WEBVTT 00:00:00.000 --> 00:00:21.915 Hey friends, and welcome back to another episode of Retirement Answers. My name is Jacob Duke, I'm your host as always. And here's the question of the day. Here's what we're gonna look at on this episode. The question is, is does my Roth four zero one ks and all the years that I've been contributing to that account specifically, do those years count towards the Roth IRA five year rule? 00:00:21.995 --> 00:00:52.245 That's what we're going talk about today. And unfortunately, it's not as simple or as straightforward as you or I would like. Now, Roth IRA five year rule, it's a common topic that even I've discussed here on the podcast and I've done other episodes on, so I'll only spend a few minutes here giving you a refresher on how that specifically works. But I want to spend most of our time focusing on the question, what happens to my Roth four zero one ks whenever I roll over those dollars into a Roth IRA? And how are the dollars that I do roll over, how are those treated? 00:00:52.245 --> 00:01:24.075 How are they treated as contributions or basis or are they treated as earnings and growth? So I'm gonna break all of this down for you right now. But first, if you are new here, welcome again, my name is Jacob Duke. I'm a certified financial planner and the owner of River Tree Wealth, a retirement planning firm that helps people just like you plan smarter and retire better. Okay, let's go ahead and just dive straight into this, but as we do, just know this this can get very technical, so I'm gonna do the best that I possibly can to slow down and communicate the nuances of everything to you as clearly as I can. 00:01:24.075 --> 00:01:49.745 So let's first start with the Roth IRA five year rules. So in general, you've got actually two different five year rules to pay attention to as it relates to your Roth IRA. The first one has to do with your normal contributions that you can add to a Roth IRA each and every year. And the second one has to do with any Roth conversions that you've done. So let's talk about contributions first, and then we'll go talk about the conversions and the difference there. 00:01:49.745 --> 00:02:24.855 So, the one thing to know about a Roth IRA is that any time that you put money into that account, you can access the contribution itself at any time for any reason, regardless of your age or how long the account has been open. So for example, I can put in $2,000 directly into a Roth IRA today, and then take out 2,000 tomorrow without tax or penalty. Why is that? Well, what I'm actually doing is I'm putting in after tax dollars into the account, there's no tax deduction like a traditional IRA would have. So, I can then therefore take that money out right away if I choose to. 00:02:25.500 --> 00:03:13.465 The five year rule, what that's really talking about is the earnings or the growth on that contribution of $2,000 in this example we're going through. So, I put $2,000 in, that money then grows to $3,000 that the $1,000 of growth in that account in this example, that is what is subject to the five year rule and the age requirement of 59.5. Now, what do those two things tell us? Those two rules are actually separate and individual, but if you take out the $1,000 of growth in the earnings before your age 59.5 and, before the account has been open for five years, you would be taxed and penalized for doing so on that $1,000. Now, you can take the 2,000 out at any point for any reason, no question, no tax, no penalty. 00:03:13.465 --> 00:03:54.350 Okay? So the five year rule really only is applying to the earnings within the account. I'm gonna come back to in a second to the ordering rules upon distributions to make sure you're super clear on that too, but let's first talk about how the five year rule for conversions works. So let's say that you've got a traditional IRA with $5,000 in it, and you want to convert that over to your Roth IRA, so that money can then start growing tax free into the future. So, you convert the $5,000 from traditional IRA to Roth, upon doing that, a five year clock would start for that conversion itself, that individual conversion. 00:03:54.350 --> 00:04:44.820 So that $5,000 that you just converted over from traditional to Roth, it is not immediately counted as a contribution or I like to call it basis. It's not immediately counted as basis in the account until after that five year timeframe is up. So here in 2026, if you convert $5,000 to your Roth IRA from a traditional IRA, it would be 2,031 before you could access that $5,000 without tax or penalty, before age 59.5 and before the five years, okay? So, this is a think of it like a seasoning period, okay, you've got to wait on a conversion, you've to wait five years. Now, again, I'm not going deep on this, I've done an episode, I'm gonna have it linked below for you where I talk more about how that changes when you get to certain ages and when you get to 59.5, does that apply still? 