There is a little confusion out there regarding Roth IRA contribution limits and rollovers. Complicating matters is that contribution limitations are different for a Roth 401(k) and Roth IRA. For a Roth IRA in 2023, you are limited to $6,500. For those age 50 or older, the limit is $7,500. However, there are phase outs based on modified adjusted gross income (MAGI). If your MAGI is over the limit, you can be excluded from contributing to a Roth IRA. View this chart from the IRS website which provides more detail as to how this could affect your ability to participate.
If you have made contributions to a Roth IRA and discover you were not eligible, you will need to contact your investment provider. Some remedies for the over-contributions are processing an “excess withdrawal” or a “recharacterization.” An excess withdrawal removes from the Roth IRA what you over contributed. The recharacterization will change it from a Roth contribution to a Traditional IRA contribution. You’ll want to act on this quickly because it is best to do it within the same tax year.
Don't Mistake Roth IRAs with Roth 401(k) Plans
Roth IRAs, the more typical and commonly known tax-free retirement accounts, limit contributions based on income. Many people are surprised to find they aren’t eligible to contribute to a Roth IRA because their income is over the IRS imposed limit. With Roth 401k however, there is no such limit. Why is this important? If you’re not eligible to contribute to a Roth IRA, you could contribute to a tax-free retirement plan via a Roth 401k. These limits are much higher. The limit for a Roth 401(k) in 2023 is $22,500 and $30,000 for those age 50 or older. There is no income limitation to contributing to Roth 401(k) as there is with a Roth IRA.
Roth IRA Contribution Limits and Rollovers
Roth IRA contribution limits do not apply to rollovers. There is no limit on rollover amounts whether to a Roth IRA or Traditional IRA assuming they are to like accounts (Roth 401(k) to Roth IRA or Traditional 401(k) to Traditional IRA). There are ways to do a “back door” Roth IRA contribution to avoid the limitation on income. This “back door” involves making a contribution to a non-deductible IRA, then converting those dollars to a Roth IRA. However, you need to be very careful with this. There are special rules in place that can be a mine field to navigate. I wrote about this in my article Roth IRA Conversions – The Pro Rata Rule Is Lurking.
Roth 401k Rollovers Are Much Different Than Roth IRA Conversions
In-plan rollovers are from the pre-tax portion of your 401k which include elective deferrals (salary contributions), matching contributions, and profit sharing contributions to the Roth 401k. This will result in taxable income in the year of the transaction. It is important to remember that just because you can do something, it doesn’t mean you should. If you are in a plan that offers in-plan Roth rollovers, there is no opportunity for a “do-over” like there are with Roth IRA conversions.
With a Roth IRA conversion, you take funds from a traditional IRA (pre-tax) and then put those funds into a Roth IRA and pay the tax up front. If you change your mind, there is a period of time when you can undo the transaction and have the funds put back into the traditional IRA. This is not the case when you do an in-plan Roth rollover. If you are considering a transaction like this, you should proceed with caution.
Roth IRA Contribution Limits – “Borrowing” from a Roth IRA
Contrary to popular belief, there is no “borrowing” from Roth IRAs or Traditional IRAs. There are only distributions. “Borrowing” from a Roth IRA or Traditional IRA is a misconception likely due to the ability to borrow from some 401(k) plans. This is accomplished via a 401(k) loan. I wrote an article about 401(k) loans called 401k Loan – 3 Reasons Not To Borrow that goes into more detail.
With regard to Roth IRA distributions, there are ways to access the funds, but it’s not borrowing. Borrowing implies that you can pay it back. You can’t pay back distributions taken from Roth IRAs or Traditional IRAs. There is an exception for distributions from an IRA that are paid back within 60 days. However, that is a totally different subject and it is also a commonly misunderstood rule.
Roth IRA withdrawals (distributions) of principal are tax and penalty free. The reason is that contributions are made with after tax dollars. The IRS has already taken their bite with regard to the principal (what you contributed). The earnings are a different story. While there can be exceptions, early withdrawals can be subject to taxes and penalties that are attributable to earnings (not principal). If you’re looking to take a withdrawal from the Roth IRA due to education, first time home purchase, or to help with a disability, you should definitely read up on the exceptions.
Early withdrawals are those made prior to age 59 ½. Withdrawals made after age 59 ½ and after having the account for at least five years will allow for withdrawals that are tax and penalty free. I wrote an article called Roth IRA – 5 Things Retirement Savers Must Know that covers other important considerations of investing in a Roth IRA.
Roth IRA Five-Year Waiting Rule
The five-year waiting rule for Roth IRAs applies in two situations:
- In order to receive a qualified distribution of earnings (not principal) tax-free, the withdrawal must not be within 5 years of the date of the first contribution. These time periods are governed by the beginning of the tax year for which the contribution applies as opposed to the actual date.
- In order to receive a qualified distribution from a Roth IRA that was converted from an IRA without penalties applied to principal, the withdrawal must not be within 5 years of the date of the conversion.
Proceed with caution when planning your rollovers or distributing from a Roth IRA. There is often more to the process than meets the eye.
Thanks for the article. Say you have a Roth IRA from the past, but are now over the income limit to contribute to it. You also have a Roth 401k at work. If you leave that job, can you roll the Roth 401k to the old Roth IRA even though your income is too high to directly contribute to the Roth IRA?
Hi Joe, thank you for the question and contributing to the conversation. Rollovers are not subject to income limits. Rollovers are not considered contributions. Only contributions are subject to income limits.
Hi David, can we get an Article & More insight on a Mega-backdoor Roth IRA.