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Will I owe taxes if I roll over my Roth 401(k) to a Roth IRA?

I have an after-tax 401(k) that I would like to roll over to a Roth IRA with Schwab. Experts at Schwab say it can be transferred to a Roth IRA without paying taxes. I think they are wrong as I will still have to pay taxes on the income and capital gains accrued over the years. I’ve spoken to two other fiduciary financial planners and they also lean toward Schwab thinking.

What do you advise? It will be an in-service rollover as I am 82 and still working full time. I also have a pre-tax 401(k) that I don’t plan to roll over yet. Thank you in advance for your invaluable assistance.

– Brahma

Contributions and the income they generate are not taxed when you roll over a Roth 401(k) directly to a Roth IRA. However, if your employer made pre-tax contributions, you’ll need to deposit those funds into a traditional IRA or pay income taxes on them as part of a Roth conversion. Additionally, the five-year rules would apply to the Roth IRA account, which could result in taxes on withdrawals if made before then. (Planning for retirement can be complicated, but working with a financial advisor can help you take control of the process.)

How Roth 401(k)s Work

A Roth 401(k) is an after-tax account, similar to a Roth IRA, but offered through an employer.

A Roth 401(k) is an after-tax account, similar to a Roth IRA, but offered through an employer.

Roth 401(k)s are employer-based retirement plans that are funded with money on which you have already paid income taxes. Contributions to Roth 401(k) accounts are subject to annual IRS maximums. In 2024, you can contribute up to $23,000 to a 401(k), plus an additional $7,500 if you’re 50 or older. You can participate in a Roth 401(k) no matter how much money you make.

The money in your Roth 401(k) grows tax-free. You do not pay taxes on income or gains within the account. When you retire, all withdrawals are tax-free as long as they are qualified distributions. To count as a qualified distribution:

  • It must have been at least five years since you made the first contribution. When you open the account, the five-year clock will not start if you do not contribute any money at that time.

  • You must be at least 59 ½ years old or disabled.

  • If any of the conditions are not met, the account earnings (but not your original contributions) will be taxable upon withdrawal.

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(If you need help choosing between a traditional pre-tax 401(k) and a Roth 401(k), consider talking to a financial advisor.)

Roth 401(k)s and employer matches

Before the SECURE Act 2.0 was passed in December 2022, employers could only make pre-tax matching contributions to their employees’ Roth 401(k) accounts. So the employee would make after-tax contributions into his own accounts, and the employer would match them with pre-tax dollars. SECURE 2.0 allows employers to make matching contributions directly into their employees’ Roth 401(k) accounts.

That choice is up to the employer. They can choose to make pre-tax matches, post-tax matches, or forego matching contributions altogether. It’s important to know what type of matching there is because it affects several things, including:

  • Your current income tax

  • Your income tax upon retirement

  • Potential tax problems when you convert your Roth 401(k) to a Roth IRA

If your employer offers pre-tax matching, that money and any growth associated with it will be taxed upon withdrawal. If your employer chooses to make matching Roth contributions, you will receive a Form 1099-R for that amount for the tax year in which the contribution is actually made. For example, if your employer matches your contributions for 2024 but not until January 2025, you will receive the 1099-R for tax year 2025. The amount on the 1099-R will be added to your taxable income for that year. (If you encounter tax questions about your employer matches, consider seeking out a financial advisor with tax planning expertise.)

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Rolling over a Roth 401(k) to a Roth IRA

A woman is looking at her Roth 401(k) balance and considering converting it to a Roth IRA. A woman is looking at her Roth 401(k) balance and considering converting it to a Roth IRA.

A woman is looking at her Roth 401(k) balance and considering converting it to a Roth IRA.

It’s easy to convert your Roth 401(k) to a Roth IRA. First, you must have a Roth IRA to accept the rollover. Then all you have to do is ask your 401(k) provider to perform a direct rollover, where they will electronically send the funds from your Roth 401(k) to your Roth IRA.

By doing a direct rollover, you can avoid the mandatory income tax withholding (usually 20%) that applies when you receive a check from your plan administrator. This is known as an indirect rollover. If you do receive a check, you have 60 days to deposit the full amount of the rollover into your Roth IRA to avoid tax consequences. That means you must replace the amount withheld for taxes or risk having that portion considered a non-qualified distribution, which will mean income taxes and a possible 10% early withdrawal penalty.

If your account contains pre-tax money, such as employer matches, you’ll have to pay income taxes on those funds when you roll them into a Roth IRA. You also have the option of putting those funds into a traditional IRA pre-tax to avoid a current tax bill. (A financial advisor can help you decide whether it makes sense for you to convert retirement savings into an IRA.)

The five-year rule

Keep in mind that Roth accounts have a five-year lock-in period. To take advantage of the full tax benefits of the Roth account, it must remain open for at least five years. The clock starts with the first contribution to the Roth account.

If you roll your Roth 401(k) into a Roth IRA, the five-year clock switches to the Roth IRA. For example, if you had a Roth 401(k) for seven years and converted it to a newly established Roth IRA in 2024, you would have to wait until 2029 before you could make qualified withdrawals. But if the receiving Roth IRA has been open and funded for four years, you only have to wait one more year to meet this five-year rule.

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(However, there is more than one five-year rule and they can be difficult to navigate. Having a financial advisor by your side can help you understand these rules and avoid the tax consequences of breaking them.)

In short

You should not owe any taxes if you convert a Roth 401(k) directly to a Roth IRA. If you think your Roth 401(k) may contain pre-tax funds (such as employer matches), you will owe income taxes on the money if you choose to roll it over to the Roth IRA. You can also transfer these funds to a traditional IRA and maintain their tax-deferred status. However, consult a financial professional for the best way to handle that portion of your retirement money.

Retirement planning tips

  • A financial advisor may be able to help you plan and save for retirement. Finding a financial advisor does not have to be difficult. SmartAsset’s free tool matches you with up to three vetted financial advisors serving your area, and you can have a free introductory meeting with your advisors to decide which one you think is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

  • Are you on track to retire with enough money to meet your needs? SmartAsset’s retirement calculator can help you estimate how much your savings could be worth by the time you retire, and how much annual income your portfolio can generate.

  • Have an emergency fund on hand in case you encounter unexpected expenses. An emergency fund should be liquid – in an account that isn’t at risk of significant fluctuations like the stock market. The trade-off is that the value of liquid cash can be eroded by inflation. But with a high-interest account, you can earn compound interest. Compare savings accounts from these banks.

Photo credit: ©iStock.com/designer491, ©iStock.com/designer491, ©iStock.com/Inside Creative House

The post I’m getting mixed advice: Will I owe taxes if I roll over my Roth 401(k) to a Roth IRA? first appeared on SmartReads by SmartAsset.

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