00:04:44.820 --> 00:05:22.900 Like there's just a lot more to it, but in general, there's a five year rule that would apply to Roth conversions, okay? Now, why is this necessary from the IRS's perspective? Like why do they put this in place? Well, if you think about it, if you contributed money to a traditional IRA and then you convert it that $5,000 over to a Roth IRA, and if we know that anything that's a contribution can be immediately taken out tax and penalty free, They're saying that you can't count that 5,000 as a contribution or as basis until it has that five year seasoning period. It has to wait five years before it turns into a normal contribution or a normal, addition to the account. 00:05:22.900 --> 00:06:03.055 So that's why they don't want you to turn around, convert it and then turn around and access it immediately as if it were a contribution, you gotta wait five years for it to quote, turn into a contribution. So that's the idea and why they had that in place. Now, when it comes to the distribution ordering and how that works out of a Roth IRA, there's an important thing to know here. Whenever you go take money out of a Roth IRA, any normal contributions that you have made to the account, those always come out first, okay? So if you put $5,000 into the account and then you converted $3,000 at some point down the road, from traditional to Roth, so now you're up to eight and then overall the earnings on that money has grown to 10. 00:06:03.055 --> 00:06:49.530 So you got $2,000 of earnings. The first thing, if you wanted to go grab a thousand dollars out of that account structured in that way, total value is 10,000, but there's three different components of that 10,000. If you go take a thousand bucks out, it's gonna pull from the contribution amount first, it's not gonna pull from earnings, it's not gonna pull from the conversions itself, it's gonna pull from actual direct contribution you made to the account first, until all of that is, spent down. So you take from that a hundred percent first and then you move to conversions second. So any converted dollar second, whether they are qualified or non qualified, depending on how far into that five years or if your past five years or not, you go to the conversions next when you're taking money out and the final thing you would ever pull out of your Roth IRA is gonna be the earnings or the growth throughout time that you've had in the account. 00:06:49.690 --> 00:07:34.090 So the distribution ordering rules and how that works is very important to understand because I've had to do this in the past actually, I've taken contributions out of my Roth IRA, therefore it's not taxable because I did not touch the earnings, okay? Same thing with you, if you need to, you know, access funds for anything, you can go get your contributions at any point, so long as you don't take out more than the contribution amount, you would be taxed or penalized. And again, that has nothing to do with your age or how long the accounts been open, that's free and clear for you to take at any point. So contributions, they can be taken out at any point for any reason, okay, no issues there. Converted dollars, they can be taken out penalty free, once you have that five year seasoning period, so five years delay. 00:07:34.410 --> 00:08:09.140 And then finally your earnings, those are subject to the five year rule and age 59.5 before they would be completely tax or penalty free, all right? So, there's obviously a little bit more to that and what happens when you do get to 59.5, does the five year rule go away or not? I'm not going to dig into that today, I've done other episodes, again, I'll try to have that linked where I talk specifically around those rules I just went through very quickly. I talk in more depth and link there on that. But what I wanna do is kind of jump to the real question of the day, which is how does rolling over my Roth four zero one ks fit into all of this? 00:08:09.455 --> 00:09:02.310 Okay, and this is where, this is where things get fun, if you want to call it that, they get very interesting to say the least, because some of you, you know, you've been saving to a Roth four zero one ks for quite some time perhaps, and other of you might have just started because of the kind of the new rules around maybe the catch up contributions because you're earning too much money and you have to put that into the Roth side. So some of you have experienced with the Roth four zero one ks, some have just started that, but regardless, you're probably wondering what happens to your Roth four zero one ks money if you roll that over to a Roth IRA, okay? And this can happen if you change jobs and roll it over, it could happen whenever you retire completely one day and decide to move that to a Roth IRA. But really, I think that the frustration or the question is like, Jacob, you're telling me, so I've been saving to my Roth four zero one ks for fifteen years, let's say, surely that fifteen years counts towards the five year Roth IRA rules, right? 