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Distributions and Rollovers: What You Need to Know About Roth 401(k)s

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The Roth 401(k) resembles the Roth IRA in that contributions are made with after-tax dollars and qualified withdrawals can be made tax free. But, as the name implies, it also is subject to many of the rules affecting traditional 401(k) plans.

If your employer offers a Roth 401(k), there are rules concerning this retirement saving vehicle that you should be aware of. In particular, if you anticipate making a job change or retiring in the near future, you’ll want to pay close attention to the rules governing distributions from Roth 401(k)s — how they differ from regular 401(k)s and how they are the same.

Does Your Roth Distribution Qualify for Tax-Free Treatment?

Like the Roth IRA, distributions from a Roth 401(k) are tax free and penalty free if the owner meets the requirements for a qualified distribution. Specifically, qualified distributions must be made:

  • After the participant reaches age 59½ or in the event of the participant’s death or disability, AND
  • After the participant has held the account for at least five tax years.

Distributions that do not meet these requirements are nonqualified distributions and are subject to income taxes and possibly penalties.

What Are Your Roth Rollover Options?

For employees who leave a job where they had been contributing to a Roth 401(k), the IRS provides several choices for managing those assets: maintain your Roth 401(k) account with your old employer; roll the account balance into another employer-sponsored retirement plan that accepts such rollovers; or roll the account into a Roth IRA. All three options generally have no tax consequences. Alternatively, if you cash in your Roth 401(k) and you fail to meet the requirements for a qualified distribution, you will have to pay taxes on the portion of the distribution that represents earnings and possibly a 10% additional federal tax.

What About Minimum Distributions?

Roth 401(k)s have the same minimum distribution requirements as traditional 401(k)s: participants generally must begin taking minimum distributions after they reach age 72. However, because Roth IRAs do not require account holders to take distributions during their lifetime, you may choose to avoid the minimum distribution requirements by rolling your Roth 401(k) over into a Roth IRA.

Other Tax Considerations

Because contributions to a Roth 401(k) are taxed at the time of the contribution, such an account might be attractive to individuals who believe that tax rates may go up in the future or who expect their own income to increase significantly over time (e.g., younger workers). By locking in today’s tax rates, these workers can create a hedge against potential future tax increases.

In addition, depending on their tax bracket and number of years until retirement, highly compensated workers may benefit from going the Roth 401(k) route, particularly if they have been shut out of contributing to a Roth IRA due to its income limitations. For 2020, eligibility to make Roth IRA contributions begins to phase out at modified adjusted gross income (MAGI) of $124,000 for single taxpayers and $196,000 for married individuals filing jointly.

 

 

 

Securities and advisory services are offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/ SIPC). Insurance products are offered through LPL or its licensed affiliates. Happy State Bank and Happy Investment Services are not registered as a broker-dealer or investment advisor. Registered representatives of LPL offer products and services using Happy Investment Services, and may also be employees of Happy State Bank. These products and services are being offered through LPL or its affiliates, which are separate entities from, and not affiliates of, Happy State Bank or Happy Investment Services. Securities and insurance offered through LPL or its affiliates are:

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