What happens to Roth 401(k) money in a rollover

Roth contributions to a 401(k) are made with after-tax pay and sit in what the IRS calls a designated Roth account. When a job ends and the account is moved, that Roth money follows its own set of rollover rules. The part that trips people up is the five-year clock, which behaves differently depending on where the money goes.

Where Roth 401(k) money can go

The IRS rollover chart shows only two permitted destinations for a designated Roth account:

• a Roth IRA, or
• a designated Roth account in another 401(k), 403(b) or governmental 457(b) plan.

It cannot be rolled into a traditional IRA or into the pre-tax side of another plan.

A rollover to a new employer's plan is possible only if that plan has a Roth feature and accepts incoming Roth rollovers. Plans are not required to do either, so this is a question for the new plan administrator. More on that option is in rolling an old 401(k) into a new employer's plan.

The chart also shows that a Roth IRA cannot be rolled into a designated Roth account in an employer plan.

Why a direct rollover matters more for Roth money

With pre-tax money, a direct rollover is mainly a way to avoid tax withholding. With Roth money moving plan to plan, it is closer to a requirement.

The IRS FAQs on designated Roth accounts explain that a Roth account distribution consists of basis (the contributions) and earnings, and that it must be rolled into another plan's designated Roth account through a direct rollover. If the money is paid to the participant first:

• The basis portion cannot be rolled into another plan's Roth account within the 60-day window. It can still go to a Roth IRA.
• The earnings portion can be rolled to another plan's Roth account within 60 days, but the participant's period of participation in the old plan does not carry over.

The general mechanics are in the guide on how a 401(k) rollover works.

The five-year clock

Earnings in a Roth account come out tax-free only in a qualified distribution. For a designated Roth account, the IRS says that generally means the distribution is made after a five-taxable-year period of participation and after reaching age 59½, death or disability. The clock starts on the first day of the tax year in which the participant first made Roth contributions to the plan.

What happens to that clock in a rollover depends on the destination.

Rolling to another employer's Roth account. With a direct rollover, the IRS states that the five-year period for the receiving plan begins on the first day of the tax year the participant first made Roth contributions to the earlier plan, if that is earlier. The time already served carries over.

Rolling to a Roth IRA. Here the time in the plan does not count. The IRS FAQs state that the period the money was in the designated Roth account does not count toward the five-year period for the Roth IRA. Instead, the Roth IRA's clock is measured from the person's earliest contribution to any Roth IRA.

Two hypothetical people show the difference. Both are 60 and have had Roth 401(k) accounts for eight years.

• The first opened a Roth IRA ten years ago with a small contribution. When the Roth 401(k) is rolled into a Roth IRA, the Roth IRA's five-year period is already satisfied. Because this person is also over 59½, distributions of the rolled-over amounts would be qualified.
• The second has never had a Roth IRA. Rolling over creates their first one, and the Roth IRA's five-year period starts with that year. The eight years in the plan do not count toward it.

For the second person the difference may or may not matter in practice, because of the order in which money is treated as leaving a Roth IRA. IRS Publication 590-B sets out ordering rules under which contributions, including rollover contributions from employer plans, are treated as distributed before earnings. The post on Roth IRA five-year rules goes through those rules.

When the account holds both Roth and pre-tax money

Many people with Roth 401(k) contributions also have pre-tax money in the same plan. Employer matching contributions have traditionally gone into a pre-tax account even when the employee's own contributions are Roth.

In a rollover, the two kinds of money usually go to two places:

Pre-tax money can also be rolled to a Roth IRA, but the IRS rollover chart notes that the amount must be included in income. That is a Roth conversion, covered in Roth conversions explained. Sending pre-tax money to a Roth IRA by accident is one of the errors described in common rollover mistakes.

Other differences between a Roth 401(k) and a Roth IRA

Because many Roth 401(k) rollovers end up in a Roth IRA, it helps to know how the two accounts differ after the move.

• Required distributions. The IRS RMD page states that withdrawals are not required from Roth IRAs or from designated Roth accounts in a 401(k) or 403(b) plan while the owner is alive. On this point the two are now treated alike.
• Non-qualified withdrawals. A non-qualified distribution from a designated Roth account is treated as a proportional mix of contributions and earnings. A Roth IRA uses the ordering rules described above.

Records worth keeping

The plan reports a Roth rollover on Form 1099-R even though it is not taxable.

The IRS FAQs note that someone rolling a designated Roth account into a Roth IRA should keep track of the amount rolled over. The final statement from the old plan, the year of the first Roth contribution and the Form 1099-R are the records that establish, years later, how much of a withdrawal is contributions and how much is earnings.