Roth 401k rollover to Roth IRA then withdraw from Roth IRA

[VVRR22]

Thank you!

[minostro]

Thank you very much @dmertz for sharing your wisdom with the community. 

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@dmertz wrote:

If you have not reached age 59½, the amounts of your contributions, conversion and earnings in your Roth 401(k) retain the same nature and add to the corresponding amounts in your Roth IRAs.

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I found what you said about the Roth 401K contributions being treated the same in the Roth IRA account after the rollover in the section "Determination of 5-Taxable-year Period after a Rollover to a Roth IRA" of https://www.irs.gov/irb/2007-22_IRB#TD-9324 

If a nonqualified distribution from a designated Roth account is rolled over into a Roth IRA, the portion of the distribution that constitutes a nontaxable return of investment in the contract is treated as basis in the Roth IRA.

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However, I couldn't find that the earnings on the Roth 401K become earnings on the Roth IRA. This logic of treating them the same makes sense, but I want to double-check that I am getting things right.

[dmertz]

Anything that is not basis must be earnings.  There is no other choice.

[VVRR22]

My biggest thing that I argue is that when you move both the contributions and earnings, you don't pay taxes on the earnings. And then I also transferred the match from my employer which both their contributions and earnings had to pay taxes since theirs are pre taxes. So by that order, the earnings on your own post tax contributions would be the only amounts that once rolled over to the roth ira have not been taxed, correct?

[minostro]

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@dmertz wrote:

Anything that is not basis must be earnings.  There is no other choice.

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That's interesting. I thought that the Roth 401K would have contributions, conversions/rollovers, and earnings for a general case.

I am *only* contributing to my Roth 401K through an in-plan conversion: I contribute after-tax dollars to my after-tax 401K, and after the contribution is made, the money is "moved" immediately to my Roth 401K. I used "moved" to avoid using converted or rolled over. So, all the money that has ever entered my Roth 401K has been after-tax.

I was under the impression that all of these "movements" were conversions/rollovers. I just checked my 1099-R, and I see that these contributions are reported as follows:

• box 5: Employee contrib/desig Roth contrib or insurance premiums
• box 7: G (Direct rollover of a distribution to a qualified plan, a section 403B plan, a governmental section 457(b) plan, or an IRA)

It looks like I was wrong. The money is being entered into the Roth 401K as a contribution. Is that right?

[dmertz]

"I thought that the Roth 401K would have contributions, conversions/rollovers, and earnings for a general case."

Correct.  Basis in contributions, basis in In-plan Roth Rollovers, and earnings.  Your basis in your designated Roth account in the 401(k) comes entirely from the IRRs and everything else in the account is earnings.

[minostro]

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@dmertz wrote:

"I thought that the Roth 401K would have contributions, conversions/rollovers, and earnings for a general case."

Correct.  Basis in contributions, basis in In-plan Roth Rollovers, and earnings.  Your basis in your designated Roth account in the 401(k) comes entirely from the IRRs and everything else in the account is earnings.

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Gotcha. So, the basis in contributions and the basis in-plan Roth Rollovers are grouped and considered the basis when the Roth 401K -> Roth IRA happens. Sorry if I sound repetitive, but I want to ensure I got this right.

By the way thank you very much for your help and patience!

[dmertz]

Upon rollover to a Roth IRA, basis in regular contributions to the Roth 401(k) becomes contribution basis in the Roth IRA and basis in IRRs becomes Roth conversion basis in the Roth IRA.  Earnings remain earnings.

[minostro]

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@dmertz wrote:

Upon rollover to a Roth IRA, basis in regular contributions to the Roth 401(k) becomes contribution basis in the Roth IRA and basis in IRRs becomes Roth conversion basis in the Roth IRA.  Earnings remain earnings.

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This is getting a bit dizzy. Previously, it was said that there were only contributions to a Roth 401K, and everything else was earnings. It looks more nuanced than that, so we have contributions, rollovers, and earnings. Is that correct?

The differentiation matters because it affects how the money is withdrawn from the Roth IRA after the Roth 401K rollover is executed. The rules are basically: bucket-1) contributions, then bucket-2) conversions/rollovers (taxable and then non-taxable), and then bucket-3) earnings.

My question is whether my IRR to Roth 401K is considered part of bucket-1 when the rollover to Roth IRA happens, or is it considered part of bucket-2? I think it should be part of bucket-1. Let me provide the evidence that I gather:

I found the following Q & A in the Treasury Decision 9324 (https://www.irs.gov/irb/2007-22_IRB#TD-9324:(

Q-3. For purposes of the ordering rules on distributions from Roth IRAs, what portion of a distribution from a rollover contribution from a designated Roth account is treated as contributions?

