Personal Finance & Money Asked on March 10, 2021
https://www.investopedia.com/articles/personal-finance/063015/roth-401k-vs-roth-ira-one-better.asp mentions this upside of Roth IRA regarding pre-retirement withdrawals:
A final advantage is greater flexibility with pre-retirement withdrawals. You can withdraw an amount equivalent to the contributions you have made at any time without penalties or taxes. This does not, however, apply to Roth IRA’s earnings, for which pre-retirement withdrawals (if you’re under 59½) do come with a 10% penalty.
If I contributed 10 kUSD to an after-tax 401(k) account, convert it into Roth 401(k), gained in value to 15 kUSD, then converted it to a Roth IRA, does the initial 10 kUSD count as contributions that I might withdraw penalty free prior to retirement from the Roth IRA?
Yes, I believe that the first $10k in your scenario can be withdrawn without tax or penalty, as long as there were no prior conversions to Roth IRA.
How amounts are treated when rolled over from Roth 401(k) to Roth IRA is described in 26 CFR 1.408A-10.A-3. Basically, contributions in the Roth 401(k) become contributions in the Roth IRA, and earnings in the Roth 401(k) become earnings in the Roth IRA.
This section was written before 401(k) in-plan conversions existed, so it doesn't address that. I couldn't find anything on how in-plan conversions are treated when rolled over into Roth IRA, but based on the pattern, I am going to take a guess that they will be treated like conversions in the Roth IRA (e.g. conversions from Traditional IRA or Traditional 401(k) to Roth IRA). Both distributions from Roth 401(k) within 5 years of an in-plan conversion, as well as distributions from Roth IRA within 5 years of a conversion, have a 10% penalty on the part of the conversion that was taxable, so it makes sense that a conversion in Roth 401(k) can be treated as a conversion in Roth IRA once rolled over.
Distributions from Roth IRA are attributed to contributions first, then conversions (ordered by year of conversion), then earnings. If you have no contributions and no prior conversions in the Roth IRA, then the $10k conversion would come out first, before the $5k of earnings. In your scenario, the distribution is within 5 years of the conversion, so there is a 10% penalty, but only on the part of the conversion that was taxable. Since the conversion was purely of an after-tax amount, with no pre-tax amounts (not even earnings), the conversion was purely tax-free, and thus there is no penalty on withdrawing it within 5 years.
Answered by user102008 on March 10, 2021
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