Can I Withdraw Funds Without Penalty if I Roll 401(k) Funds Into a Roth IRA?

When you take a distribution from your 401(k) plan before turning 59 1/2 years old, you're usually on the hook for an early withdrawal penalty unless an exception applies. Converting to a Roth IRA won't automatically fix the problem, and in some cases, it could cause you to owe a penalty when you wouldn't have if you had taken the money straight out of a 401(k). But there are also exceptions that only apply to IRAs and not 401(k)s from which you could benefit.

Roth IRA Qualified Distributions

Qualified distributions from Roth IRAs are both tax-free and penalty-free. To qualify, your Roth IRA must be at least five years old, and you must be either 59 1/2 years old, permanently disabled or taking out up to $10,000 for a first home. If you have an existing Roth IRA that you've had for more than five years, you're good on the first requirement. However, there's a separate five-year waiting period for conversions that you must meet before being able to avoid the penalty. For example, if you convert, then take money out a year later, you won't pay taxes on the converted amount a second time, but you might still owe the early withdrawal penalty on those amounts unless an exception applies.

Age Exception

Once you hit age 59 1/2 years old, you're off the hook for any early withdrawal penalties on money you take out from your Roth IRA, no matter how long ago or how recently you converted the money. Your age is determined at the time of the distribution, not the time of the conversion. For example, if you convert at age 57, then take a distribution at 60, you won't owe any penalties because you were over 59 1/2 when you took the withdrawal.

Gain IRA Penalty Exceptions

IRAs offer several additional penalty exceptions that you would not have qualified for if you took the distribution directly from a 401(k) plan. First, you're allowed to withdraw money for higher education expenses, such as your child's college tuition, without penalty. Second, if you're unemployed, you can take money out without payment to pay for health insurance. Third, you can take out up to $10,000 to buy a first home. For example, if you took $5,000 out to pay for your daughter's college tuition, you'd owe the penalty if the money came out of a 401(k) plan, but not if you take it out of a Roth IRA.

Lose 401(k) Exceptions

The downside is that if you convert to a Roth IRA, you won't get to use the 401(k) early withdrawal exceptions anymore. For example, if you leave your job after turning 55, you can withdraw as much as you want from your 401(k) plan without paying any penalties. But, that exception doesn't apply to your IRA. For example, if you left your job at age 56, you're off the hook for the penalty for 401(k) distributions, but not Roth IRA distributions. Also, there's not an exception for a qualified domestic relations order for IRAs.

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About the Author

Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."

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