age 55 rule. While the law does allow these withdrawals with no early withdrawal tax, many employer retirement plans do not allow partial withdrawals. These employers don't want to deal with the administrative cost of dealing with retirees who are getting monthly checks from the plan. They'd rather you roll your money into an IRA so they don't have anything to do with you anymore. Therefore they put a provision into the plan rules saying that former employees who make a withdrawal must withdraw their entire balance all at once. If this applies to you, you obviously won't be able to make periodic withdrawals from your workplace retirement plan to bridge the gap between 55 and 59˝.

Of course this doesn't apply to every plan. Many employers are just fine with their retired employees keeping their money in the plan while they make withdrawals to fund their retirement. Just be sure to check what the rules are for your particular employer before you plan to rely on the age 55 rule.

To me the easy workaround would be to create a Solo 401k at a provider who allows partial withdrawals, put in $100 of side-gig income,* and roll everything into that. "Retire" from your side gig. Vanguard even has a form for setting up periodic withdrawals.

Any gotchas I'm missing? I don't recall seeing this suggested previously.

*Don't have side-gig income? Craigslist some junk and declare it as income.

FIRE4Science

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Re: How to withdraw funds from your IRA and 401k without penalty before age 59.5
« Reply #113 on: December 13, 2016, 11:07:01 AM »
2 major problems here.

1) "paying any normal income tax due on that amount" on the conversion. Sucks if you are still in the accumulation phase.

2) 5 years in a Roth IRA does save on any further taxes for the amounts contributed and withdrawn, but those amounts have been taxed once already, and now they are locked up for 5 years least you pay a penalty and taxes. If you've paid the tax on it on the conversion, why not just put it in a normal brokerage account, and look for benefits of long term capital gains/dividend? Paying a little tax for liquid availability of your money. Your already taxed money is then at least not locked up for 5 years, and is liquid cash.

MDM

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Re: How to withdraw funds from your IRA and 401k without penalty before age 59.5
« Reply #114 on: December 13, 2016, 11:22:29 AM »
1) "paying any normal income tax due on that amount" on the conversion. Sucks if you are still in the accumulation phase.
Yes, so having ~5 years expenses in a taxable account can be useful.

Quote
2) 5 years in a Roth IRA does save on any further taxes for the amounts contributed and withdrawn, but those amounts have been taxed once already, and now they are locked up for 5 years least you pay a penalty and taxes. If you've paid the tax on it on the conversion, why not just put it in a normal brokerage account, and look for benefits of long term capital gains/dividend? Paying a little tax for liquid availability of your money. Your already taxed money is then at least not locked up for 5 years, and is liquid cash.
You could do so if you are willing to pay the extra 10% tax on a tIRA withdrawal (that you don't pay on a tIRA->Roth conversion), and any tax you might incur in the taxable account (that you wouldn't have to pay in a Roth account).

ETA: Is this an annual question?
« Last Edit: December 13, 2016, 11:28:22 AM by MDM »

seattlecyclone

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Re: How to withdraw funds from your IRA and 401k without penalty before age 59.5
« Reply #115 on: December 13, 2016, 11:50:44 AM »
2 major problems here.

1) "paying any normal income tax due on that amount" on the conversion. Sucks if you are still in the accumulation phase.

You're right that Roth conversions when you're still working full-time generally aren't the greatest idea. The whole point of this is to defer as much income as possible until after you quit working when your tax rate will be lower.

Quote
2) 5 years in a Roth IRA does save on any further taxes for the amounts contributed and withdrawn, but those amounts have been taxed once already, and now they are locked up for 5 years least you pay a penalty and taxes.

There's just the 10% early withdrawal tax if you withdraw converted amounts within five years. You don't pay your regular income tax on top of that.

Quote
If you've paid the tax on it on the conversion, why not just put it in a normal brokerage account, and look for benefits of long term capital gains/dividend? Paying a little tax for liquid availability of your money. Your already taxed money is then at least not locked up for 5 years, and is liquid cash.

As MDM pointed out, the option to pull this money into a brokerage account is there, but you'll have to pay an extra 10% tax compared to the Roth conversion.
I made a blog! https://seattlecyclone.com/

The Roth IRA was named after William Roth, who represented Delaware in the US senate from 1971-2001. "Roth" is a name, not an acronym. There's no need to capitalize the final three letters.

markbike528CBX

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Re: How to withdraw funds from your IRA and 401k without penalty before age 59.5
« Reply #116 on: December 13, 2016, 01:01:15 PM »

The age 55 rule has been mentioned several times here, but it's always good to provide a reminder for those who are planning to retire between 55-60.

