If you rollover a 401k into a Roth individual retirement account, you can generally take most of your money out of the Roth IRA right away. However, you must still deal with certain taxes and penalties the Internal Revenue Service imposes for early withdrawals from IRAs, if you are under age 59 1/2. Additionally, some 401k plans restrict your ability to withdraw money, even for rollovers, while you are still working with the company.
Taxation of Roth IRA Rollovers
Contributions and rollover transfers into Roth IRA accounts are made with taxable dollars. You don't get a tax deduction for moving money into a Roth, no matter the method. This means that you will have to pay income taxes on the amount of money you roll over from a tax-deferred 401k account into a Roth IRA account. If you have your 401k plan send money directly to you, intending to move the money into the Roth yourself, the 401k will withhold 20 percent of your balance and send it to the IRS. You will declare the entire rollover balance as income. If you execute a trustee-to-trustee transfer, instructing your 401k plan to send assets directly to the IRA custodian, they will not withhold taxes, but you will still have to pay the income tax on everything you transfer.
Roth IRA Withdrawals
Once you move the money into a Roth IRA, you generally do not pay income taxes on that money ever again. However, unless certain hardship circumstances apply, you will still have to pay a 10-percent penalty on any earnings within the Roth IRA, if you make the withdrawal, or "distribution," prior to age 59 1/2. The IRS considers withdraws to be "first-in, first out," meaning that your investment is returned to you penalty free first, then earnings. However, money must be left in the Roth IRA for at least five years to qualify for this favorable treatment. If money has been in the Roth for less than five years, you will have to pay a 10-percent penalty on your contributions, as well as the Roth earnings.
Access to Money
You can access your money right away after moving it into the Roth. If you make the withdrawal prior to the next tax filing due date (typically April 15th of the following year), however, the IRS treats the transfer into the Roth as though you had never executed the transfer. Note that this still leaves you liable for the penalty from the 401k withdrawal, if applicable.After a year has elapsed, however, you will have to declare the distribution to the IRS when you file your individual tax return, however, and pay any penalties due at that time. Roth IRA custodians generally do not withhold income tax and penalties from your distribution.
401k In-service Withdrawals
You may not be able to execute the rollover, however. This is because some 401k plans prohibit "in-service distributions" from 401k plans. Effectively, you cannot move money out of the plan while still employed with the company. Check your specific plan rules or consult with your supervisor or human services department for information specific to your plan.
Leslie McClintock has been writing professionally since 2001. She has been published in "Wealth and Retirement Planner," "Senior Market Advisor," "The Annuity Selling Guide," and many other outlets. A licensed life and health insurance agent, McClintock holds a B.A. from the University of Southern California.