In Service Roth 401k Distribution Timing | Ed Slott and Company, LLC

In Service Roth 401k Distribution Timing

I have a client +63 yo that has been contributing to his Roth 401k for + 5 years. He also has funds in the Traditional portion of his 401k Plan. He plans to retire in 2021. He does not have an existing Roth IRA. We understand that if he rolls the Roth 401k to a Roth IRA his 5-year clock would start. Part of his retirement plan is to use the funds from the Roth 401k for the construction of his retirement home in 2021. His Plan allows for in-service 401k distributions. When he retires in 2021, he plans to roll over his Traditional 401k to a Traditional IRA.

Would there be any negative impacts on his plan if he takes the in-service distribution from his Roth 401k in the same year that he rolls over his Traditional 401k to a Traditional IRA?

Thank you.

Ed

  • His Roth 401k is qualified and all distributions will be tax free. Any portion rolled to a Roth IRA will be treated as regular Roth IRA contributions, available anytime without tax or penalty. Only earnings generated in the Roth IRA would be taxable for the first 5 years, and they come out last. 
  • If his plan allows him to select which portion (Roth or pre tax) of the 401k is being distributed, there are no negatives from taking the distributions from the plan instead of waiting and taking them from the Roth IRA.
  • However, if he retires in 2021 early in the year, making a 2021 a very low tax year, he might withdraw from the pre tax or TIRA accounts at a very low tax rate instead of from his Roth 401k funds, after contributing to Roth and paying higher taxes on those contributions while working.  Of course, he could also draw from both accounts to manage his 2020 and 2021 taxes. Much of this planning relates to how long he will work into 2021 and of course other income he or spouse may have. Obviously, drawing from Roth funds has a long range cost, since future tax free gains are being forfeited by such withdrawals.
 

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