Tax planning and compliance for investors
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By Kaye A. Thomas
Updated January 26, 2008
They're similar to Roth IRA distributions, but with some important differences.
The main rules for taking distributions from Roth 401k or 403b accounts are similar to the rules for Roth IRAs, but with a few differences.
This is one area where 401k and 403b accounts differ from IRAs. If you want to take money from your Roth IRA, all you have to do is contact the financial institution and tell them to send the money (selling assets for that purpose, if necessary). In this area, a Roth 401k account works the same as a traditional 401k account. You can take the money any time you want after termination of employment, but prior to termination you usually can't take money out of your account unless you qualify for a hardship distribution.
You have the same access to your Roth 401k account as your traditional 401k account: no more, no less.
If you have both traditional and Roth accounts in the same 401k or 403b plan and you make a partial withdrawal, you should be able to choose which account the money is coming from. This choice may be useful for tax planning in general and also for avoiding nonqualifying distributions from the Roth 401k or 403b account, as described below.
Unless you're rolling your money to another Roth account (a Roth IRA or a Roth account in another employer's plan), you'll want your distributions to qualify for tax-free treatment. The rules here are similar to the Roth IRA rules. You need to have the account five years and in addition you have to be 59½ or disabled. (Distributions after your death can qualify also.)
The Roth IRA rule for first-time homebuyers does not apply to a Roth 401k account.
There's one difference you'll want to note if you work for more than one company that offers these accounts. The five-year rule applies to each employer's 401k separately, except you get credit for prior years if you roll money from one plan to another.
Example: Your first Roth 401k contribution at one employer was in 2006. In 2008 you changed jobs and began contributing to the Roth 401k at a second employer. Assuming you're over 59½, you can begin to take qualifying distributions from the first account in 2011, but you have to wait until 2013 to take qualifying distributions from the second account. If you roll the money from the first account to the second one, though, the combined account is treated as one that was started in 2006.
This is different from the rule for Roth IRAs, where new accounts acquire the "aging" of earlier accounts without the need for a rollover.
If you don't meet the requirements described above, and you take money out of your Roth 401k or 403b account without rolling it to another Roth account, you'll have a nonqualifying distribution. When you take nonqualifying distributions from a Roth IRA, your distributions are tax-free until you've withdrawn all your contributions. According to the Treasury, a Roth 401k account doesn't work that way. When you take a nonqualified distribution from this account, you have to report taxable income in proportion to the account's earnings when you take a distribution. For example, if 80% of the money in the account is from your contributions and another 20% is from earnings, your distribution will be 20% taxable even if the amount you withdraw is less than the amount of your contributions.
This rule looks only at the account from which you took the distribution. Some of the rules for IRAs say you have to add all your accounts together to figure the ratio between contributions and earnings, but those rules don't apply here.
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