BASIC WITHDRAWAL RULES OF A ROTH 401K
- To withdraw from a Roth 401k, you must be at least 59½ years old and your Roth 401k account must be at least 5 years old.
- Early withdrawals are subject to a 10% penalty, plus income taxes.
- Withdrawals from a Roth 401k are prorated between contributions and earnings. If your account consists of 70% contributions and 30% earnings, then only 30% of your withdrawals are taxed and penalized. 70% can be withdrawn free of taxes and penalties.
- Qualified distributions (after you turn 59½ years old, and after your Roth 401k account is at least 5 years old) from a Roth 401k are tax-free since you contributed with after-tax dollars.
- Unlike a Roth IRA, you cannot withdraw just your contributions at any age without penalties. Withdrawals of contributions must be taken once you reach the age of 59½.
- A Roth 401k has required minimum distributions (RMD). At the age of 73, you’re required to start taking distributions each year, until your account is emptied. However, under the new SECURE Act 2.0 provisions, RMDs will no longer be required to be taken from a Roth 401k account starting in 2024.
A Roth 401k has slightly different withdrawal rules than a normal 401k. With a Roth 401k, you contribute to your account with after-tax dollars and withdrawals in retirement are completely tax-free. Like a traditional 401k, you must wait until you’re at least 59½ years old before you can take money out of your account without penalties. However, there are some additional withdrawal rules for the Roth 401k.
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When can I withdraw from a Roth 401k?
To withdraw from a Roth 401k without any penalties or taxes, you must wait until you’re at least 59½ years old. In addition, at least 5 years must have passed since you made your first Roth 401k contribution. This is known as the 5 Year Rule.
Are Roth 401k withdrawals taxed?
Qualified distributions from a Roth 401k are not taxed at all. Since your contributions were already taxed as regular income, your withdrawals in retirement are tax-free.
Also read: Roth 401k vs Traditional 401k
The 5 year rule
Like all Roth retirement accounts, the Roth 401k has a 5 year rule. In addition to being over the age of 59½, your account must be at least 5 years old. For example, if you contribute to a Roth 401k for the first time at the age of 58, you’ll have to wait until you’re 63 years old in order to start taking qualified distributions without penalties and taxes.
The 5 year clock starts on January 1st, the year you make your first contribution. For example, if you make your first Roth 401k contribution in November of 2022, the 5 year clock would technically be January 1, 2022.
Withdrawal rules for qualified distributions
If you’re over the age of 59½ and your Roth 401k is at least 5 years old, any withdrawals made from your account are completely tax-free, with no penalties applied. Since you already paid income taxes when you contributed, your withdrawals in retirement are tax-free.
What are the penalties for early withdrawals?
Early withdrawals before the age of 59½, and before your account is 5 years old, are considered unqualified distributions and are hit with a 10% penalty and income taxes on the amount drawn.
However, the entire amount does not get taxed and penalized, only the earnings.
With a Roth 401k, withdrawals are prorated between contributions and earnings.
Your contributions were already taxed as regular income, so this portion of withdrawals is not taxed or penalized. The earnings portion of your account receives the 10% penalty, plus income taxes.
How to calculate which portion of withdrawals get taxed
You can’t withdraw only your contributions from your account. Every withdrawal is prorated between your contributions and earnings.
To calculate the portion of withdrawals that get taxed, multiply the withdrawal amount by the ratio of total earnings in your account.
For example, if you contributed $90,000 to your 401k over the years, and have a total account value of $100,000, that means you earned $10,000 in gains from your investments. In this case, your earnings ratio is 10%. If you decide to make an early withdrawal of $10,000 from your 401k, only 10% of that amount will be subject to taxes and penalties. $9,000 can be withdrawn free of taxes and penalties, and $1,000 (10%) would be hit with 10% penalty plus income taxes.
This is a slightly different withdrawal rule than the Roth IRA, which lets you withdraw your contributions at any age without penalties or taxes. The withdrawal amount from a Roth IRA is not prorated between contributions and earnings.
Does a Roth 401k have required minimum distributions (RMD)?
Yes, both the traditional and Roth 401k have an RMD rule. You’re required to start taking distributions from your account when you reach the age of 73. You must withdraw your RMD amount each year, until your account is emptied.
To calculate your RMD amounts, you can refer to the RMD table.
Note: Starting 2024, RMDs will no longer be required to be taken from Roth accounts in employer retirement plans.
Rollover your Roth 401k
If you’re leaving your employer, you can rollover your Roth 401k to another retirement plan. If you have a solo 401k, you can rollover your Roth 401k into a Roth solo 401k and immediately get access to the additional tax benefits a solo 401k offers.
If you begin employment at a new company that also offers a Roth 401k, you can rollover your existing Roth 401k into your new Roth 401k.
However, it’s generally a better idea to rollover your Roth 401k to a Roth IRA or Roth solo 401k rather than a new Roth 401k.
A Roth IRA has more investment options than a typical corporate 401k plan, and also has no RMDs. With a Roth IRA, you’re not required to take distributions when you turn 73 years old and can continue compounding your money for as long as you’re alive.
A Roth solo 401k has an RMD, but you get full checkbook control over your investments. Rather than being limited to the dozen or so mutual funds that your company 401k plan offers, you can invest in any asset class from stocks and ETFs to alternative assets like crypto and real estate.
Note: Most employers do not allow rolling over your 401k while you’re still employed. Rollovers are typically only allowed when you end your employment with the company providing your 401k plan.
Also read: Direct vs Indirect Rollovers
Borrow from your Roth 401k
Both the traditional 401k and Roth 401k allow you to take out a loan from your account. If your 401k plan allows loans, you can borrow up to 50% of your account’s value up to a maximum of $50,000.
Interest rates are Prime Rate + one or two percent and you’re given 5 years to repay the money back into your account. If you use the money to purchase a primary residence, you’re given up to 15 years. The downside is that some plan providers will not let you make any additional contributions to your Roth 401k until your loan is paid off.
Borrowing from your Roth 401k is usually a never a good idea since you’re taking money out of your retirement account, but if you really need the money, the interest rates are much lower than paying the Roth 401k early distribution penalties and taxes.
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