A-3. (a) Under section 408A(d)(4), distributions from Roth IRAs are deemed to consist first of regular contributions, then of conversion contributions, and finally, of earnings. For purposes of section 408A(d)(4), the amount of a rollover contribution that is treated as a regular contribution is the portion of the distribution that is treated as investment in the contract under A-6 of §1.402A-1, and the remainder of the rollover contribution is treated as earnings. Thus, the entire amount of any qualified distribution from a designated Roth account that is rolled over into a Roth IRA is treated as a regular contribution to the Roth IRA. Accordingly, a subsequent distribution from the Roth IRA in the amount of that rollover contribution is not includible in gross income under the rules of A-8 of §1.408A-6.

They confirm what you said about the treatment of the rollover contribution money. But there is still a nagging thought in my mind, which is that the contributions to my Roth 401K are solely coming from IRRs, which are reported in my 1099-R as:

• box 5: Employee contrib/desig Roth contrib or insurance premiums
• box 7: G (Direct rollover of a distribution to a qualified plan, a section 403B plan, a governmental section 457(b) plan, or an IRA)

So, my Roth 401K has no "direct contributions." It only has IRRs and earnings. I then looked closer at the text: "That is treated as investment in the contract under A-6 of §1.402A-1". I went to the definition of A-6 of §1.402A-1 (https://www.law.cornell.edu/cfr/text/26/1.402A-1) which states the following:

A-6. (a) If a distribution from a designated Roth account is rolled over to another designated Roth account in a direct rollover, the amount of the rollover contribution allocated to investment in the contract in the recipient designated Roth account is the amount that would not have been includible in gross income (determined without regard to section 402(e)(4)) if the distribution had not been rolled over. Thus, if an amount that is a qualified distribution is rolled over, the entire amount of the rollover contribution is allocated to investment in the contract.

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They talked about rolling over a designated Roth account to another designated Roth account, which I found weird because the Treasury Decision was talking about rollovers to a Roth IRA. One thing that caught my attention was the following "the amount of the rollover contribution allocated to investment in the contract in the recipient designated Roth account is the amount that would not have been includible in gross income (determined without regard to section 402(e)(4)) if the distribution had not been rolled over. "

I then looked up what Box 5 means (https://www.irs.gov/instructions/i1099r please also append this to the end of the URL#en_US_2024_publink[phone number removed])in my 1099-R, and I found the following:

Enter the employee's contributions, designated Roth account contributions, or insurance premiums that the employee may recover tax free this year (even if they exceed the box 1 amount). The entry in box 5 may include any of the following: (a) designated Roth account contributions or contributions actually made on behalf of the employee over the years under the plan that were required to be included in the income of the employee when contributed (after-tax contributions), (b) contributions made by the employer but considered to have been contributed by the employee under section 72(f), (c) the accumulated cost of premiums paid for life insurance protection taxable to the employee in previous years and in the current year under Regulations section 1.72-16 (cost of current life insurance protection) (only if the life insurance contract itself is distributed), and (d) premiums paid on commercial annuities. Do not include any DVECs, any elective deferrals, or any contribution to a retirement plan that was not an after-tax contribution.

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Given that language, the IRRs that I have in Roth 401K are considered contributions, and as such, when the Roth 401K rollover happens, my Roth 401K IRRs will roll over as contributions, too.

Curious to hear your thoughts @dmertz. 

[dmertz]

"My question is whether my IRR to Roth 401K is considered part of bucket-1 when the rollover to Roth IRA happens, or is it considered part of bucket-2? I think it should be part of bucket-1."

No, it's bucket #2.

The 2007 Treasury Decision that you referenced predates the permissibility of IRRs.  Prior to September 28, 2010, rollovers from a designated Roth account could consist only of regular contribution basis and earnings (because prior to that date there could be no basis in IRRs).  IRRs became available for only those distribution made after September 27, 2010.  See IRS Notice 2010-84 issued after the passing of the law that added IRRs to the tax code.

As I said in my previous reply, basis in IRRs becomes Roth conversion basis in the Roth IRA.  Note, however, that your IRR was, absent any investment gains, a nontaxable IRR so that when rolled over to the traditional IRA it becomes basis in nontaxable Roth conversions, nearly equivalent to Roth IRA contribution basis because a distribution of basis in nontaxable Roth conversions is not subject to any early-distribution penalty; only taxable distributions are potentially subject to an early-distribution penalty.  Under the ordering rules, though, basis in nontaxable Roth conversions is distributed after basis in taxable Roth conversions from the same taxable year, so if there is any basis in taxable Roth conversions from the same year, perhaps because there was an investment gain prior to the IRR that made some portion of the IRR taxable, the basis in taxable Roth conversions would come out first, potentially subject to an early distribution penalty.  After the 5-year clock for the particular Roth conversion basis has run out the penalty on the distribution of that basis in taxable Roth conversions is no longer subject to any early-distribution penalty.

