Can I apply the Five-Year Rule to my Roth 401(k)?
I am 62 years old and recently retired. I have an employer sponsored Roth 401(k) that I started to contribute to in 2014. I also have a Roth IRA that was opened in 2010. Can I do a direct rollover of the balance in my Roth 401(k) to my Roth IRA without incurring taxes on the earnings since I contributed to the Roth IRA more than 5 years ago?
I would recommend transferring your Roth 401(k) into your Roth IRA. And no, you would not incur any taxes and the funds would be available immediately since you are 62 years old.
The five year rule applies if you do a Roth conversion before you are 59.5 years of age, is that you have to wait five years or until you are 59.5, whichever comes first, before you can withdraw the principle without tax and penalty. If you are already 59.5 when you make the conversion, you can withdraw the principle immediately but have to wait five years before you withdraw any of the earnings without penalty.
An investor may withdraw his or her contributions to a Roth IRA at any time without tax or penalty. But, that is not the same case for any earnings or interest that you have earned on your Roth IRA investment. In order to withdraw your earnings from a Roth IRA tax and penalty free, not only must you be over 59.5 years old, but your initial contributions must also have been made to your Roth IRA five years before the date when you start withdrawing funds. If you did not start contributing in your Roth IRA five years before your withdrawal, your earnings would not be considered a qualified distribution from your Roth IRA because of its violation of the five year rule.
The five year rule for your Roth IRA earnings starts on January 1st of the year you make your first contribution. That is when your clock starts. Because you can make a Roth IRA contribution up to April 15th of the next year, your five years technically would not have to be five calendar years. The clock for earnings could count as having started on January 1st as long as you designated contributions up until April 15th for the previous tax year.
The clock only starts with regular Roth IRA contributions in the very beginning with the first contribution ever to be placed into the Roth. However, this is not the case with a Roth IRA conversion; the five year rule clock restarts with every conversion with the amount and date it was converted.
The simple answer is yes. If you are no longer employed, you can roll your Roth 401k into your Roth IRA directly (custodian to custodian transfer) without any issues. The 5 year rule only comes into play when you are taking money ("distributions") out of your Roth.
Regarding the 5 Year Rule (which doesn't apply here), because you have met that 5 year guideline and due to your age, anything you ever take out of your Roth is completely tax & penalty free. And as long as you don't need the money or are doing tax planning with your other retirement assets, leave the money in the Roth as it continues to grow tax free and is asset protected from creditors. There are also no minimum required distributions (MRDs) like with a traditional/rollover IRA or 401k. So you or your spouse if they inherited from you in Roth form can pass on whatever is left to your kids/heirs. At that point, your heirs will have to take out MRDs either over 5 years OR can spread over their life expectancy. This is known as a stretch IRA. This is why your Roth is so flexible and valuable. Congratulations.
Hope this helps and best of luck, Dan Stewart CFA®
You can absolutely do a direct transfer from your Roth 401k to Roth IRA. You should not worry about the possible tax liability for this process; you might have confused with the Roth IRA withdrawal. Yes, in that scenario, one indeed has to hold Roth for five years, plus satisfying other possible exceptions, such as 59 1/2 , death, disability, etc. Since your question is only about the Roth rollover, you’re good to go. Best!
The best approach here would be to transfer the assets into the ROTH IRA, which, since it is older than 5 years old, shouldn't face any gains taxes. Additionally, since you are over the age of 59 & 1/2, you can make withdrawals from the IRA without the 10% penalty for early withdrawals.
Do not do a rollover; do a transfer from your Roth 401(k) into your Roth IRA. The IRS tightened the rules on rollovers a year ago which almost no one knows about; transfers are much safer and won't subject you to a potential tax audit. There is no tax implication and no taxes due upon doing the transfer. If your Roth IRA was opened more than 5 years ago, that is good since it means that any future withdrawals from that IRA will be tax-free since you are over 59-1/2.