00:09:02.550 --> 00:09:32.840 Unfortunately, the answer is no. Those fifteen years or however long you've had money in that Roth four zero one ks, it does not directly count towards any Roth IRA years around the five year old. It doesn't count towards that because the four zero one ks and the IRA, they're viewed as completely different things. They don't overlap, they don't correlate, they're completely different things. That's why they have different tax codes and rules and regs on what you can or can't contribute, what your income can or can't be for those different things. 00:09:33.160 --> 00:10:10.685 So you can't carry over or tack on any years to your Roth IRA timeline. So for example, if you've got, you know, fifteen years in a Roth four zero one ks, it's not gonna count towards the Roth IRA five year requirement, or even if you opened, let's say your Roth IRA two years ago, and you've got five years worth of time in a Roth four zero one ks, you can't go grab any years from the four zero one ks and then tack them on to the top of your Roth years that you've accumulated so far. So they're completely separate things. So you're thinking, yeah, this is a problem, right? Because maybe I've never opened a Roth IRA before, because I was just saving to the Roth four zero one ks the whole time. 00:10:10.685 --> 00:10:26.130 And now you're telling me, Jacob, I've got to start this five year clock when I do a rollover and I can't access all my money. And then it becomes a question of, well, what is a contribution and what's not a contribution? What's earnings? What's not earnings? And that's where it gets really messy, if you will, and kind of nuanced. 00:10:26.130 --> 00:10:56.070 And so I need you to kind of hear me through on this, again, I'm gonna try to explain it as best I can, but this is where the rubber meets the road. Okay, so anytime you take money from a Roth four zero one ks, whether it be a distribution like to your bank account for you to go spend, or as a rollover, that will be treated as either qualified or non qualified. Okay, so anytime you take money out of a Roth four zero ks, it's gonna be qualified or non qualified. Now what makes this distinction? Well, it's really simple. 00:10:56.070 --> 00:11:46.085 If you take the money from the Roth four zero one ks for any reason to roll over or just take the money and spend it. If you do this after age 59.5, and the account has been funded for at least five years, it would be considered qualified. If you take a rollover the money before 59.5 or before the account has been open or funded for five years, it would be non qualified. Now, I'll dig into what that really means here in a second, you're gonna see that there is a little bit of light at the end of the tunnel here, but you understand it so you can plan correctly, but that is the distinction, okay? The same years and same age apply to the qualification or non qualification of the dollars out of the Roth four zero one ks, but what is actually happening is what's different here. 00:11:46.085 --> 00:12:28.460 So one small thing, I don't know if it's a small thing, one thing about the Roth four zero one ks and how it differs from the Roth IRA, remember earlier how I was talking about whenever you take money out of a Roth IRA, the contributions are your basis, that always comes out first. Well, in a Roth four zero one ks that is not the case. It actually operates in a pro rata scenario. So for a Roth four zero one ks, if it's non qualified, okay, meaning you've not met that five year requirement and you're not 59 and a half, it would be a pro rata distribution. So, for example, you've got $10,000 you put into the account and you've got $8,000 of growth in that Roth four zero one ks. 00:12:28.995 --> 00:13:14.820 Whenever you go to take, I don't know, $5,000 out, you're not taking out $5,000 of contributions, you're taking out as a percentage, you're taking out a pro rata distribution of the 5,000, it's gonna be whatever the math works out to 10,000 out of 18, that percentage, whatever the math is there, that is how much you would then, take out as contribution within that 5,000. The remaining percentage, the 8,000 out of the 18, that percentage that would be applied to the 5,000 and that's the taxable portion, okay? Now, that's if you take the money out and actually take to your bank account and spend it. So, Jacob, what happens in the rollover scenario, Right? That's the confusing part. 00:13:14.820 --> 00:13:57.325 So if we say, hey, it's a non qualified distribution, meaning you've rolled over, you're rolling over your Roth four zero one ks dollars before age 59.5 and the Roth four zero one ks being open for five years. If you do it in that way, it's non qualified. What that means is, it doesn't disqualify every dollar in the account and say all of its taxable. What it does is it says, there's a difference between the contributions and there's a difference between that and the earnings. So, let's say that you've got $20,000 in a Roth four zero one ks and then you roll over all 20,000 to your Roth IRA, but you do that in a non qualified fashion, meaning before the requirements have been met. 00:13:58.605 --> 00:14:35.430 That $20,000 will be broken down. Let's say we break it down, you've got $13,000 of