Understanding Rollovers from 401(k), 403(b) & 457(b) Roth Accounts

Navigating Rollovers from 401(k), 403(b), and 457(b) Roth Accounts

For many retirement savers, employer-sponsored plans such as 401(k), 403(b), and governmental 457(b) accounts include the option to make after-tax contributions into a designated Roth account. These contributions – along with any earnings – can be withdrawn tax-free, provided specific IRS requirements are met.

Understanding how rollovers from these accounts work is essential, particularly as they allow for greater flexibility while preserving the tax-advantaged nature of your retirement savings.

What Is a Rollover?

A rollover involves transferring funds from one eligible retirement account to another – typically from a designated Roth account to a Roth IRA or another employer’s designated Roth account. Done correctly, this process helps maintain the tax-deferred or tax-free status of your assets.

Rollovers may be executed in two ways:

• Direct Rollover: Funds are transferred directly between accounts.
  
  
• Indirect Rollover: Funds are distributed to you, and you must deposit them into a new account within 60 days to avoid tax consequences.

Key Rollover Destinations

1. To Another Employer’s Designated Roth Account

You may transfer your Roth 401(k), 403(b), or 457(b) balance to a new employer’s designated Roth account – assuming the new plan permits such rollovers. To preserve the after-tax basis (your original contributions), this must be completed as a direct rollover. If the transfer is indirect, only the taxable portion (earnings) may be moved to another designated Roth account.

2. To a Roth IRA

You may also roll over your designated Roth account into a Roth IRA. Both contributions and earnings may be transferred – either via direct rollover or within the 60-day window for indirect rollovers. However, it is important to note:

• The five-year holding period for Roth IRAs begins with your first Roth IRA contribution, not when you began contributing to the Roth 401(k), 403(b), or 457(b).

Timing and Tax Treatment

The 60-Day Rule

If you receive a distribution, you must complete the rollover within 60 days to avoid taxation and penalties. In certain hardship cases, the IRS may waive this deadline.

Qualified vs. Nonqualified Distributions

• Qualified distributions – generally those made after age 59½ and after five years of participation – are tax-free.
  
  
• Nonqualified distributions may result in the earnings portion being taxable.
  
  
• If only part of the distribution is rolled over, the IRS treats the taxable portion as rolled over first.
  

No Recharacterizations Allowed

Once funds are rolled into a designated Roth account, the transaction is irrevocable – it cannot be recharacterized as a pre-tax contribution.

The Five-Year Rule

Understanding the five-year rule is critical in determining whether a distribution will be qualified and tax-free.

• When rolling to another designated Roth account, your holding period may carry over, which can help you qualify for earlier tax-free withdrawals.
• When rolling to a Roth IRA, the clock resets to your earliest Roth IRA contribution date – not your employer plan start date.

Rollover Scenarios

• Partial Rollover Example:
  Bob receives a $14,000 distribution: $11,000 in contributions and $3,000 in earnings. He rolls over $7,000 to a Roth IRA. The IRS treats this as $3,000 in earnings and $4,000 in contributions – preserving the tax-free treatment of the rolled-over funds.
  
  
• Qualified Distribution Example:
  Carrie, who is disabled, receives a $12,000 qualified distribution. The IRS formula allocates between basis and earnings to ensure proper tax treatment – with the entire distribution likely excluded from taxable income.

In-Plan Roth Rollovers

In certain cases, you may convert traditional (pre-tax) 401(k) or other retirement plan assets to a Roth account within the same plan.

Eligible Sources Include:

• Elective deferrals
• Employer matching or nonelective contributions
• After-tax contributions and associated earnings

Plans may restrict the types of contributions eligible for in-plan conversion, so it is essential to consult your plan administrator.

Tax Considerations:

The converted amount is included in your gross income in the year of conversion. While it is not subject to the 10% early withdrawal penalty at the time of rollover, future withdrawals may trigger penalties if made within five years and before age 59½ – unless an exception applies.

Special Considerations

• Required Minimum Distributions (RMDs): Until recently, designated Roth accounts were subject to RMDs. The Secure Act 2.0 has begun to phase out this requirement – aligning more closely with Roth IRA treatment.
  
  
• Outstanding Loans: Some employer plans allow outstanding plan loans to be rolled over as part of an in-plan conversion. Check with your administrator for eligibility.
  
  
• IRS Reporting: All rollovers and distributions must be reported on IRS Form 1099-R. Plan administrators are responsible for tracking the five-year holding period and contribution history.

Final Thoughts

Rollovers from designated Roth accounts offer valuable planning flexibility, but the rules governing them are complex. By understanding how timing, destination, and the five-year rule affect your strategy, you can avoid costly mistakes and enhance the long-term tax efficiency of your retirement savings.

As always, we recommend consulting a qualified tax professional or financial advisor before initiating a rollover to ensure alignment with your broader retirement and estate planning goals.

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