Roth 401K

[Jeff Pratt 1]

Follow-up to my first question..

My understanding is:

1. If I open a Roth IRA any time in 2023, it's start date is Jan 1, 2023?

2. The 5 Year rule is in play to Jan 1, 2028?

3. If I move more un-taxed money into it from another account at ANY TIME in that 5 years, is that money available tax and penalty free on Jan 2, 2028, or does the 5 Year rule start every time I make a un-taxed contribution? 

4. Or, is that money automatically taxed when it is deposited into the Roth IRA?

[KarenL4]

HI, 

Each new conversion starts its own five-year clock, and you'll need to account for multiple conversions to make sure you don't take out too much money too soon. Note that the five-year rule applies equally to Roth conversions for both pre-tax and after-tax funds in a traditional IRA.

This article may also help with additional questions.

https://blog.turbotax.intuit.com/retirement/roth-ira-withdrawal-rules-and-penalties-53233/

Please cheer below with a thumbs up if this was helpful!

Best,

Karen

[TylerH_EA]

.

[Aimee-O]

Hi Jeff!

Great questions!!

1. If I open a Roth IRA any time in 2023, it's start date is Jan 1, 2023?    Yes.  The rule for that conversion actually begins on January 1 of the tax year.

2. The 5 Year rule is in play to Jan 1, 2028?   Yes.

 3. If I move more un-taxed money into it from another account at ANY TIME in that 5 years, is that money available tax and penalty free on Jan 2, 2028, or does the 5 Year rule start every time I make a un-taxed contribution?    Contributions- The five-year clock starts with your first contribution to any Roth IRA.  Conversions- The five-year clock RESETS at each conversion, so you will want to keep track of your dates of conversions.

4. Or, is that money automatically taxed when it is deposited into the Roth IRA?  Roth contribution/conversion/rollover is always at after tax dollar.  To clarify more, if you are converting a Traditional IRA/401k (pre-tax) to a ROTH IRA, you will pay taxes on the amount converted on your tax return.  You will be given a 1099R from the Company/brokerage that held the Traditional IRA/401k at tax time to report on your tax return. You will be taxed at  your current tax rate (no penalty just tax on the "distribution" that is converted).  I recommend to prepare for that.  (you may want to consider having the company withhold taxes) If it's a contribution, you just won't get a deduction on your tax return.  And if it is a rollover, ROTH to a ROTH, then there will not be any tax consequence.

Great Article:
Roth account rules and penalties 

Hopefully that helps!

[stone8pin]

so it's pretty much up to the owner to withdraw the correct amount of money each year without penalty?

In other words, there is NO warning that the amount of withdrawal is too much?

[Opus 17]

1. Yes.

2. Yes.

3. No. Each conversion has a separate 5 year clock.

4. Any movement from a pre-tax account (401k or traditional IRA) into a Roth IRA is a conversion and you pay income tax at the time of the conversion.  The 5 year rule applies to the 10% penalty for early withdrawal.

It works like this:

When you withdraw from a Roth IRA, you withdraw contributions first, conversions second, and earnings last.  There is a 5 year clock on opening the IRA and a separate 5 year clock on each conversion.  Here is how you are taxed:

If you withdraw contributions	Never taxed
If you withdraw conversions less than 5 years after the conversion	10% penalty for early withdrawal if under age 59-1/2, no tax if over age 59-1/2
If you withdraw conversions more 5 years after the conversion	Not taxed
If you withdraw earnings before the 5 year period for opening the IRA	Subject to income tax. Also subject to the 10% penalty for early withdrawal if you are under age 59-1/2
If you withdraw earnings after the 5 year period from opening the IRA	Subject to income tax and the 10% penalty if under age 59-1/2.  No tax if over age 59-1/2.

There are also some exceptions to the 10% penalty for various circumstances as allowed by law.  

[Aimee-O]

You have GREAT insight!  You are correct.  There is NO warning or safeguard in place.  It is up to the owner/taxpayer.  It's possible the brokerage company may have information.  But a lot of times that info can get muddled or lost in the conversions, contributions, rollovers.  

