Distributions from Designated Roth Accounts

By Kaye A. Thomas
Current as of November 17, 2013

They’re similar to Roth IRA distributions, but with some important differences.

The main rules for taking distributions from designated Roth accounts are similar to the rules for Roth IRAs, but with a few differences.

Access to the money

This is one area where 401k and similar accounts differ from IRAs. If you want to take money from your Roth IRA, all you have to do is contact the financial institution and tell them to send the money (selling assets for that purpose, if necessary). In this area, a designated Roth account works the same as a traditional account in a 401k or similar plan. You can take the money any time you want after termination of employment, but prior to termination you usually can’t take money out of your account unless you qualify for a hardship distribution.

You have the same access to your designated Roth account as your traditional account: no more, no less.

Choice of account

If you have both traditional and Roth accounts in the same 401k or similar plan and you make a partial withdrawal, you should be able to choose which account the money is coming from. This choice may be useful for tax planning in general and also for avoiding nonqualifying distributions from the Roth account, as described below.

Qualifying distributions

Unless you’re rolling your money to another Roth account (a Roth IRA or a Roth account in another employer’s plan), you’ll want your distributions to qualify for tax-free treatment. The rules here are similar to the Roth IRA rules. You need to have the account five years and in addition you have to be 59½ or disabled. (Distributions after your death can qualify also.)

The Roth IRA rule for first-time homebuyers does not apply to a designated Roth account.

There’s one difference you’ll want to note if you work for more than one company that offers these accounts. The five-year rule applies to your account in each employer’s plan separately, except you get credit for prior years if you roll money from one plan to another.

Example: Your first Roth 401k contribution at one employer was in 2010. In 2012 you changed jobs and began contributing to the Roth 401k at a second employer. Assuming you’re over 59½, you can begin to take qualifying distributions from the first account in 2015, but you have to wait until 2017 to take qualifying distributions from the second account. If you roll the money from the first account to the second one, though, the combined account is treated as one that was started in 2010.

This is different from the rule for Roth IRAs, where new accounts acquire the “aging” of earlier accounts without the need for a rollover.

Nonqualified distributions

If you don’t meet the requirements described above, and you take money out of your designated Roth account without rolling it to another Roth account, you’ll have a nonqualifying distribution. When you take nonqualifying distributions from a Roth IRA, your distributions are tax-free until you’ve withdrawn all your contributions. According to the Treasury, a designated Roth account doesn’t work that way. When you take a nonqualified distribution from this account, you have to report taxable income in proportion to the account’s earnings when you take a distribution. For example, if 80% of the money in the account is from your contributions and another 20% is from earnings, your distribution will be 20% taxable even if the amount you withdraw is less than the amount of your contributions.

This rule looks only at the account from which you took the distribution. Some of the rules for IRAs say you have to add all your accounts together to figure the ratio between contributions and earnings, but those rules don’t apply here.