Roth IRA Distributions After a Rollover from a Roth 401(k)

A reader writes in, asking:

“You have written before about the rules for distributions from a Roth IRA, in which the treatment depends on whether the money coming out was a contribution, conversion, or earnings. What about money that was rolled over to the Roth IRA from a Roth 401K? That doesn’t seem to fit neatly into any of those 3 categories? My best guess is it would be treated as conversion money?”

As background information for anybody who hasn’t seen the articles the reader is referencing, here they are:

• Roth IRA distribution rules
• Roth IRA distribution tool

The short answer to the reader’s question is that when you roll money from an employer plan such as a 401(k) or 403(b) into a Roth IRA, the dollars in question essentially “remember” what they were to begin with and are lumped into the appropriate category in the Roth IRA.

• Amounts that you contributed to a Roth 401(k) or Roth 403(b), which you then roll into a Roth IRA, fall into the contributions category. That is, they now count as if they were contributions directly to the Roth IRA to begin with. (Point being, they can come out tax-free, penalty-free at any time.)
• Any growth (earnings) in the Roth 401(k) or Roth 403(b) that gets rolled to a Roth IRA counts the same as earnings in the Roth IRA.
• Any amounts that were rolled from a traditional 401(k) or traditional 403(b) to a Roth IRA are treated as converted amounts — because they are converted amounts (i.e., you moved them from tax-deferred to Roth).

Example: You have the following accounts:

• A Roth IRA with a $100,000 balance, consisting of $40,000 of contributions and $60,000 of earnings.
• A Roth 401(k) with a $50,000 balance, consisting of $30,000 of contributions and $20,000 of earnings.

You roll the Roth 401(k) into your Roth IRA. Your Roth IRA now has $150,000 in it. And that’s considered to be $70,000 of contributions ($40,000 + $30,000) and $80,000 of earnings ($60,000 + $20,000). Nothing in the IRA is considered to be from a conversion.

Track Your Contributions to Roth Accounts and Conversions

A super key point here is that it’s very important to track your contributions to Roth accounts, including Roth accounts in an employer plan. Contributions can come out of a Roth IRA tax-free and penalty-free, but you have to be able to demonstrate how much “contribution” is in the account. You don’t want to count on the brokerage firm having this information, because they likely don’t — especially if you have moved the IRA from one brokerage firm to another.

With contributions to a Roth IRA, that means keeping your Form 5498 each year.

With contributions to a Roth account in an employer-sponsored plan, that means keeping a copy of your Form W-2. (Contributions to the plan are reported in box 12, with the code depending on what type of plan it was. AA for Roth 401(k) contributions. BB for Roth 403(b) contributions. And EE for Roth contributions to a governmental 457(b) plan.)

Similarly, because converted amounts in a Roth IRA have better treatment than earnings, you also want to keep track of how much you have converted over the years (which in this case means keeping copies of your Forms 8606 and Forms 1099-R).