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5 Key Roth Retirement Account Rules You Should Know



Debra H. says, “I really enjoy learning about retirement topics on your podcasts. Would you please explain how the 5-year rule applies to transferring a Roth 401(k) to a Roth IRA in an upcoming podcast? Thanks for the valuable information you provide.”

David R. is also interested in learning more about Roth accounts. He says, “My employer offers a Roth 401(k) option, but I don’t think I qualify due to my income. I like the idea of paying tax for my contributions now. Can you explain if there’s a way for me to participate?”

Thanks for your questions, Debra and David! Roth accounts have nice benefits that cut taxes. But like anything governed by the IRS (Internal Revenue Service), they have a sea of rules, which can be confusing to navigate.

What Is a Roth Retirement Account?

Most retirement plans—such as a traditional IRA, a 401(k), and a SEP-IRA—allow owners to make tax-deductible contributions if you meet certain requirements.

For instance, if you earn $60,000 and contribute $5,000 to a workplace 401(k), you pay income tax on $55,0000 not on $60,000. However, when you retire and take withdrawals of contributions and earnings, Uncle Sam catches up with you by imposing income tax on any distributions.

But Roth accounts—such as a Roth IRA, a Roth 401(k), or a Roth Solo 401(k)—have the opposite taxation. Contributions to any type of Roth are taxed in the year you make them. However, your account earnings and all future withdrawals are completely tax-free if you meet certain rules, which we’ll cover.

If you invest for decades and your Roth account mushrooms in value, it’s really nice to know that you’ll never have to pay income tax on those earnings. And if income tax rates increase down the road, that could make having a Roth especially sweet.

Now, let’s look at some things you need to know about Roth retirement accounts.

5 Things You Should Know About Roth Retirement Accounts

1. You can withdraw original Roth contributions without penalty.

Besides tax-free income in retirement, one of the best parts about having a Roth is the ability to tap it before retirement without paying an early withdrawal penalty. This is why a Roth is often used for non-retirement goals such as paying for college, buying a home, or starting a business.

With other types of retirement accounts you must reach age 59½ before withdrawals are penalty-free. But note that this only applies to your original Roth contributions. That’s because you previously paid tax on that portion of funds in your account.

2. You must own a Roth for five years to withdraw earnings tax-free.

If you want to withdraw the earnings from your Roth, there are some key rules to know. The most important is that if you’re younger than 59½, you must pay income tax plus an additional 10% early withdrawal penalty on the earnings portion of a distribution.

Also, even if you’re older than 59½, you must have owned your Roth for at least five years for an earnings withdrawal to be penalty-free.

Now, let’s get to Debra’s question about rolling over a Roth 401(k) to a Roth IRA. This would be an option after leaving an employer for any reason, such as being fired or quitting. Once you’re no longer employed, you could transfer funds from a Roth 401(k) into a Roth IRA without triggering any tax consequences.

But what can trip you up is not understanding that the five-year rule applies to the account receiving the rollover funds, not the old account. In other words, if you open a brand-new Roth IRA to accommodate your rollover, you’re at day one of the five-year holding period—even if you made contributions to the old Roth 401(k) for decades.

However, if you already have a Roth IRA and use it for a rollover from a Roth account at work, its age counts toward the holding period. So, if it’s three years old, you’d have to wait two more years to pass the ownership test for taking withdrawals that are penalty-free. And if you’ve already owned a Roth IRA for five years and use it for a rollover, you pass the ownership test.

So, if you have a Roth 401(k) or Roth 403(b) and don’t already have a Roth IRA, go ahead and open one. That will start the clock ticking and reduce the likelihood that you’d ever get held up by a waiting period.

Otherwise you could be over 59½ and still not qualify to withdraw the earnings portion of your Roth IRA without paying an additional 10% penalty.

When you’re ready to open a Roth IRA, it’s as easy as opening a bank account. You complete an application and transfer funds to activate the account. Look for a company that offers the kinds of retirement investments that you want to make, offers free investment advice and gives you simple options.

The minimum amount you need to open an IRA is typically small, such as $50 or $100. Once it’s open and funded you don’t have to put in another penny. Simply having a Roth IRA in your name counts toward the five-year requirement.

Now, if you lose your job or decide to leave your employer, you can roll over Roth funds into an already-established Roth IRA.

For a summary of rules for using different retirement accounts, download the free Retirement Account Comparison Chart. This handy resource spells out everything you need to know on a one-page PDF.

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4. Roth accounts at work don’t have income limits.

A workplace Roth and a Roth IRA are very similar; however, there are some important differences to know. First, anyone with income can use a Roth IRA. But you can only have a Roth 401(k) or a Roth 403(b) if it’s offered by your employer.

A huge, often-overlooked benefit of having a Roth workplace plan or Roth solo 401(k) is that there are no annual income limits to qualify. With a Roth IRA, you can’t contribute if your income exceeds certain amounts for your tax filing status (such as single or married filing jointly). I’ll give you the limits in a moment.

But anyone can contribute to a Roth 401(k) or 403(b), regardless of how much money you make! So, the answer to David’s question is that he qualifies for a Roth 401(k) at work no matter how much or little he earns. David could contribute solely to the Roth 401(k) or split contributions between the Roth and his traditional 401(k).

If you’re wondering, here are the 2019 income limits to qualify for a Roth IRA:

If you file taxes as a single and your modified adjusted gross income is higher than $137,000, you cannot contribute to a Roth IRA. When you earn from $122,000 to $137,000, your contribution total is reduced.

If you’re married and file taxes jointly, you cannot contribute to a Roth IRA when your household’s joint modified adjusted gross income exceeds $203,000. And when you earn from $193,000 to $202,000, your contribution total is reduced.

5. You can have multiple retirement accounts.

Having a Roth IRA or a Roth at work is terrific—but don’t stop there. You can easily pair them with other Roth or traditional accounts, if you don’t exceed the total annual contribution limits.

For 2019, you can contribute up to $19,000, or $25,000 if you’re over age 50, to a workplace retirement plan. The annual limit is lower for a traditional or Roth IRA: $6,000, or $7,000 if you’re over 50.

So, that means you could max out a Roth 401k at work and contribute to the maximum amount to a Roth IRA or a traditional IRA. You could also split your contributions between traditional and Roth accounts in any proportion you like. For instance, you could contribute $10,000 to a traditional 401(k) and $9,000 to a Roth 401(k). Or $3,000 to a traditional IRA and $3,000 to a Roth IRA if you’re under age 50 and don’t earn too much to get locked out of a Roth IRA.

Depending on your income, your tax deduction for a traditional IRA may be reduced or eliminated when you or a spouse also have a traditional workplace retirement plan where no matter your income, you can still contribute.

But there’s no conflict with a Roth IRA because those contributions are not tax-deductible. So, as long as you don’t earn too much to contribute to a Roth IRA in the first place, you can max out both a Roth IRA and a workplace retirement plan every year and get 100% of the tax benefit.

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