When it comes to retirement savings, there are different routes you could go. You may have your traditional 401(k). You could also have an individual retirement account (IRA) or a Roth IRA. But what if you have a Roth 401(k)? How does one work and what are the Roth 401(k) withdrawal rules? Let’s answer these questions and more here. You can also work with a financial advisor to not only get your questions answered but to help you manage your retirement plan and investments.
What Is a Roth 401(k) and How Does It Work?
A Roth 401(k) is an employer-sponsored retirement savings program that uses post-tax money. That means that the government has already taxed the money you put in the account. Because it’s already been taxed, you don’t pay taxes on withdrawals when you retire, like with a Roth IRA. However, you can’t deduct contributions from your taxes like you can with a traditional 401(k).
What Are the Basic Roth 401(k) Withdrawal Rules?
There are four basic Roth 401(k) withdrawal rules that you m just follow to avoid penalties or unnecessary taxes. These withdrawal rules are:
1. Qualified Withdrawals Are Tax-Free
If you wait until you’re 59 ½, you can take withdrawals on your Roth 401(k) without paying taxes. That includes contributions as well as earnings. Compare this to a traditional 401(k), where you avoid the taxes upfront but pay on both contributions and earnings when you withdraw. You can see why, if your employer offers it, a Roth 401(k) might be a good option.
2. Withdrawals Before Age 59 ½ Could Face an Early Withdrawal Fee and Taxes
Like other retirement accounts, any Roth 401(k) withdrawals made before the age of 59 ½ face a 10% early withdrawal fee. That means that if you want to withdraw $5,000, you’ll be charged $500. On top of that, if your contributions have earned money, the earnings are prorated and taxed on an early withdrawal.
For example, say you have $20,000 in your Roth 401(k), $18,000 of which is contributions and $2,000 is earnings. If you make an early withdrawal of $10,000, $9,000 will come from contributions and $1,000 will come from earnings. The $1,000 will be taxed, along with the full $10,000 receiving a 10% fee of $1,000.
Early withdrawals are also known as non-qualified withdrawals. As you can see, the government does a lot to discourage you from making them. If you need the money, it may be a better idea to borrow against your 401(k).
3. The Five-Year Rule
There is an exception to qualified withdrawals being able to happen at 59 ½ and that’s the five-year rule. This rule simply requires that it be at least five years from your first deposit before you can make a penalty-free withdrawal. So, if you start your Roth 401(k) at 57, you have to wait until you’re 62 to withdraw without penalty.
This rule also qualifies for rollovers, which can cause problems for people. Many people roll over their 401(k) into a Roth 401(k) or roll over their Roth 401(k) into a Roth IRA. Say you do one of these rollovers at 59, you’re going to have to wait until you’re 64 to make a penalty-free withdrawal
4 . You Must Take the Required Minimum Distributions at Age 72
Unlike a Roth IRA, when you turn 72, you must take the required minimum distributions (RMDs) from your Roth 401(k). That’s because a Roth IRA isn’t an employer-sponsored plan. The exact amount you have to withdraw from your Roth 401(k) is determined by the IRS. If you don’t take the RMD, you’re subject to a 50% penalty, so it’s in your best interest to pull out the money, even if it’s just to invest it elsewhere.
Additional Questions About Roth 401(k)s
There are additional rules dealing with a Roth 401(k) that you need to be aware of because these situations typically impact potential withdrawals. These rules involve rolling money into the account so that you can withdraw funds or take a loan from your account and then attempt to pay it back.
Can You Roll Your 401(k) Into a Roth 401(k)?
You may be able to convert your 401(k) into a Roth 401(k) if your employer offers it. There can be good reasons to do this, the biggest being that you won’t have to pay taxes on withdrawals. However, you will have to pay income taxes on the amount you convert. To cover the taxes, you’ll need to set this cash aside, outside of your retirement account.
Can You Take a Loan from Your Roth 401(k)?
Instead of making an early withdrawal, it could be a better option to borrow from your Roth 401(k). You need to discuss this with your HR department and see if they’ll allow it. Know that you could be sabotaging your retirement with this type of loan and if you lose your job, you may have to pay the remainder of the loan in full.
The Bottom Line
Now that you know the Roth 401(k) withdrawal rules, you can better understand how Roth 401(k)s works and if they’re the right choice for you. They have some big benefits. Your contributions can grow without you worrying about taxes when you make a qualified withdrawal. Still, there are other aspects to consider when contributing to a Roth 401(k) that can help you when trying to navigate what you want to do.
Tips for a Financially Successful Retirement
- Whether you’re about to retire or it’s decades off, managing multiple accounts can be hard. A financial advisor can take a comprehensive look at your finances and help manage your money on your behalf. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- The retirement tax laws in the state you want to retire in can have a big impact on your retirement. By minimizing your retirement tax burden, you can maximize the value of your savings in retirement.
- When saving for retirement, it helps to know exactly what your goal is. After all, how will you know you have enough? SmartAsset’s retirement calculator allows you to input your information and get an achievable savings goal that you can plan for.
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