Tag Archive for: qualified distribution

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Designated Roth Account Rollover and Five-Year Rule

“My client participates in a 401(k) plan, has a Designated Roth account and wants to roll over the Designated Roth account to a Roth IRA. Can my client count the time in the 401(k) plan towards the five-year waiting period for the Roth IRA needed for taking qualified distributions?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with an advisor in Pennsylvania is representative of a common inquiry regarding Designated Roth contributions in a 401(k) plan.

Highlights of Discussion
The short answer is, surprisingly, “No.” If your client rolls over his or her 401(k) plan Designated Roth account assets to a Roth IRA, the time spent in the Designated Roth account will not carry over to the Roth IRA (IRS Treasury Regulation § 1.408A–10, Q&A 4).

That means, if your client established his or her first Roth IRA with the rollover of Designated Roth account assets, the five-year period for determining qualified distributions from the Roth IRA would begin that year. In essence, the five-year period for determining qualified distributions in the 401(k) plan is determined separately from the five-year period for determining qualified distributions in the Roth IRA.

It’s another one of those “earlier of” scenarios for the Roth IRA and the five-year period §1.408A–6, Q&A 2. The five-year period for the Roth IRA begins with the earlier of the taxable year in which

• The first Roth IRA contribution (or conversion) is made to any Roth IRA owned by the individual, or
• A rollover contribution of a Designated Roth account is made to a Roth IRA.

Conclusion
The five-year period for determining qualified distributions from a 401(k) plan Designated Roth account is determined separately from the five-year period for determining qualified distributions in a Roth IRA. For that reason, it may be advantageous for investors to make a Roth IRA contribution sooner rather than later in order to put the five-year clock in motion in the Roth IRA.

 

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Roth 401(k)s and the Five-Year Clock

“Can you explain how the ‘five-year clock’ applies to Roth 401(k) contributions?”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from New York is representative of a common inquiry related to designated Roth contributions in a 401(k) plan.

Highlights of the Discussion

Distributions of Roth 401(k) contributions (i.e., designated Roth contributions) can be taken tax and penalty free if the participant meets certain conditions for a “qualifying distribution.” A qualifying distribution is one that is made after a five-taxable-year period of participation (“the five-year clock”), and the participant has attained age 59 ½, has become disabled, or in the case of a beneficiary, following the participant’s death.

The five-year clock begins on the first day of the participant’s taxable year in which he or she first makes designated Roth contributions to the plan. If the first Roth contribution is a rollover of designated Roth contributions from another 401(k) plan, the starting of the five-year clock depends on whether the rollover is direct or indirect.

If the participant completes a direct rollover from a designated Roth account under another 401(k) plan, the five-year period is deemed to have begun on the first day of the taxable year that the employee made Roth 401(k) contributions to the other plan. In contrast, an indirect rollover contribution restarts the five-year clock under the receiving plan for a participant who has made no prior Roth 401(k) contributions to the receiving plan (Treasury Regulation 1.402A-1, Q&A 4).

Conclusion

Since the five-year clock for determining a tax-free, qualifying distribution of Roth 401(k) contributions begins on the first day of the participant’s taxable year in which he or she first makes a designated Roth contribution to the plan, it may be wise for a participant—if he or she has the option—to designate even $1 of elective contributions as a Roth 401(k) contribution right away in order to start the ticking of the five-year clock. And if a participant is rolling over Roth 401(k) contributions—a direct rollover is the only way to avoid restarting the five-year period.

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© Copyright 2022 Retirement Learning Center, all rights reserved