Know the Rules for Roth 401(k) Rollovers

Fact checked by Suzanne KvilhaugReviewed by Khadija KhartitFact checked by Suzanne KvilhaugReviewed by Khadija Khartit

The most significant difference between a traditional 401(k) and a Roth 401(k) is that a traditional plan is funded with pretax dollars. Roth contributions are made with post-tax dollars, so there’s no tax hit on a qualified withdrawal that’s typically made in retirement.

You have a few Roth 401(k) rollover options if your job is at stake, you’re changing employers, or you’re considering a career move,

Key Takeaways

• Roth accounts are funded with after-tax dollars and they grow tax-exempt.
• A Roth 401(k) can be rolled over to a new or existing Roth IRA or Roth 401(k).
• Transferring to a Roth IRA is generally the most desirable option because it facilitates a wider range of investment options.
• It’s best to move the money into an existing Roth IRA account if you have one due to a five-year rule that governs qualified distributions.
• Moving the transferred funds to another Roth 401(k) may provide favorable tax treatment if you plan to withdraw the transferred funds soon.

Your Roth 401(k) Rollover Options

Your choices for a Roth 401(k) follow those with a traditional 401(k) for the most part but the transfers should be to Roth versions of the available accounts. You should transfer the funds from the Roth 401(k) into a Roth IRA if you elect to roll the funds over to an individual retirement account (IRA). You should also be able to roll the old Roth 401(k) into the new Roth 401(k) if your new employer has a Roth 401(k) option and allows for transfers.

IRAs frequently come with more options than 401(k)s. Your options in a 401(k) can sometimes be limited to mutual funds or a few different exchange-traded funds (ETFs) depending on the custodian versus being able to invest in a plethora of choices in an IRA.

One way to accomplish a rollover to either a Roth IRA or another Roth 401(k) is from trustee to trustee. This ensures a seamless transaction. You can still roll over the entire distribution to a Roth IRA within 60 days of receipt, however, if you decide to have the funds sent to you instead of directly to the new trustee. The paying trustee is generally required to withhold 20% of the account balance for taxes if you choose this route.

Funds held inside 401(k)s are often well-protected against some legal judgments and from creditors.

Distributions From Your Rolled-Over Roth

It’s typically not advisable to tap retirement funds before you leave the workforce, but this may be your only option in tight times.

For the distribution to not incur any taxes or penalties, it must be considered qualified. This means that the distribution must meet what’s known as the five-year rule, which states that funds must have remained intact in the account for a five-year period. (This rule also applies to inherited retirement accounts.)

The five-year rule can be tricky. Carefully consider how it applies to your situation, and perhaps consult the advice of a tax professional.

How to Roll a Roth 401(k) Into a Roth IRA

Roth IRA contributions can be withdrawn tax-free and penalty-free at any time regardless of age, but the rules for distributions of earnings vary. A qualified distribution from a Roth IRA meets the five-year rule and is also made at or after age 59½, after death, or as the result of a disability or a first-time home purchase. These qualified distributions are free of both taxes and penalties.

Withdrawals from the account will be subject to both selective income taxes and a penalty if these conditions aren’t met. Income taxes will be levied pro-rata on earnings on your contributions and a 10% penalty may apply to part of the distribution if you take a non-qualified distribution.

Funds from a Roth 401(k) rolled into another such account are subject to favorable treatment concerning the five-year holding period. The same treatment doesn’t apply to the timing of a Roth 401(k) that’s rolled over to a new Roth IRA, however. The holding period for that account applies to all its funds, however, if you already have a Roth IRA account. This includes funds rolled over from a Roth 401(k) account.

Let’s assume that you opened your Roth IRA in 2016. You worked for your employer from 2019 to 2023 and were then let go or you resigned. The full distribution rolled into the Roth IRA meets the five-year rule for qualified distributions because the Roth IRA that you’re rolling the funds into has been in existence for more than five years.

How to Roll a Roth 401(k) Into Another Roth 401(k)

The specific distribution rules from the new account will vary by the plan if you roll your old Roth 401(k) into a new Roth 401(k). Your new employer’s human resources department should be able to assist with this.

Some basic conditions apply, however. The number of years the funds were in the old plan should count toward the five-year period for qualified distributions if you decide to roll the funds from your old Roth 401(k) over to your new Roth 401(k) through a trustee-to-trustee transfer. This is also referred to as a direct rollover. The first employer must contact the new employer regarding the employee contributions that are being rolled over and to confirm the first year they were made.

The rollover must generally be complete for the new funds to enjoy the carryover of the period from the old Roth 401(k). The five-year period would start again if an employee did only a partial rollover to the new Roth 401(k). You don’t get credit for the period the funds were in your old Roth 401(k).

Speak with your tax or financial advisor about what may be best for you before making a decision. You might end up leaving the Roth 401(k) in your previous employer’s plan, depending on your circumstances and that plan’s rules.

How Can I Meet the Five-Year Rule After a Rollover?

There are two ways to roll over your Roth 401(k) into a different account and satisfy the five-year rule. The first is to roll the Roth 401(k) funds into an existing Roth IRA. The rollover funds will be counted toward the clock that’s been ticking since the opening of the Roth IRA.

The second way is to roll your current Roth 401(k) into a new Roth 401(k) with your new employer. The time your money spent in the first account counts in the total tally in this case.

Does a Roth 401(k) Rollover Count Against the Yearly Contribution Limit?

No. Rollover money is counted as a rollover, not a contribution. You would still be able to contribute the full $23,000 for the 2024 tax year if you are under age 50, or $30,500 if you are 50 or older.

Can I Roll My Roth 401(k) Over to a Traditional IRA?

No. The funds can only roll over to another Roth-eligible account when you contribute money post-tax into a Roth account. You can’t mingle pre-tax and Roth contributions.

The Bottom Line

The rules for rolling over funds to a Roth 401(k) are complicated. Be sure to fully investigate the tax and other implications before you decide how to handle these funds after you leave the company whose plan held them. A mistake here could be costly.

Read the original article on Investopedia.