[minostro]

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@dmertz wrote:

The 2007 Treasury Decision that you referenced predates the permissibility of IRRs.  Prior to September 28, 2010, rollovers from a designated Roth account could consist only of regular contribution basis and earnings (because prior to that date there could be no basis in IRRs).  IRRs became available for only those distribution made after September 27, 2010.  See IRS Notice 2010-84 issued after the passing of the law that added IRRs to the tax code.

As I said in my previous reply, basis in IRRs becomes Roth conversion basis in the Roth IRA.

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Thank you for pointing this out. I read both https://www.irs.gov/irb/2010-51_IRB#NOT-2010-84 and https://www.irs.gov/irb/2013-52_IRB#NOT-2013-74, but I couldn't find where they mentioned that basis in IRRs on the Roth 401K are considered to be rollovers/conversion basis (bucket 2) in the Roth IRA. Please point me to the paragraph that mentions that or that one could make such an interpretation.

Note, however, that your IRR was, absent any investment gains, a nontaxable IRR so that when rolled over to the traditional IRA it becomes basis in nontaxable Roth conversions, nearly equivalent to Roth IRA contribution basis because a distribution of basis in nontaxable Roth conversions is not subject to any early-distribution penalty; only taxable distributions are potentially subject to an early-distribution penalty.

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Yes, I agree with you on this. My IRRs come from after-tax money, which I rolled over immediately to the Roth 401K. So when the Roth 401K --> Roth IRA rollover is executed, they become part of the nontaxable contribution/rollover (bucket 2) --Here, I am going with your interpretation of IRRs being considered Roth conversions.

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Under the ordering rules, though, basis in nontaxable Roth conversions is distributed after basis in taxable Roth conversions from the same taxable year, so if there is any basis in taxable Roth conversions from the same year, perhaps because there was an investment gain prior to the IRR that made some portion of the IRR taxable, the basis in taxable Roth conversions would come out first, potentially subject to an early distribution penalty.  After the 5-year clock for the particular Roth conversion basis has run out the penalty on the distribution of that basis in taxable Roth conversions is no longer subject to any early-distribution penalty.

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Right. First come taxable conversions/rollovers, and then non-taxable conversions/rollovers. The 5-year clock applies because the IRR is considered to be a conversion/rollover, but it only applies to the taxable part of it. I checked my 1099-R forms and see that every year, I have about 2 or 4 dollars reported in box 2.a (taxable amount).

To summarize, I am not 100% sure that IRRs belong to bucket 2, and it would be great if you could point me to where this is defined or interpreted.

In my case, the difference doesn't matter much because my Roth IRA only has money from a) after-tax contributions to a Traditional IRA that was then converted to a Roth IRA (backdoor Roth) and b) IRRs that I would start rolling over once I am not longer employed (assuming < 59 1/2).

[dmertz]

I did some testing with TurboTax and it appears that TurboTax puts this in bucket 1.  However, it's my belief that an amount attributable to an IRR retains its character when rolled over to a Roth IRA, which would mean that in this case it becomes basis in nontaxable conversions and would comes under the Roth IRA ordering rules as an amount attributable to a nontaxable Roth conversion, bucket 2.  I don't have a reference that I can use to justify this belief.  TurboTax does treat a rollover of after-tax funds from a traditional 401(k) account to a Roth IRA as nontaxable conversion basis (bucket 2), which I agree with, so I think it's unreasonable to be able to cause the basis to be treated instead as contribution basis in the Roth IRA by first sending it through the designated Roth account by performing an IRR before rolling the designated Roth account over to a Roth IRA.

I agree that the IRS Notices do not really address this issue.

[minostro]

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@dmertz wrote:

I did some testing with TurboTax and it appears that TurboTax puts this in bucket 1. 

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That's consistent with what is discussed in this boglehead post:  https://www.bogleheads.org/forum/viewtopic.php?p=6272503#p6272503 

They say that IRRs are investments in contracts and should be reported in line 22 of form 8606. I am curious what your thoughts are. They seemed confused at first, but it looks like the term "investment in contracts" convinced them that IRRs should go in line 22.

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I agree that the IRS Notices do not really address this issue.

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Yeah, I read the notices several times to ensure I understood everything. Thanks for confirming this.

[AlexaAli]

You should be able to report your Roth 401(k) rollover to a Roth IRA in TurboTax under the section for 1099-R forms. Look for the option to enter retirement income, and select the appropriate form for your rollover. Make sure to indicate that it was a direct rollover to a Roth IRA so it's classified correctly. Since your Roth IRA was opened before 2008, it should satisfy the 5-year rule for tax-free withdrawals, but if you have further questions, it might be helpful to consult TurboTax support or a tax professional for guidance.

[AlexaAli]

You're very welcome! I'm glad I could help clear things up for you. It can definitely be tricky navigating through all the rules about contributions and rollovers between different types of retirement accounts. As for my experience, I’ve been working with tax preparation and financial planning tools for a while, helping people navigate situations like yours with retirement accounts, investments, and general tax questions. Happy to assist anytime.