Rolling Over Your Roth 401(k)? Here are 4 Must-Know Moves

While rolling over a traditional 401(k) account has its quirks, rolling over a Roth 401(k) comes with a unique set of rules. This article highlights some key considerations to keep in mind when rolling over a Roth 401(k).

Before we begin, here are some ground rules to keep in mind:

• A designated Roth account is a Roth 401(k), Roth 403(b), or governmental Roth 457(b). For the purpose of this article, we use Roth 401(k) as the collective term for all these accounts.
• This article focuses on rollovers by plan participants. It does not cover the rules that apply to beneficiaries.
• Your Roth 401(k) cannot be rolled over to a traditional IRA or traditional 401(k). It can be rolled over to a Roth IRA or another Roth 401(k) account, providing the amount is eligible for rollover.
• You cannot roll over your Roth IRA to your 401(k).

Let’s review some important reminders about rolling over a Roth 401(k).

1. Make Sure the Amount Is Eligible to Be Rolled Over

Like rollovers from traditional accounts under employer plans, rollovers from Roth 401(k)s must include only eligible amounts. Amounts not eligible for rollover include:

• Hardship withdrawals.
• Corrective distributions of excess contributions.
• Certain loans deemed as distributions due to not meeting applicable compliance requirements.

Important Note: As of 2024, Roth 401(k) participants are not subject to required minimum distributions. Therefore, unlike rollovers from traditional 401(k) and other employer plans, there is no RMD to be withdrawn before the rollover.

As with traditional accounts, your plan administrator must explain how much of your distribution is eligible for rollover.

2. Determine If Your Roth 401(k) Distribution Is ‘Qualified’

A qualified distribution from a Roth 401(k) is tax-free and represents basis in the receiving Roth IRA or Roth 401(k)—that is, those amounts will be tax-free when distributed from the receiving account. If your Roth 401(k) distribution is nonqualified, it will include a prorated amount of basis and earnings, and how it is applied in the receiving account depends on whether the account is a Roth IRA or Roth 401(k).

So, how do you know if your Roth IRA distribution is qualified? By checking to see if it meets the following two qualifying requirements:

1. At the time of your distribution, you are at least age 59 ½ or disabled.
2. Your distribution is made no earlier than five years after Jan. 1 of the year the Roth 401(k) was first funded.

Example: If your first Roth 401(k) contribution was made at any time during 2020, distributions taken on Jan. 1, 2025, or after would meet the five-year period.

If these two requirements are met, your distribution is qualified. Otherwise, it is nonqualified.

For a nonqualified distribution from your Roth 401(k):

• A prorated amount of basis and earnings is generally included.
• The basis is nontaxable.
• The earnings would be taxable.
• Distributions of the earnings before age 59 ½ should be subject to the 10% penalty unless an exception applies.

The qualified status of your distributions from your Roth 401(k) determines how they are treated when rolled over, as discussed next.

3. Know the Impact of Choosing Direct Rollover vs. Indirect Rollover

There are two methods for rolling over your Roth 401(k):

1) Direct Rollover

• With a direct rollover to a Roth IRA, the distribution is paid to your Roth IRA custodian for credit to your Roth IRA.
• With a direct rollover to a Roth 401(k), the distribution is paid to your Roth 401(k) plan trustee for credit to your Roth 401(k).

2) Indirect Rollover

• With an indirect rollover, the distribution is paid to you.
• You have 60 days to roll over any eligible amount to your Roth IRA or Roth 401(k).

When choosing your rollover method, consider the end results, discussed next.

Rollover to Your Roth IRA

Amounts rolled over from a Roth 401(k) to a Roth IRA take on the characteristics of the Roth IRA, including determining whether a distribution from the Roth IRA is taxable.

While qualified distributions are fully tax-free, the taxability of a nonqualified distribution from a Roth IRA depends on the tranche from which the amount is distributed.

If your Roth 401(k) distribution is qualified, it creates a pure basis in your Roth IRA, and the entire amount is allocated as basis, called Tranche 1. Under the Roth IRA ordering rules, Tranche 1 is distributed first and is penalty-free and tax-free.

If your Roth 401(k) distribution is nonqualified, the basis is allocated to Tranche 1, and the earnings are allocated to Tranche 3.

Distributions of these earnings amounts are taxable if withdrawn from your Roth IRA as a nonqualified distribution. In addition, a 10% additional tax or early distribution penalty applies to the earnings portion if the distribution occurs before you reach age 59 ½ unless you qualify for an exception.

If the distribution is from an indirect rollover and includes only a partial amount of the Roth 401(k) distribution, your rollover will come from your earnings first, thus preserving nontaxability.

Example: Tom is 49 years old and not disabled.

He has a Roth 401(k) with Widgets and Things Inc. valued at $500,000. The $500,000 is composed of $200,000 in earnings and $300,000 from his contributions and rollovers from his traditional 401(k).

When Tom left Widgets and Things, he requested a distribution of the entire balance be paid to him. He later decided to roll over $200,000 to his Roth IRA. The $200,000 will come from the earnings. This would be nontaxable due to being rolled over by the deadline.

The balance of $300,000 would be nontaxable as it is from Tom’s basis amount. Tom can still roll over any portion of this $300,000—up to 100%—as long as the rollover is completed in a timely manner.

Planning Tip

Advisors often recommend funding a Roth IRA—with a regular contribution if eligible or a conversion or rollover—as soon as possible because:

• The five-year period for your Roth 401(k) is not carried over to your Roth IRA.
• Only the five-year period for your Roth IRA counts when determining if your Roth IRA distribution is qualified.

Starting your Roth IRA early would ensure the tax-free treatment of:

• Any earnings from your Roth 401(k) rollover.
• Earnings that accrue in your Roth IRA before and after the rollover become tax-free once you reach age 59 ½ or have another qualifying event and meet the Roth IRA’s five-year period.

Rollover to Your Roth 401(k)

You may roll over your Roth 401(k) to an employer plan only if that plan has a Roth 401(k) feature. Be sure to check with your plan administrator before providing rollover instructions.

If you intend to roll over the entire distribution amount from one Roth 401(k) to another, the rollover must be a direct rollover.

If the distribution is qualified, the entire amount is allocated as basis in your Roth 401(k).

If it is nonqualified, the allocation is carried over as allocated in your old 401(k). The basis is allocated as basis, and earnings are allocated as earnings in your receiving Roth 401(k).

For indirect rollovers, only the earnings portion can be rolled over.

4. Keep Track of Your Taxable vs. Nontaxable Amount

Proper tracking of your Roth balance and funding sources will help ensure that you do not pay income tax on amounts that qualify to be tax-free.

For your Roth IRA, you are responsible for tracking how much is tax-free.

For Roth 401(k)s, your plan administrator is responsible for ensuring they track how much is tax-free and how much is not. But just in case, you should keep track of the amount, as you could appear to owe income tax on a nontaxable amount if your plan administrator makes a mistake.

Get Your Advisors Involved

Should you keep your Roth 401(k) assets in a Roth 401(k) or move it to your Roth IRA? What is right for you depends on your retirement and tax profile. Should you decide to move your account:

• Consult your advisors to determine suitability.
• Track the funding sources of your Roth accounts to help ensure that you do not pay income tax on tax-free amounts.
• Inform your tax preparer and provide them with tax reporting forms and other documents for your transaction.

By sharing the details with your advisors, you help to ensure that your transactions are processed and reported accurately.