Let me make sure I am understanding this.
If my employer supports this, I can contribute extra post-tax money to a roth 401k, which can be rolled over to a roth IRA. That's it. Basically, I can fund my roth IRA much more than I could before.
Is that right?
If so, this might be quite meaningful - my income is too high for a traditional IRA, and I have a bunch in taxable accounts...
The amount rolled over can be withdrawn completely tax-free and penalty-free after five years in every case. Even before five years, only the amount that was taxable at the time of rollover (i.e. any earnings on the after-tax amount before the rollover) is subject to a penalty.
Just to be clear, any rollover portion that is not earnings is only subject to income tax, and not the 10% penalty (if withdrawn before 5 years)?
When you take money out of a Roth IRA, the taxation depends on exactly which funds you are removing. The tax code specifies a set of
ordering rules that determine which funds you are removing and how they are taxed.
The ordering is as follows:
1) Direct contributions to the Roth IRA. These can always be taken out tax-free and penalty free.
2) Conversion/rollover contributions. These include any "backdoor" contributions from a traditional IRA or after-tax 401(k). These come out in first-in, first-out order. Each rollover can potentially be further divided into two parts:
2a) The part that was taxable at the time of the conversion (i.e. earnings on your after-tax 401(k) contribution) comes out first. This part is tax-free at the time of withdrawal (you already paid tax on it when you did the conversion), but is subject to a 10% early withdrawal penalty if withdrawn within five years of the conversion.
2b) The part that was not taxable at the time of the conversion (i.e. your after-tax 401(k) principal) comes out next. This part is always tax-free and penalty-free.
3) Any earnings within the Roth IRA come out last. These are taxed at your normal marginal rate plus a 10% early withdrawal penalty if withdrawn before age 59½.
As an example, suppose you have a Roth IRA with $100k in it.
* $10k came from direct contributions over the life of the IRA,
* $20k was converted from a traditional after-tax 401(k) in 2008 ($2k was taxable earnings),
* $30k was converted from a traditional after-tax 401(k) in 2011 ($3k was taxable earnings),
* $15k was converted from a traditional after-tax 401(k) in 2013 (all principal, no taxable earnings),
* the remaining $25k is earnings from investment growth within the IRA.
You could withdraw $30k completely tax-free and penalty-free right now. Contributions come out first irrespective of what year they were made, and they are always withdrawn tax-free and penalty-free. Conversions are tax-free and penalty-free after five years, so that would apply to the 2008 contribution.
You have to pay a 10% penalty on the originally taxable portion of any conversion from the past five years. So after the first $30k, you'll have to pay a 10% penalty on the next $3k you withdraw (since the originally taxable portion of a conversion comes out before the originally tax-free portion).
Then the next $42k (the tax-free portion of your 2011 conversion and the entire 2013 conversion) is tax-free and penalty-free upon withdrawal. So in this example you could withdraw $75k and only owe $300 in tax penalties. Not a terrible deal.
You wouldn't really want to go beyond $75k until age 59½. Any non-qualified distributions of earnings count as regular income and have a 10% penalty on top of that. So if you're in the 15% tax bracket during retirement, you'll be paying 25% on every dollar you take out beyond $75k. But if you wait until 59½, it's tax-free.