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In my current employer's 401(k) plan, I began with traditional 401k deferred taxation contributions. A few years ago realizing how much deferred taxes I was building up (and with a change where minimizing annual tax was less critical) I changed to a mix of traditional 401(k) and Roth 401(k) contributions. I am now making 100% Roth 401(k) contributions to the plan.

I have one 401(k) account that holds both. The current breakdown by source is approximately:

  • Employee 401(k) 44%
  • Roth Basic 26%
  • Employer Optional 17%
  • Employer Matching 13%

My question for planning ahead is, if I choose to retire at 55 and use the "Rule of 55" to withdraw from this account to fund an early retirement period, will I be able to withdraw based on source (i.e. draw the deferred portion and company match first, realizing the deferred taxable income well before any interactions with social security and medicare rules, and also allowing the Roth pool to remain compounding longer) or will withdraws be prorated from each pool that went into the total account, such that if I made a withdrawl today, 26% would be Roth tax free, and 74% taxable income?

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  • 1
    What is "Employer Optional"? Commented yesterday
  • @DStanley an annual bonus separate from the matching Commented yesterday
  • 3
    Off topic but related: Look up and understand the various 5-year rules for Roth IRAs. (See IRS Pub 590A and 590B) If a Roth IRA will ever play a role in your retirement planning, figure out if you will ever be in a situation where you say, "Dang it, I can't do (XYZ) without a penalty because I haven't had a Roth IRA for 5 years!" If so, open a minimal Roth IRA now. Anywhere, any amount will start the 5-year clock. Commented yesterday

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You will have to talk to the company administering the 401(k) and you may need to review the documents defining your plan.

One issue will be do they allow partial withdrawals. Some don't.

If you were to pull the pre-tax money and the company funds into an IRA, you would not be able to use the rule of 55. But maybe you could roll the Roth 401(k) into a Roth IRA, thus leaving only the non-taxed funds in the 401(k)?

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Short answer: yes, almost all major 401(k) plans let you choose which money source to draw from on each Rule of 55 distribution. You should not be locked into pro-rata treatment.

The mechanics: the IRS requires plans to track different sources separately for tax reporting. Pre-tax employee contributions, Roth employee contributions, employer match (always pre-tax), and employer profit sharing each get their own subaccount with their own 1099-R coding at distribution. Plans must track these independently because the tax treatment differs. Where the pro-rata rule (IRS Notice 2014-54) actually bites is on a partial rollover from a 401(k) to two different IRAs (one Traditional, one Roth). In that case, the rollover must split pro-rata across pre-tax and Roth basis. But for a withdrawal taken as cash from the plan itself, you can almost always specify the source.

For your situation: you'd want to draw from the pre-tax pool first, leaving Roth 401(k) to keep compounding tax-free. Two things to verify with your plan administrator before separating:

  1. Does the plan let you specify source on each distribution, or does it default to pro-rata? The Summary Plan Description (SPD) should spell this out, often under "Form of Distribution" or "Distribution Options."
  2. Does the plan allow installment or partial distributions, or is it all-or-nothing? Plans with all-or-nothing distributions are uncommon but not extinct, and they can effectively block strategic use of Rule of 55. The existing answer flagged this and it's worth confirming.

One thing the other answer mentioned but is worth resolving: if you roll the Roth 401(k) to a Roth IRA before separating, you lose Rule of 55 access on those funds (Rule of 55 is 401(k)-only; Roth IRAs use SEPP/72(t) or the 5-year ladder). And the Roth IRA 5-year clock on rolled funds restarts unless your Roth IRA has been open 5+ years. So leaving the Roth 401(k) in the plan is usually the right call until at least 59.5.

The Employer Optional bucket you mentioned (annual bonus match) is tracked separately too. It's pre-tax, so you'd want to draw from it before touching either Roth bucket.

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