When you’re eligible to take money from your designated Roth account, you can roll it to a Roth IRA or to a Roth account with another employer.
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You may end up wanting to roll your designated Roth account to a Roth IRA or to another employer’s retirement plan. You should be aware of a few twists in these rules.
Rolling to a new employer
When you change jobs, you may want to roll your account to your new employer’s plan. You can’t do this unless the new employer accepts Roth accounts. If your new employer won’t do that, you have to either leave the money with the old employer or roll the account to a Roth IRA.
There’s a special benefit if you can roll the account to a new employer: you get to count the “age” of the old account toward the five-year requirement for the new account. Without the rollover, you start all over with a new five-year requirement at the new employer.
The Treasury says you have to use a direct trustee-to-trustee rollover if you want to move your entire designated Roth account to a new employer. This is to make sure the new employer will be able to keep track of the nontaxable amount in the new Roth account. If you receive a distribution from a Roth 401k or similar account, you’re allowed to roll the taxable amount, but not the nontaxable amount, to a Roth account with your new employer. Otherwise you can simply roll the entire distribution to a Roth IRA (see below).
You aren’t allowed to roll money from a Roth IRA to an employer account. This is true even if the Roth IRA consists entirely of money received in a rollover from an employer account.
Rolling to a Roth IRA
Money you withdraw from a Roth 401k or similar account can generally be rolled to a Roth IRA. (There are exceptions for certain kinds of distributions, such as a distribution you take to correct an excess contribution.) In this case you don’t have to use a direct rollover, although that approach is highly recommended to avoid potential problems. There’s an important hitch in these rules, however: the years of participation in the designated Roth account don’t count toward the five-year requirement to take tax-free distributions from a Roth IRA. That rule doesn’t make much sense, but for now at least we have to live with it.
In most cases this will not present a problem because the rules for Roth IRAs allow you to withdraw your basis tax-free even when you take a nonqualified distribution. Your basis is the amount you contributed to the designated Roth account if your rollover is a nonqualified distribution. If you roll over a qualified distribution, the entire amount of the rollover becomes basis in your Roth IRA.
Example: Over a period of six years you contribute $65,000 to a Roth 401k account. Then you leave that company and roll the entire account, worth $100,000, to a Roth IRA. Before this rollover, you didn’t have a Roth IRA.
Even though you’ve had the Roth 401k account more than five years, this is a nonqualified distribution if you aren’t over 59½ or disabled. In that case you would get $65,000 of basis in your Roth IRA. You would be able to withdraw up to $65,000 tax-free any time you want. To withdraw more than that amount tax-free you’ll have to wait five years (and be over 59½ or disabled).
If you’re over 59½ or disabled at the time the money comes out of the Roth 401k, you’re rolling a qualified distribution. The entire $100,000 is included in your basis for the Roth IRA, but you still don’t get to transfer the holding period from the Roth 401k. That means you can withdraw up to $100,000 from the Roth IRA tax-free any time you want, but you’ll have to wait five years before you can take a tax-free withdrawal of any additional earnings in the account.
Although you don’t get to count the years you held the Roth 401k before the rollover, you do get to count any time you held a Roth IRA. For example, if you held a Roth IRA three years before the rollover, you would only have to wait two years after the rollover to meet the five-year requirement.
Rolling part of a distribution
If you receive a distribution that’s eligible for rollover from a designated Roth account, you may choose to roll only part of it if you have some immediate needs. In this case, the first dollars you are considered to be rolling come from the taxable portion of the distribution. The part that isn’t rolled over is treated as coming first from the nontaxable portion of the distribution.
Example: You contributed $11,000 to your Roth 401k account and the total value is $14,000 when you take a nonqualified distribution of the total balance. You decide to roll over $7,000 to a Roth IRA and use the other $7,000 to pay off a credit card. The earnings portion of the distribution is included in the part you rolled over, so your distribution is not taxable.