Do be sure to check your employer plan's rules before you count on being able to rely on the age 55 rule. While the law does allow these withdrawals with no early withdrawal tax, many employer retirement plans do not allow partial withdrawals.

That partial thing hit me.   I have to wait till I'm Age 55.01 to be "retired" per a 70points plan (55+service years>70)
Dang, I was all excited about the year turning 55 rule, as it cut 11 months off my time.

2inabowl

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Re: How to withdraw funds from your IRA and 401k without penalty before age 59.5
« Reply #117 on: December 18, 2016, 07:09:48 PM »
Regarding roth conversions for spouses w/10 years age difference, is it better to convert the younger or older spouse's $ first?

Monkey Uncle

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Re: How to withdraw funds from your IRA and 401k without penalty before age 59.5
« Reply #118 on: December 19, 2016, 03:21:12 AM »
Regarding roth conversions for spouses w/10 years age difference, is it better to convert the younger or older spouse's $ first?

I'd convert the older spouse's first since that person is closer to RMDs.
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overwhelmed

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Re: How to withdraw funds from your IRA and 401k without penalty before age 59.5
« Reply #119 on: December 19, 2016, 08:53:26 AM »
Thanks for that, Mother Fussbudget.

The age 55 rule has been mentioned several times here, but it's always good to provide a reminder for those who are planning to retire between 55-60.

Do be sure to check your employer plan's rules before you count on being able to rely on the age 55 rule. While the law does allow these withdrawals with no early withdrawal tax, many employer retirement plans do not allow partial withdrawals. These employers don't want to deal with the administrative cost of dealing with retirees who are getting monthly checks from the plan. They'd rather you roll your money into an IRA so they don't have anything to do with you anymore. Therefore they put a provision into the plan rules saying that former employees who make a withdrawal must withdraw their entire balance all at once. If this applies to you, you obviously won't be able to make periodic withdrawals from your workplace retirement plan to bridge the gap between 55 and 59˝.

Of course this doesn't apply to every plan. Many employers are just fine with their retired employees keeping their money in the plan while they make withdrawals to fund their retirement. Just be sure to check what the rules are for your particular employer before you plan to rely on the age 55 rule.

Big thanks to everyone offering information on this thread (especially  Mother Fussbudget & those mentioning the Rule of 55/ 55 rule)

This weekend I reviewed the plan information I could find for my 401k & just got off the phone with them.

The website (TRowe administration for my current plan) - mentions the IRS rule of 55 but wanted to make sure there wasn't any other plan documentations that I didn't see that didn't allow it.

Initially I was told that for ANY withdrawal before 59 1/2, they take the taxes & the 10% out. He said that I would need to get it back when doing my tax return. I decided that made no sense, why adhere to 1 rule (59 1/2) but not the other (55)?
I asked where I could find the information that explains that they choose to ignore the rule of 55 & as we were reviewing the legal information, he decided to keep researching.

Finally, he said that the Rule of 55 is the exception to the 59 1/2 rule, they do allow for withdrawal without penalty if you retire after 55 (following the rule) & they do not take the 10% out :)

This is a game changer for me. Glad there are some of us 'not young' people here sharing information.
So once again - thanks so much to everyone here - until this weekend I had never heard of this rule & probably never would have.

T0dd

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Quick conversion ladder question - I have investments in Roth 401k & Roth TSP. If I roll those over to my Roth IRA, does that still have a 5 year waiting period before I can access that money without penalty? Thanks.

MDM

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Quick conversion ladder question - I have investments in Roth 401k & Roth TSP. If I roll those over to my Roth IRA, does that still have a 5 year waiting period before I can access that money without penalty? Thanks.
Maybe.  Depends on other circumstances.  E.g.,
Quote
...when a designated Roth account from an employer retirement plan is rolled into a Roth IRA, the years in the Roth employer plan do not count towards the Roth IRA. Instead, under Treasury Regulation 1.408A-10, Q&A-4(a), for a Roth IRA it’s the original 5-year rule for the Roth IRA that counts. And if there was no existing Roth IRA and the rollover from the Roth 401(k) creates the account for the first time, that starts a new 5-year clock for the IRA, even if the ‘old’ Roth 401(k) had satisfied its own 5-year rule.

See Two 5-Year Rules For Roth IRA Contributions & Conversions for the context of that quote and more details.

seattlecyclone

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Moving from Roth to Roth does not count as a "conversion" that would invoke the five-year waiting period used for the Roth pipeline. Whatever your original contributions were to the Roth 401(k) or Roth TSP, that amount will count as a "contribution" when it's in the Roth IRA. Like any other Roth IRA contributions, that money can be withdrawn at any time with no tax or penalty due. Any earnings that accrued within your Roth employer account would then be treated as earnings within the Roth IRA.