contributions and $7,000 of earnings. Whenever you roll that money over, you're gonna get a $10.99 from the custodian, the four zero one ks custodian later in the year that says in box five, it'll have it in box five, this much of this distribution is contribution or it won't say basis, but I think of it as basis. So if we say that 13,000 is how much you put in that $10.99, it will say 13,000 is how much you do not owe any taxes on ever. Okay? 00:14:35.510 --> 00:15:32.990 And then that would be translated to your Roth IRA as contribution or basis, meaning you can grab and take that 13,000 out of your Roth IRA immediately upon rollover no matter what, Okay, so that comes over as if you made a contribution to your Roth that 13,000. The 7,000, the remaining portion of your $20,000 rollover, that would be considered earnings. Okay, and then that will not be shown in box five as a contribution on your ten ninety nine R. So that 7,000, you've got to keep up with your ten ninety nine to know that only 13 of my 20 is actually basis, the other 7,000 inside the Roth IRA, not the Roth four zero one ks, Roth IRA because I've now rolled it over, that would be considered earnings. Okay, and that 7,000 that would be then subject to the five year rule within the Roth IRA and the age 59.5 requirement before you could touch it without tax or penalty. 00:15:33.230 --> 00:16:07.660 The 13,000 remember that is completely free because you've on box five on your ten ninety nine R that you're going get on the roller, that is saying, hey, that is qualified money. You put that money into your account throughout your time in the four zero one ks plan. Therefore, when you roll it over, you don't lose that priority or that I guess, the way that money is classified. So that is what happens whenever you do a Roth four zero one k rollover and the the when at the time which you do the rollover, it's a non qualified distribution. Okay? 00:16:07.660 --> 00:16:34.220 So that means that you're not yet 59.5 when you do the rollover and the account has not been open for five years. Okay, so rollover, great, easy to do, that's not a problem, but you got to understand how it actually works whenever you do it, so that you'd understand, hey, only this portion of it is actually contribution or basis inside of the Roth IRA once it gets into that account. Okay. Hope you're following. If you need to press pause, press pause and re listen. 00:16:34.220 --> 00:16:56.420 But now let's go to the other side. The qualified distribution or qualified rollover, if you wanna think of it that way from a Roth four zero one ks. This means that you are over age 59.5 and the five year timeframe of having that Roth four zero one ks has been met. So both of those things have been done. Now what happens? 00:16:57.300 --> 00:17:32.710 Jacob, does that mean that I still have this 13,000 that's actual contribution going into my Roth IRA and 7,000 is still classified as earnings? The answer is no. Since you have met the qualifications on the Roth four zero one ks side, you then get the treatment of all $20,000 if we're using that example still here, all $20,000 that you roll over to your IRA are going to be treated as if they are contributions. Why? Well, you're gonna get a ten ninety nine still when you do this, but that ten ninety nine will say a different thing in box five. 00:17:32.790 --> 00:18:08.645 It's gonna tell you that you have a $20,000 basis, right? Or $20,000 of contributions because what happens is, the four zero one ks plan, they keep track of it. They know that once you're past the five years and past 59 and a half, that 7,000, that then becomes qualified and gets moved over or lumped in or kind of put together with the 13,000 that was original contribution. So then it's all one bucket. So when you have this qualified distribution, all of the rollover amount is counted as basis in the Roth IRA. 00:18:09.045 --> 00:18:37.455 Your ten ninety nine will show that on your ten ninety nine R box five. So a couple takeaways there before I jump into a little bit more about this. Pay attention to your ten ninety nine, hold it forever, keep it, scan it, file it, save it, keep track of it, right? Because you will need to know what box five says whenever you take money out of your Roth IRA in the future saying, actually, this is a non taxable distribution. You gotta have that to know what your basis really is. 00:18:38.175 --> 00:19:17.430 Now, here's the nuance of the situation. Because if you go back, remember I said, I told you that the Roth four zero one ks and how long that money has been there or how long the accounts been open, that doesn't change anything about your Roth IRA five years. Now, here's what's interesting. It doesn't mean that you're gonna be hurt too badly if a couple things are true and I'll get to those in a second, because this play this out. Let's say that let's say you do have a qualified distribution out of your your Roth four zero one ks when you do the rollover, right? 