[stone8pin]

Tyler, so if a person has ONE Roth IRA and contributes $5,000 every year to this fund, then (after each successive 5 year period) a person can withdraw A MAXIMUM of $5,000 tax free per year without a penalty?

[TylerH_EA]

Hi @stone8pin,

I need to clarify. There is a difference between contributions and conversions/rollovers. If you only make contributions (i.e. deposits of your own funds into a Roth IRA), there is only one 5-year rule that applies to your Roth IRA. Specifically, the 5-year period starts from January 1st of the year in which you made the first contribution. There is no 5-year rule for any subsequent contributions. Therefore, if you make a $5,000 contribution to your Roth IRA in 2023, the 5-year period starts on January 1, 2023 and ends on January 1, 2028. If you make additional contributions (e.g. $5,000 in 2024, 2025, 2026, etc.) there will not be new 5-year periods that apply to those contributions. Accordingly, if you are at least 59 1/2 in 2028, you will be able to withdraw any amount from the Roth IRA without being subject to tax or a 10% penalty. For example, in the situation that you are describing, if you withdraw $10,000 in 2028, none of that distribution will be subject to tax.

There is a separate 5-year rule for conversions (e.g. rolling over a pre-tax 401k into a Roth IRA). Every time you convert a pre-tax account into a Roth IRA, a 5-year period is attached to each conversion. 

[Aimee-O]

Hi Jeff!

Great questions!!

1. If I open a Roth IRA any time in 2023, it's start date is Jan 1, 2023?    Yes.  The rule for that conversion actually begins on January 1 of the tax year.

2. The 5 Year rule is in play to Jan 1, 2028?   Yes.

 3. If I move more un-taxed money into it from another account at ANY TIME in that 5 years, is that money available tax and penalty free on Jan 2, 2028, or does the 5 Year rule start every time I make a un-taxed contribution?    Contributions- The five-year clock starts with your first contribution to any Roth IRA.  Conversions/Rollover- The five-year clock RESETS at each conversion, so you will want to keep track of your dates of conversions.

4. Or, is that money automatically taxed when it is deposited into the Roth IRA?  Roth contribution/conversion/rollover is always at after tax dollar.  To clarify more, if you are converting a Traditional IRA/401k (pre-tax) to a ROTH IRA, you will pay taxes on the amount converted on your tax return.  You will be given a 1099R from the Company/brokerage that held the Traditional IRA/401k at tax time to report on your tax return. You will be taxed at  your current tax rate (no penalty just tax on the "distribution" that is converted).  I recommend to prepare for that.  (you may want to consider having the company withhold taxes) If it's a contribution, you just won't get a deduction on your tax return.  And if it is a rollover, ROTH to a ROTH, then there will not be any tax consequence.

Great Article:
Roth account rules and penalties 

Hopefully that helps!

[Opus 17]

---

@stone8pin wrote:

Tyler, so if a person has ONE Roth IRA and contributes $5,000 every year to this fund, then (after each successive 5 year period) a person can withdraw A MAXIMUM of $5,000 tax free per year without a penalty?

---

No, all contributions are contributions.  Suppose you contribute $5000 per year for 5 years, and at the end, your balance is $29,000 because of investment growth.  $25,000 is contributions and $4000 is earnings.  You can withdraw up to the total amount of your contribution at any time for any reason without paying any tax.  You could withdraw $5000 per year or all $25,000 at once, it doesn't matter.  If you withdraw the earnings, you will pay income tax plus a 10% penalty, unless you are over age 59-1/2 and meet the 5 year rule.

You have to keep track of your contributions, conversion, and withdrawals, so that you, your tax software, or accountant, can know whether you are withdrawing contributions, earnings or conversions.  The IRS can send you an inquiry at any time, and if you can't prove what you did, they can tax everything.

[Opus 17]

Also, be aware:

You titled your post "Roth 401k" but all the questions and answers have been about a Roth IRA.

401(k)s and other workplace plans are NOT IRAs.  IRAs are controlled by different sections of the tax laws and have different rules than workplace plans, and some of the rules for a designated Roth account inside of a 401(k) plan are different than the rules for a Roth IRA.

If you are asking about a designated Roth account inside of a 401(k) plan, you will need to clarify that for us.