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

[minostro]

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@dmertz wrote:

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. 

I wanted to share my final interpretation on this matter with you @dmertz. It's as follows:

• A Roth 401K is a designated Roth account.

• In-plan Roth Rollovers (IRRs) are generated when an after-tax contribution to a 401K account is immediately rolled over to a Roth 401K account.
• IRRs are considered to be investment in the contract. Investment in the contract is the same as basis or contribution:

* Box 5 of Form 1099-R uses the “investment in contract” language: Generally, this shows the employee’s investment in the contract (after-tax contributions)

* This Bogleads post provides good context on the definition of “Investment in the contract”: https://www.bogleheads.org/forum/viewtopic.php?p=5689938&sid=9c48f49fe0302c46b31e9f97ffd6259b#p56899... 

• IRRs are reported in Form 1099-R as follows:
  • box 1: Gross contribution
  • box 2a: Taxable amount
  • 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)

• An IRR has two components: non-taxable (Form 1099-R, Box 5) and taxable (Form 1099-R, Box 2a). The non-taxable portion is the contribution made via payroll, and the taxable is the tiny gains that are generated when the IRR doesn't happen fast enough.
• The IRS has decided that the IRRs (non-taxable and taxable) should be reported in box 22 (contribution basis) when they are rolled over from a Roth 401K to a Roth IRA:
  • Increase the amount on line 22 by any amount rolled in from a designated Roth, Roth SEP, or Roth SIMPLE account that is treated as investment in the contract.
• The IRS provides further guidance in the instructions for Box 24 to exclude the IRR total amount:
  • Don’t include amounts rolled in from a designated Roth, Roth SEP, or Roth SIMPLE account because these amounts are included on line 22. 
• The following is observed regarding Roth IRA withdrawal rules after IRRs are rolled over:
  • IRRs non-taxable is considered as a contribution (bucket #1) 
  • IRRs taxable are subject to penalty when(special recapture rule):
    • They were contributed < 5 years at the time of the Roth 401K → Roth IRA happened, and
    • They were distributed < 5 years after the Roth 401K → Roth IRA happened.

• All the gains that the IRRs generated in the Roth 401K will be treated as gains (bucket #3) in the Roth IRA. This amount is not reported when the Roth 401K → Roth IRA happens.

[dmertz]

"In-plan Roth Rollovers (IRRs) are generated when an after-tax contribution to a 401K account is immediately rolled over to a Roth 401K account."

True, but IRRs are happen when any funds are rolled over from the traditional account in the 401(k) to the designated Roth account in the same 401(k).  I think that you address this later.

"IRRs are considered to be investment in the contract. Investment in the contract is the same as basis or contribution:"

That statement is a bit too broad since it does not account for the taxable amount of the IRR that might be subject to recapture of the early-distribution penalty.

"IRRs taxable are subject to penalty when(special recapture rule):

• They were contributed < 5 years at the time of the Roth 401K → Roth IRA happened, and
• They were distributed < 5 years after the Roth 401K → Roth IRA happened."

That is incorrect.  If what you described applied, the 5-year clock could become a 9-year clock.  The 5-year recapture clock starts at the beginning of the year in which the particular IRR occurred.  The timing of the rollover from the designated Roth account to the Roth IRA has no effect on the running of this clock.  https://www.irs.gov/retirement-plans/retirement-plans-faqs-on-designated-roth-accounts

I still have a bit of a problem problem that treating as contribution basis when rolled over to a Roth IRA the nontaxable part of an IRR that consists of both taxable and nontaxable parts.  Doing so produces a different result with regard to Roth IRA ordering rules than if the funds were rolled from the traditional 401(k) to a traditional IRA and then converted to Roth (when there are no other funds in traditional IRAs).  Maybe that's reasonable, though, since there is no MAGI limit on making contributions to the 401(k).

[minostro]

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@dmertz wrote:

"IRRs are considered to be investment in the contract. Investment in the contract is the same as basis or contribution:"

That statement is a bit too broad since it does not account for the taxable amount of the IRR that might be subject to recapture of the early-distribution penalty.

That's correct, but I clarified that IRR has a taxable and non-taxable amount in my post.

"IRRs taxable are subject to penalty when(special recapture rule):

• They were contributed < 5 years at the time of the Roth 401K → Roth IRA happened, and
• They were distributed < 5 years after the Roth 401K → Roth IRA happened."

That is incorrect.  If what you described applied, the 5-year clock could become a 9-year clock.  The 5-year recapture clock starts at the beginning of the year in which the particular IRR occurred.  The timing of the rollover from the designated Roth account to the Roth IRA has no effect on the running of this clock.  https://www.irs.gov/retirement-plans/retirement-plans-faqs-on-designated-roth-accounts

I stand corrected. I was wrong. I thought the IRR clock would reset when the Roth 401K -> Roth IRA rollover occurred, but it does not.

I still have a bit of a problem problem that treating as contribution basis when rolled over to a Roth IRA the nontaxable part of an IRR that consists of both taxable and nontaxable parts.  Doing so produces a different result with regard to Roth IRA ordering rules than if the funds were rolled from the traditional 401(k) to a traditional IRA and then converted to Roth (when there are no other funds in traditional IRAs).  Maybe that's reasonable, though, since there is no MAGI limit on making contributions to the 401(k).

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The confusing part is that the IRRs are reported in box 22 of form 8606, not in box 24. However, that doesn't mean all IRRs can be taken penalty-free. The special recapture rule targets the taxable part of the IRR. The other bit that's confusing is that I was expecting the taxable amount of the IRR to be reported in a different box when the Roth 401K --> Roth IRA occurred. Still, I couldn't find any guidance on that, so the only option is to report the entire amount in box 22 and then follow the special recapture rule.