Do You Know All the Rules for Rolling Over a Roth 401(k)?

This week’s Slott Report Mailbag examines 401(k)s, Roth 401(k)s, and spousal beneficiary rules. As always, we recommend you work with a competent, educated financial advisor to keep your retirement nest egg safe and secure. You can find one in your area here.

Question:

I have been getting Ed Slott and Company’s emails for a few years now. They are very informative. I have not seen this question yet. I also looked through his book The Retirement Savings Time Bomb.  No answers there either.

I know you have to wait 5 years regardless of age to get tax free earnings out of a Roth 401(k) or Roth IRA. My question may seem silly but the tax rules don’t always make sense. If I rollover a Roth 401(k) to a new Roth IRA does that 5-year requirement begin again?  Or do I go back to the time my assets were added to the Roth 401(k)?

Thanks for your help,
Craig

Answer:

The rule for tax-free distributions from a Roth account is a two-part rule. One is the five-year requirement, the other is that you must be age 59 ½, or the distribution is due to the death or disability of the owner, or, for an IRA, the distribution is for a first-time home purchase.

To answer your question, we will assume that you do not meet the requirements for a tax-free distribution. In other words, your distribution from your Roth 401(k) is not a qualified distribution.  When you move the Roth 401(k) assets to a Roth IRA the earnings lose all the time they have in the Roth 401(k). They will be governed by the time you have had a Roth IRA. If you already have a Roth IRA that has been established for more than five years, then any distributions from any Roth IRA will be tax free. If you have no Roth IRAs and have to set up a new one to receive your Roth 401(k) assets, then you will have to start the five-year holding period all over again for tax-free distributions of earnings.

If, on the other hand, you do meet the requirements for a tax-free distribution when your Roth 401(k) is rolled over, you have a qualified distribution and then all funds, including earnings, go into the Roth IRA as basis and are available for distribution tax-free. However, the five-year holding period for qualified distributions of earnings from the Roth IRA will be the period applicable to the Roth IRA.

Question:

To whom it may concern,

If my wife is not a US Citizen but has an ITIN number, can she be my beneficiary on my 401(k) and life insurance policy? Will she have any issues claiming the money when I pass away?

Manny

Answer:

There is no requirement in the tax code that the beneficiary of your retirement accounts and life insurance be a U.S. citizen. But that does not mean that your wife may not face challenges in setting up her own IRA and taking required distributions. If she remains in the U.S. she would most likely be able to do that with few problems. But if she moves out of the country, the process becomes more difficult. Not all financial institutions will set up IRAs for individuals living outside the country. Each institution will have some countries they work with and some that they don’t. There could also be mandatory withholding on distributions, depending on the tax treaty with the country she lives in. You should try to find a financial or tax advisor who can help you plan for these issues.