Roth 401(k) Knowledgebase
Participants can take distributions from a Roth 401(k) account under certain circumstances while working or during retirement. They are also permitted to roll over their account to another employer’s plan (assuming the recipient employer plan permits this action), or to a Roth IRA.
Revenue Ruling 2004-12 provides that a rollover takes on the character of the recipient plan in certain respects. This means that the participant’s options for distributions are ultimately dependent on the recipient plan of the rollover.
The ability for a Roth 401(k) account to take on the character of a Roth IRA is significant relative to distribution planning opportunities. The following distribution distinctions between Roth 401(k) and Roth IRA accounts are key to the retirement and estate planning opportunities afforded by the Roth 401(k).
Distinctions between Roth 401(k) and Roth IRA
Five-year Rule The original contribution year of the Roth 401(k) deferral is not considered in determining the satisfaction of the five-year rulefor distributions from a Roth IRA. For Roth IRAs, the first year is determined by the date of any contribution to any Roth IRA. Therefore, if the Roth 401(k) distribution is not rolled into a previously established Roth IRA that qualifies under the Roth IRA’s five-year rule (and no other Roth IRA previously established by the plan participant so qualified), the five-year period for a Roth IRA established at the time of the rollover from the 401(k) plan begins in the calendar year of the rollover.
Nonqualified Distributions The rule requiring taxation of a proportionate amount of investment earnings on nonqualified distributions from a Roth 401(k) account does not apply to Roth IRAs. Nonqualified Roth IRA distributions up to the principal basis of the after-tax contributions are treated as first money in, first money out. Therefore, because the rollover of the Roth 401(k) into the Roth IRA takes on the character of the recipient plan, nonqualified distributions of rolled over Roth 401(k) accounts are tax-free up to the principal amount of the contributions.
Roth IRAs are not subject to the same minimum distribution requirements as qualified retirement plans or other non-Roth IRA accounts. In particular, the minimum distribution requirements do not apply to a Roth IRAwhile the owner is alive. Therefore, the IRA owner (the former plan participant) has the option to take no distributions from the Roth IRA while living, thereby leaving the entire account to his heirs who must comply with the minimum distribution requirements after the owner’s death. Required payments to beneficiaries of Roth IRAs are calculated as if minimum distributions were required, with the Roth IRA owner dying prior to the required beginning date.
Payments to the designated beneficiary must satisfy one of two distribution rules:
1) The five-year payment rule, which requires that the death benefit is completely distributed no later than the December 31 of the fifth calendar year following the calendar year of the death of the Roth IRAowner; or
2) The life expectancy rule, which allows payments to be calculated using either the account balance or annuity distribution method if payments commence by December 31 of the calendar year following the death of the Roth IRA owner. The applicable life expectancy factor used to determine payments under the life expectancy rule depends on the number of beneficiaries, whether or not there are multiple accounts, and the relationship of the beneficiary to the Roth IRA owner.
Spousal Beneficiary A spouse who is the sole beneficiary is permitted to postpone the required payment date to the last day of the calendar year in which the Roth IRA owner would have attained age 70-1/2.
Nonspousal Beneficiary Nonspousal beneficiaries cannot postpone the required payment date for distributions. To extend the payment of death benefits (the IRA proceeds) beyond the December 31 of the fifth calendar year following the calendar year of the death of the Roth IRA owner, distributions using the life expectancy rule (based on the account balance or annuity method) must commence by December 31 of the calendar year following the death of the Roth IRA owner.
If the IRA is not segregated prior to, or at death, and there are multiple nonspousal beneficiaries the age of the oldest beneficiary is used to calculate minimum distributions. If the IRA account is segregated into multiple accounts, each with a separate beneficiary, then the age of each beneficiary is use to separately when calculate minimum distributions.