The other five-year rule that MDM refers to will determine whether your withdrawal counts as a "qualified distribution." For a Roth IRA distribution to be "qualified," you need to have had a Roth IRA for at least five years and also be 59˝ or disabled or dead. If you haven't had a Roth IRA at all for five years, your distribution won't be "qualified," but if you're an early retiree withdrawing at age 40 your distribution wasn't going to be "qualified" anyway. So the question then becomes: what tax is due on that non-qualified distribution?

Non-qualified distributions follow the ordering rules: first contributions, the conversions, then earnings. Contributions are completely tax-free when withdrawn. Conversions are tax-free if withdrawn at least five years later, or are subject to the 10% early withdrawal tax if withdrawn sooner. Earnings counts as regular income and are taxed accordingly, plus a 10% early withdrawal tax.
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T0dd

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Thank you both, that's great information. Yes I've had the Roth IRA since 2010 and will start to build up taxable investments soon to add to our flexibility.

sean777

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Moving from Roth to Roth does not count as a "conversion" that would invoke the five-year waiting period used for the Roth pipeline. Whatever your original contributions were to the Roth 401(k) or Roth TSP, that amount will count as a "contribution" when it's in the Roth IRA. Like any other Roth IRA contributions, that money can be withdrawn at any time with no tax or penalty due. Any earnings that accrued within your Roth employer account would then be treated as earnings within the Roth IRA.

The other five-year rule that MDM refers to will determine whether your withdrawal counts as a "qualified distribution." For a Roth IRA distribution to be "qualified," you need to have had a Roth IRA for at least five years and also be 59˝ or disabled or dead. If you haven't had a Roth IRA at all for five years, your distribution won't be "qualified," but if you're an early retiree withdrawing at age 40 your distribution wasn't going to be "qualified" anyway. So the question then becomes: what tax is due on that non-qualified distribution?

Non-qualified distributions follow the ordering rules: first contributions, the conversions, then earnings. Contributions are completely tax-free when withdrawn. Conversions are tax-free if withdrawn at least five years later, or are subject to the 10% early withdrawal tax if withdrawn sooner. Earnings counts as regular income and are taxed accordingly, plus a 10% early withdrawal tax.

I recently did research on figuring out my contribution basis for my Roth IRA and found out that in those ordering rules, the "contributions" part includes both regular contributions (Box 10 on 5498) and rollover contributions (Box 2). When rolling over a Roth 401(k) to a Roth IRA, both contributions and earnings in the 401(k) turn into rollover contributions for the Roth IRA (source: my 2015 5498 did not distinguish between contributions and earnings, the whole amount was in Box 2). This means that you could immediately withdraw the whole rollover amount from the IRA tax free (assuming the Roth IRA was already 5 years old). If I had known this before the rollover, I probably would have waited so that I could access the compounded earnings before I turned 59.5.

seattlecyclone

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I can't say I agree with your interpretation, that Form 5498 somehow transforms your money into a contribution that is freely withdrawable.

The controlling source on Roth 401(k) to Roth IRA transfers that I have found is Q-3 of this link. The question specifically asks about rollover distributions and how much counts as contributions, and the answer says that only the "investment in the contract" counts as original contributions after you do the rollover. Another section that is referenced defines "investment in the contract" basically as the amount that wouldn't count as income if you withdrew it to your checking account instead of doing a rollover. That means the original 401(k) contributions, but not the earnings.

The whole amount would be reported as a rollover contribution, but that doesn't make the whole amount non-taxable if you make an early withdrawal.
I made a blog! https://seattlecyclone.com/

The Roth IRA was named after William Roth, who represented Delaware in the US senate from 1971-2001. "Roth" is a name, not an acronym. There's no need to capitalize the final three letters.

sean777

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Thanks, I thought it was too good to be true but couldn't find that missing link.

samickle

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Pardon me if I've overlooked something, but the rules for distributions from Roth 401k subaccounts differ from the rules for a Roth IRA. Roth 401k distributions are pro-rata earnings and after-tax contributions. If Roth 401k funds are rolled-over to a Roth IRA, could distributions then be taken using the Roth IRA ordering rules (basis first)? Thanks!

seattlecyclone

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Yes. That's exactly what the link I posted above is about. It says that when you roll over your Roth 401(k) into a Roth IRA, the "investment in the contract" is treated as Roth IRA contributions for the purpose of the ordering rules, and any remaining balance is treated as Roth IRA earnings.
I made a blog! https://seattlecyclone.com/

The Roth IRA was named after William Roth, who represented Delaware in the US senate from 1971-2001. "Roth" is a name, not an acronym. There's no need to capitalize the final three letters.