Roth IRA Rules for a Rollover

Andy S. asks:

“I work for a university and have a 403(b) retirement account—but I’ll be leaving the job next year to go to medical school. What are the Roth IRA rules for doing a rollover? And could I withdraw money from a Roth IRA to pay for school expenses?”

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ANSWER:

When you leave a job where you have a retirement plan, like a 401(k) or 403(b), you can roll over all or a part of it into an IRA. This is generally recommended—unless you have a great reason to leave money in your ex-employer’s plan, like an extensive menu of low-cost investment choices.

IRA Rollover Rules

Rolling over funds from a traditional pre-tax workplace retirement account into a traditional IRA is simple because you don’t have to pay income tax or penalties (as long as you complete the rollover within 60 days). It’s also clear-cut if you roll over from a post-tax Roth 401(k) or 403(b) into a Roth IRA.

However, rolling over funds from a traditional retirement account into a Roth IRA means you must pay income tax on any amount that wasn’t previously taxed. In other words, the money you roll over gets added to your taxable income because you convert it from a pre-tax account into a post-tax account. (Remember, you never paid tax on contributions made to a traditional 401(k) or 403(b).)

So, the answer to the first part of Andy’s question is “yes.” He can roll over money from his 403(b), pay tax on it, and convert it into a Roth IRA.

Related Content: Your Guide to the Roth IRA, Part 1

Roth IRA Withdrawal Rules

Now, let’s tackle the second part of his question about withdrawing money from a Roth IRA to pay for education.

The Roth IRA rules for taking withdrawals aren’t as simple as for a traditional IRA:

• With a traditional IRA, distributions are generally subject to income tax plus a 10% early withdrawal if you’re younger than age 59½.

• With a Roth IRA, taxes and penalties for distributions depend on whether you’re withdrawing original contributions, rollover conversions, or earnings—and on how long you’ve owned the account.

If you have a Roth IRA with contributions that didn’t come from a rollover conversion, those are regular, original contributions. You have the most flexibility withdrawing original contributions because you can take them out at any time with no taxes or penalties.

However, the rules are different for funds in a Roth IRA that were rolled over and converted. To withdraw rollover conversions without taxes or penalties, there is a 5-year waiting period that starts on January 1 of the tax year you convert.

And no matter whether you have original contributions or conversions in your Roth IRA, you can’t withdraw the earnings on those funds without paying income tax plus the 10% early withdrawal penalty if you’re younger than age 59½. (Remember that you paid tax on the contributions or conversions—but not on the earnings or growth in the account.)

Related Content: Your Guide to the Roth IRA, Part 2

Exceptions to the Early Withdrawal Penalty

There are several exceptions to the rules that allow you to take early distributions from a traditional or Roth IRA at any time without getting hit with the 10% penalty. They include:

• Disability

• Medical expenses

• Taking distributions as an annuity

• Costs to buy, build, or remodel a first home

• Higher education expenses

(This is not a complete list so refer to IRS Publication 590, Individual Retirement Arrangements for complete information.)

If Andy uses Roth IRA funds to pay for higher education, he can avoid the early withdrawal penalty even if he doesn’t have it for 5 years.

He could use the money for tuition, fees, books, supplies, and equipment that is required for his coursework. Additionally, as long as he is at least a half-time student, room and board is also an allowable expense.

Confusing? No doubt. To sum up, Andy can:

• Rollover his 403(b) into a traditional IRA. This option would allow him to take early withdrawals for education expenses without penalty and require him to pay income tax on those distributions.

• Rollover his 403(b) into a Roth IRA. This option would require him to pay income tax on the full amount he converts. Then he could take early withdrawals for education expenses without penalty.

   

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15 IRA Rules You Should Know

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