00:19:18.150 --> 00:19:52.710 When you do that, essentially all the dollars are going to go into the Roth IRA like I talked about as one big contribution and then you have access to that money right away in the Roth. You like, well, Jacob, what about the five year clock? Maybe I didn't have a Roth IRA at all before and I just opened it so that I can receive this Roth four zero one rollover money. Well, cool part is, is the money that you roll over if it is qualified and it does count as basis as we're talking about, who cares about the five year holding period on that money because it is treated as contribution. It's treated as basis. 00:19:52.710 --> 00:20:35.615 You don't need a five year holding period on that specific money, right? The only thing that the five year rule, if you're just starting and opening the account for the first time, the only thing that is going to apply to is the earnings on the money you rolled over. So let's say you roll over the $20,000 like we talked about earlier, you can go get that 20,000 immediately if it was qualified, your $10.99 will tell you. The 20,000 if that grows to 25,000 and this is the first time you've ever had a Roth IRA, you just opened it to help receive the $20,000 rollover, the $5,000 of earnings, that is subject to the five year holding period. So that's the worst case scenario if you have a qualified distribution out of the four zero one ks upon the direct rollover that you do. 00:20:36.110 --> 00:21:05.680 The earnings would be subject to the five year rule once the money's in the Roth IRA, not the rollover itself. That money is accessible if it was qualified. Now, if we go back to the non qualified side, right, and this is the first time we're opening a Roth IRA, we have never had one open before, funded anyone in any of them in the past. You would start the five year clock immediately upon opening the account and funding it. Now, let's go back to our $13,000 and $7,000 example. 00:21:05.680 --> 00:21:21.695 The $13,000 that you've contributed to the Roth four zero one k that gets rolled over, right? That is your basis. That's your contribution to the account. It's counted that way and viewed that way. The 7,000 of earnings, if it's non qualified, again, comes over and stays as earnings in the account. 00:21:22.095 --> 00:22:15.365 That $7,000 plus any subsequent or future earnings on the dollars inside the Roth IRA, all of that is subject to the five year rule. So the 7,000 plus any earnings going forward, that does have to meet the five year rule and the 59 and a half requirement to not be taxed or penalized. Okay, so do you see the difference there in the breakdown of qualified and non qualified rollovers from the Roth four zero one ks, it really does matter because I mean, a lot of you might have a bunch of money in a Roth four zero one ks, you might have put in, you know, $80 over your career and you've got $400 sitting there and you're like, man, this is kind of a big deal, I need to know what the right answers are here. That if you take what I'm telling you here and apply that to your numbers and your data, you can figure out fairly quickly, hey, what what do I stand on this? Now, I hope that all is clear and make sense as much as it possibly can. 00:22:15.525 --> 00:22:39.790 I know it can be quite confusing, so go back and listen to it again if you need to, but I wanna give you two primary takeaways today. One's really simple, one is one that you would never know to do unless you knew about what I just told you. The first one is, is get a Roth IRA open and put a $100 in it. Simple as that, start the clock, right? I run into people all the time, don't have a Roth IRA at all or have never had one. 00:22:39.790 --> 00:23:15.275 Now here's the thing, if you don't have one open today, but you did twenty years ago and you've had some money in it and then drained it out and then you never opened one again, guess what? The the account you opened twenty years ago, that count towards your five years of having one open. Okay, so you could be, even if you don't have one actively open today, something in the past could have qualified you under the five years. All right, so don't think you have to have one open actively for consistent five years to be qualified. It's throughout time, the first time you ever opened a Roth IRA, that is your start year, even if it was twenty years ago. 00:23:16.395 --> 00:24:00.850 If you've never had one open and you don't have one open actively right now today, open a Roth IRA, it's your favorite custodian, I don't really care Schwab, Fidelity, Vanguard, pick one, open a Roth IRA and put up, don't know, $5 in it, a $100 in it, just open it and fund it. And Jacob, I can't fund it because I can't contribute to it because I don't have, I earn too much money and I can't add money straight to it. It doesn't matter. Go ahead and convert money from a traditional IRA to that Roth IRA, convert a $100 and pay tax on a $100. Or if you don't have any money in an IRA and it's all in your employer plan, your four zero one ks, do a backdoor Roth contribution to a traditional IRA and then convert it over to the Roth to get it, you know, get it started. 