How Does the Roth 401k to Roth IRA 5 Year Rule Work?

Moving a Roth 401(k) to a Roth Individual Retirement Arrangement (IRA) is a common financial step after leaving a job. This rollover allows savings to continue growing with tax advantages, but it introduces complexity regarding when you can withdraw money without taxes or penalties. The confusion often centers on the “5-year rule,” which actually refers to two separate timing requirements that apply differently to Roth IRAs. One rule governs the tax treatment of investment earnings, while the other determines if penalties apply to the principal amount that was rolled over.

The Two Distinct Roth IRA 5-Year Rules

The first 5-year rule for Roth IRAs determines when withdrawals of earnings become tax-free. For a withdrawal of earnings to be a “qualified distribution,” the account holder must be over age 59½ and the 5-year holding period must be satisfied. This clock starts on January 1 of the tax year for which the first contribution was made to any Roth IRA. This is a single clock that applies to the person, not the account.

Once this 5-year period is met, it applies to all Roth IRAs the individual will ever own. For example, if a person’s first Roth IRA contribution was for the 2020 tax year, their clock began on January 1, 2020. Starting January 1, 2025, any withdrawal of earnings from any of their Roth IRAs would satisfy this 5-year test.

A second, separate 5-year rule applies to funds rolled over from a workplace plan into a Roth IRA. This rule concerns the 10% early withdrawal penalty on the principal amount that was moved. Each rollover event has its own distinct 5-year clock to determine if the funds can be withdrawn without this penalty.

This penalty rule only applies to account holders under age 59½. Once an individual reaches age 59½, they can withdraw rolled-over principal without the 10% penalty, even if that specific rollover has not been held for five years.

How a Roth 401(k) Rollover Interacts with the 5-Year Rules

The tax treatment of earnings rolled over from a Roth 401(k) depends on whether the distribution from the 401(k) was “qualified.” A qualified distribution from a Roth 401(k) requires that the account has been open for at least five years and the owner is at least 59½ years old.

If the distribution from the Roth 401(k) is qualified, the earnings portion of the rollover is not subject to the Roth IRA’s five-year rule for earnings. However, if the distribution is non-qualified because the 5-year or age requirement was not met, the earnings portion of the rollover will be subject to the Roth IRA’s 5-year rule once moved into the IRA.

This means if you have a 12-year-old Roth 401(k) but are under 59½, a rollover to a brand-new Roth IRA would cause the earnings portion of those funds to be subject to a new 5-year clock. The clock would begin on January 1 of the year the rollover occurs.

Conversely, if you already have a Roth IRA that has satisfied its own 5-year rule, any non-qualified earnings rolled in from a Roth 401(k) would benefit from the seasoned IRA. Subsequent earnings generated within the account would be eligible for tax-free withdrawal as soon as you meet a qualifying event, such as reaching age 59½.

Withdrawal Ordering Rules After a Rollover

When you take money out of a Roth IRA that contains both direct contributions and rolled-over funds, the IRS has strict rules that dictate the order of withdrawal. For withdrawal purposes, the IRS treats all of an individual’s Roth IRAs as a single, aggregated account. You do not get to choose which type of money comes out first; the source is determined by a specific, non-negotiable order.

• Regular, direct contributions aggregated from all your Roth IRAs. These were made with after-tax money and can be withdrawn at any time, at any age, completely free of both income tax and penalties.
• Converted and rolled-over amounts from all accounts. These are treated on a first-in, first-out basis, meaning the oldest rollovers are distributed first. While not subject to income tax, they may incur the 10% early withdrawal penalty if taken out before their specific 5-year holding period is met and the account holder is under 59½.
• Investment earnings from across all your Roth IRAs. This is the last type of money to be distributed. These earnings are only free from income tax and penalties if the withdrawal is a “qualified distribution,” which requires that the primary 5-year clock for the Roth IRA has been met and you are over age 59½.

The Rollover Process

Before initiating a rollover, you must gather specific account details and decide how the funds will be transferred. You will need your Roth 401(k) account number, the contact information for your plan administrator, and the account number for the receiving Roth IRA.

The main decision is choosing between a direct and an indirect rollover. A direct rollover is a trustee-to-trustee transfer where your 401(k) provider sends the funds directly to your Roth IRA provider. This method is recommended because it is simpler and avoids potential tax complications.

An indirect rollover involves your 401(k) administrator sending you a check made out in your name. You then have 60 days from the date you receive the funds to deposit them into a Roth IRA. A detail of this method is that the plan administrator is required to withhold 20% of the distribution for federal income taxes. To complete a full rollover and avoid taxes on the withheld amount, you must use your own funds to make up for the 20% and deposit the entire original distribution amount within the 60-day window.

Once you have your information and have decided on the transfer method, you will complete the necessary paperwork. This usually includes a distribution form from your 401(k) administrator and a new account or rollover contribution form for the receiving IRA. Submitting the distribution request to your 401(k) plan administrator formally begins the process.

After the funds have been successfully transferred and deposited into the new Roth IRA, you should receive a confirmation from the IRA provider. The transfer process can take anywhere from a few days to several weeks to complete. In the following tax year, you will receive Form 1099-R from your former 401(k) provider, which reports the distribution to the IRS.