Why a Tiny Roth IRA Today Can Supercharge Your Roth 401(k) Tomorrow

If you’ve been putting money into a Roth 401(k) at work (in general, great move), you might assume you’re set for tax-free withdrawals later. Now, while that’s mostly true, there’s a timing rule that trips people up: the 5-year clock.

In short, Roth accounts require time to “season” before earnings are withdrawn tax-free. And here’s the twist that matters for PG&E employees and anyone with a workplace Roth: your Roth 401(k)’s 5-year clock doesn’t carry over to a Roth IRA. Once you roll a Roth 401(k) to a Roth IRA, the IRS looks at the Roth IRA’s 5-year clock. If you’ve never opened a Roth IRA before, that clock starts at zero on rollover day. That can delay when your earnings are tax-free, even if your Roth 401(k) is much older. 

So the practical move is simple: open a Roth IRA now, even with a tiny contribution, so its 5-year clock is already running when you retire and roll your Roth 401(k) over. 

First, what counts as a “qualified” (tax-free) withdrawal?

A qualified distribution is when your Roth meets both tests:

1. It has been open at least 5 years, AND
2. You are 59 1⁄2 or older, or you meet another qualifying reason (death/disability; Roth IRAs also allow a one-time $10,000 first-home withdrawal). 

For Roth 401(k) accounts, the plan has its own 5-year clock for qualified withdrawals; for Roth IRAs, the IRA has its own 5-year clock. They’re separate. 

Why opening a small Roth IRA now helps, even if you love your Roth 401(k)

When you eventually roll your Roth 401(k) to a Roth IRA, the Roth IRA’s 5-year clock controls whether those dollars’ earnings are tax-free going forward. Opening a Roth IRA “early,” even with a small amount, starts the IRA clock today, so you’re not waiting years after retirement to access tax-free earnings. 

It is important to understand what a Roth IRA qualified status is. The 5-year period starts on January 1st of the tax year in which you make your first Roth IRA contribution, even if that first contribution is just $1 and you make it as late as the April deadline the following year. In other words, a tiny contribution can start the clock for the whole bucket. 

If income limits block a regular Roth IRA contribution, you can still start the clock with a small Roth conversion from a traditional IRA. Same effect: the IRA’s 5-year clock is running. Remember, Roth conversions must be completed by December 31st; they do not receive the extra time that IRA contributions do.

Feeling a bit overwhelmed? We can help, our team works with PG&E retirement planning everyday. Schedule a meeting with us today!

Roth 401(k) vs. Roth IRA: different rules under the hood

Two practical differences make the Roth IRA attractive once you leave the company:

• Ordering vs. pro-rata rules. Roth IRAs use ordering rules (contributions come out first, tax and penalty-free), while non-qualified Roth 401(k) distributions use pro-rata (every withdrawal is part contribution, part earnings). It is the cream in your coffee; pre- and post-tax money are taken out together. That gives Roth IRAs more flexible access to tax-free dollars. 
• No lifetime RMDs. Roth IRAs have never required minimum distributions for the owner. Roth 401(k)s are now also exempt from lifetime RMDs, but many people still roll to a Roth IRA for simplicity and control. 

Simple scenarios (so you can see the timing)

Scenario 1: You currently have a Roth 401(k) but no Roth IRA yet. You retire, then roll your Roth 401(k) to a brand-new Roth IRA. 

Result: the IRA 5-year clock starts now, and you may be waiting up to five years before earnings are tax-free (even if you’re already over 59½). 

Scenario 2: You opened a Roth IRA five plus years ago with a small contribution. You retire and roll your Roth 401(k) into that Roth IRA. 

Result: the IRA’s 5-year requirement is already satisfied, so if you’re 59½ or older, earnings are tax-free immediately. 

Scenario 3: You’re under 59½ and doing Roth conversions.

Result: There’s a second 5-year rule tied to conversions and the 10% penalty (applies only to people under 59½). Each conversion has its own 5-year “penalty clock,” which starts on January 1st of the conversion year. This rule prevents “convert today, withdraw tomorrow” to dodge the penalty. 

What about staying in a Roth 401(k) instead of rolling to a Roth IRA?

If you take qualified Roth 401(k) distributions (account 5+ years and you’re 59½+), those withdrawals are tax-free. If you take non-qualified distributions from the Roth 401(k), they’re pro-rata (part basis, part earnings). Example: Kathy has a balance of $40,000, and she defers $30,000, then withdraws $12,000. $9,000 is tax-free, and $3,000 is taxable earnings. 

The point isn’t that one account is “better.” It’s that the Roth IRA’s clock and ordering rules can give you earlier, cleaner access to tax-free money, if you start that IRA clock now. 

Action plan (plain and simple)

1. Open a Roth IRA this year, even with $50–$100.
2. That single dollar starts your Roth IRA 5-year clock on January 1st of the contribution year. 
3. If your income is too high for a Roth IRA contribution, consider starting the clock with a small conversion.
4. Convert a small amount from a traditional IRA to a Roth to trigger the IRA’s 5-year clock. 
5. Continue or start to use your Roth 401(k) at work.
6. It’s still a great savings vehicle. When you leave, you can roll it to your Roth IRA, ideally one that’s already “seasoned.” 
7. Prefer direct rollovers.
8. When rolling between employer plans or to a Roth IRA, direct (trustee-to-trustee) transfers avoid withholding and paperwork headaches. (Note: employer-to-employer direct rollovers can preserve an older plan’s 5-year start date inside the new plan, but not into a Roth IRA, which follows the IRA’s own clock.) 
9. Track basis and clocks.
10. Keep records of contributions, conversions, and rollover basis so you always know what’s tax-free. 

PG&E-focused note

Many PG&E retirees roll pre-tax 401(k) dollars to a traditional IRA and Roth 401(k) dollars to a Roth IRA at retirement. If your Roth IRA has already met its 5-year rule (thanks to that tiny “starter” contribution years earlier), you’ll have smoother access to tax-free earnings the moment those Roth 401(k) dollars land in the IRA. That’s real flexibility when coordinating pension, Social Security, and RMD-free Roth income. 

What to remember

• Roth 401(k) and Roth IRA have separate 5-year clocks for tax-free earnings. 
• After you roll a Roth 401(k) into a Roth IRA, the Roth IRA’s clock controls. Open the IRA early, even with a token amount, so you’re not stuck waiting later. 
• If you can’t contribute due to income limits, a small conversion still starts the Roth IRA clock. 

I can help you check whether your Roth IRA clock is already ticking and determine the best time to roll over your PG&E 401(k) or Roth 401(k). I’ll line it up with your pension and Social Security, so your first withdrawals are clean, simple, and tax-free where possible.

The finance world can be confusing, so we are here to help at Powering Your Retirement. We specialize in PG&E retirement plans and can help you roll out your PG&E 401k. Give us a shout, we would love to hear from you.