Should I Roll Over My Roth 401(k)?

Mike Piper the Oblivious Investor writes: A reader writes in, asking:

“I recently changed employers. I’ve read that it’s usually advantageous to roll over a 401K to an IRA. Does the same go for rolling over a Roth 401K?”

In short, yes, as with a traditional (pre-tax) 401(k), most of the time you’ll get access to more (and less expensive) investment options by rolling a Roth 401(k) into a Roth IRA.

And there’s another point in favor of rolling it over: Roth 401(k) accounts are subject to required minimum distribution rules, whereas Roth IRAs are not. So by rolling your Roth 401(k) to a Roth IRA, you can avoid having to deal with RMDs.

Reasons Not to Roll it Over

There are, however, some circumstances in which you might not want to roll over your Roth 401(k):

1. The investment options in your 401(k) are actually better than they would be in an IRA (because your 401(k) offers access to super cheap “institutional” share classes, for example).
2. You left your employer in the year in which you turned age 55 (or older) and you want to spend some of the earnings in your Roth 401(k) prior to reaching age 59.5. (The 10% penalty doesn’t apply to 401(k) distributions — whether Roth or traditional — if you separated from service in a year in which you are 55 or older, whereas a pre-age-59.5 distribution of earnings from a Roth IRA could be subject to the 10% penalty.)

With regard to point #2, however, please note that when money comes out of a Roth IRA, it’s first considered to come from contributions (which come out free from tax and penalty) until all of the contributions have been distributed. So this exception to the 10% penalty (which you could have access to by keeping the money in your Roth 401(k) rather than rolling it to a Roth IRA), is only relevant if you expect your Roth distributions prior to age 59.5 to exceed your contributions.

So, to summarize, you might want to keep the Roth 401(k) with your prior employer if you don’t mind being subject to RMDs (or are young enough that RMDs aren’t yet a concern), and either:

• The investment options in your 401(k) are better than what you would have access to in a Roth IRA, or
• You separated from service in the year in which you turned 55 (or older) and you want penalty-free access to all of the money prior to age 59.5.

Finally, on a note related to last week’s discussion: As with Roth IRAs, you definitely want to keep track of your Roth 401(k) contribution history (as well as your history of any in-plan traditional-to-Roth conversions that you make), so that you can prove how much of your account balance is the result of contributions or conversions rather than earnings. This will become especially important if you roll a Roth 401(k) over to a Roth IRA, because the new brokerage firm will likely not have records as to the contributions you made with the prior company.