00:24:00.850 --> 00:24:44.745 So can do a $100 there. Just get money into a Roth IRA through one of those three avenues, contribute it directly, convert it from an existing IRA over to the new Roth or do a backdoor contribution. And by the way, whenever you convert it or do the backdoor, technically that's classified a conversion, so it would fall into the non contribution bucket, but that won't really matter because it's still the five year wait period and you're needing to wait five years anyway, so it does the job of doing what we need to do here. That's the easiest step you can take and it's one that we do with all of our clients by the way. If you don't have a Roth IRA open or have never had one, we're gonna open one for you pretty much immediately and we're gonna put a few bucks in it, we're gonna put something there, just to get that clock started. 00:24:44.745 --> 00:25:20.900 Now, the second thing is more in-depth and otherwise you wouldn't think to do it unless you just listen to what I talked about earlier around the qualified versus non qualified piece. Once you understand how that works and what's really going on, that can and maybe should change when you decide to roll over your Roth four zero one ks. Let's say you're, you know, eight years into a Roth four zero one ks and you retire at 58. You're like, Jacob, should I roll over my Roth four zero one ks to a Roth IRA? This really matters if you don't have any Roth IRA dollars. 00:25:20.900 --> 00:26:14.730 If you already got a Roth IRA and have had one open forever, it kind of doesn't matter as much. If you do that and roll over at 58 years old, and you don't have a Roth IRA already open or existing, and you've had it open for eight years, what you're doing is, is you're giving up all of your time that you've accumulated to get it qualified, almost qualified because you're not 59 and a half yet. And you're going to get the money over and it's still going be a non qualified distribution from the the Roth four zero one ks, meaning you've got to wait on all of your earnings in that four zero one ks. You got to all that will be classified as earnings and then you have to to wait five years. So, what happens here is if you just wait to roll over the Roth four zero one ks until you are in the qualified status, meaning five years the accounts been open and you're age 59.5. 00:26:14.730 --> 00:27:00.615 If this gentleman who I'm just saying, hey, he's 58 right now and rolled over. If he just waits a year and a half to age 59.5, it'd be a qualified rollover and all of the money in the rollover would then be treated as a contribution to the Roth IRA. Yes, you're just still starting the five year clock on the Roth IRA side, right? But by waiting that extra year and a half to roll over, you then got to grab all of the earnings, however big of a sum that is, like all those earnings got to be treated immediately as a contribution, meaning they're free to access right away. The five year clock on the Roth IRA side, an example only matters on the matters on the earnings moving forward because you waited until it was a qualified rollover, a qualified distribution. 00:27:01.575 --> 00:27:34.015 So rolling over too soon, even if you're an early retiree, rolling over too soon could cost you, you know, years that you've already put in. It could cost you the opportunity to go touch a large portion of your Roth IRA without tax or penalty because you didn't wait just long enough in order to roll that money over. So, I know this is quite a technical topic, but it's a question that comes up a lot in just conversations. Hey, Jacob, what my Roth? What happens to my Roth four zero one ks when I roll that over? 00:27:34.015 --> 00:27:55.765 Do all the does that count towards my five year rule? I've never had a Roth IRA before. The answer is no, it doesn't count towards it, but how you do the rollover and structure that and when you do it, definitely matters. So hopefully this gives you some perspective and thought around how this actually works. If you have questions on this or comments or hey, Jacob, I think you missed something here, like I'm open to feedback because again, it is a complex thing. 00:27:55.765 --> 00:28:18.265 I hope I communicated it clearly and correctly, but always open to feedback. So feel free to reach out via email, or if this was really helpful, please share it with a friend. Hey, hey, this is probably something that you should listen to because it might apply to you. Whatever we can do to help people like you understand how all this stuff, really complex stuff works, that way you can retire better and be confident in your plan. That's what we're trying to do here. 00:28:18.265 --> 00:28:37.340 So thanks so much for tuning in to this week's episode. I will see you again in the next one. Hey, it's Jacob again, and I wanted to remind you that nothing discussed in today's episode is meant to be financial, legal, or tax advice. Retirement Answers is for educational purposes only. Thanks for tuning in to this week's episode. 00:28:37.340 --> 00:28:39.420 I look forward to talking with you again next week.