Can You Rollover Your 401k to a Roth IRA?

Joseph Meyer
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Need to open a Roth IRA?

When I first opened an IRA, it was under the old 401(k) retirement system, and you had to wait until the age of 59.5 to do so. Today, I can open a Roth IRA at the age of 18, which is allowed for any taxable account.

With the United States government having a balanced budget, which is an income and a spending figure, if you can prove you have a certain income, you can open an IRA or a Roth at an earlier age.

I am talking about the new system with the individual retirement accounts, or IRAs. You can open your IRA at 18, and if you can prove you have an income, you can open your 401(k) at 34.

You have to prove you have substantial income, depending on what you want to do.

Roth IRA Rollover Rules From 401k

A Roth IRA can hold investments that conventional IRAs can’t, such as exotic options and real estate. It also has different contribution limits and income requirements.

However, a Roth IRA can also function as an alternative to a 401k. A 401k rollover to a Roth IRA is basically an indirect rollover. If you’re allowed to transfer funds to a Roth IRA, then you’re allowed to transfer funds to a Roth 401k. But a rollover to a Roth 401k isn’t always a feasible solution.

Contributions to a Roth 401k are limited to the taxpayer’s taxable compensation. In many cases, this makes a Roth 401k an inferior contribution option compared to an ordinary 401k, which has an infinite contribution limit. For example, if you have a 401k as a secondary retirement savings option to your IRA, there’s a good chance that the amount of money you can save in a 401k is higher.

3 Brokerage Options to Rollover Your 401k Into a Roth IRA

If you have a 401k plan at work, you have the option to roll it over into a Traditional IRA or a Roth IRA. However, there are certain conditions to which you must follow when doing so. Here’s what you need to consider.

Ally Invest

If your company does not offer a 401k and you’ve found yourself in this moneymaking situation, don’t worry too much.

As a company owner, you still have the option to roll over the 401k account into an IRA with a 401k alternative like Ally Invest.

In addition to opening a rollover IRA with us, you can also continue to contribute to a regular IRA as true tax-free retirement funds. The rollover IRA is just an option to making use of some of the funds in your 401k that you may be taxed on.


TD Ameritrade

When you sign up for a Roth 401k plan at a new company, you may be told that you can rollover the amount into a Roth IRA account. To be clear, this is not a rollover in the sense that you are moving money from one account to another. Fundamentally, a rollover is an accounting term to denote how the money is deposited into the account.

A 401k plan is a type of defined contribution retirement plan where you set aside specific amount from your paycheck to accumulate retirement savings. You typically set aside a percentage of your annual salary that your employer matches, although the number can vary depending on the company. If you change jobs, you can rollover your 401k plan balance to a 401k plan offered by your new employer or roll it over into an IRA.

Recap on Roth IRA Conversion Rule

President Barack Obama signed a bill repealing the Pension Protection Act provision that had delayed the implementation of the rule that allows a 100% tax-free conversion from a traditional IRA to a Roth IRA.

That means the rule went into effect on January 1, 2010. The conversion must be completed by April 15, 2010.

Here are the general guidelines on how to go about it:

{1}. If you have IRA money sitting in a company pension plan or 401(k), it’s easy. The money is held, in a sense, in limbo, and you are permitted to roll it directly over into a Roth IRA with no tax liability.
{2}. If you have a traditional or SEP IRA at a bank, you need to take a distribution. Then you can convert the money into a Roth IRA within the 60-day window.
{3}. If you have money in a traditional IRA elsewhere, you have to take a minimum tax-deductible distribution or pay a 10% penalty on that money. Out of that amount you now roll into the Roth IRA. Make sure you keep records that you have met the distribution threshold. The sooner the better because you want to take advantage of the no-tax portion of the rollover.

How Do I Rollover if I Receive the Check?

You can rollover a 401k retirement account to a Roth IRA in a few simple steps. In order to qualify for a rollover, the funds you want to take from 401(k) must be eligible to be distributed from your employer’s plan. Only Qualified 401(k) Distributions are allowed. These are non-taxable retirement withdrawals which includes hardship distributions and certain other permitted distributions.

First, you must have a valid (not administratively revoked, not suspended, or not currently in the process of being corrected) Individual Retirement Account (IRA). You simply must be an active participant.

From this option, you may take a lump sum distribution. If you are taking your 401(k) funds as a lump sum distribution, you may only roll them over to an IRA that is established by you or in a direct trustee-to-trustee transfer. The funds must be in a checking or savings account not into or out of a company sponsored plan or retirement account. They must be paid directly from your DC plan. You can roll them over without penalty as long as you do it within the 60-day time frame following your withdrawal from the plan. If you choose a rollover or a direct transfer into the IRA, you must state on the direct rollover form that you want the amount contributed to the Roth IRA.

What About the Roth 401k?

The 401k is one of the most popular tax-deferred retirement vehicles. However, there are limitations with these accounts that make traditional 401k accounts less than optimal when you retire and begin making withdrawals. The first limitation is that you must begin making withdrawals from your account beginning the April after you turn 70.5 years old. Typically you can make these withdrawals in the form of a lump sum, or in monthly payments. Because you are age 70.5 and are likely in your later years, assuming you can hang on that long, this means you will likely die before you get to the end of your 401k account.

So how do you make withdrawals from a traditional 401k once you turn age 70.5? You can rollover your traditional 401k to a Roth 401k. When you make a conversion to a Roth 401k, you are essentially creating taxable income by moving pre-tax retirement dollars to an account that will provide you with income tax-free withdrawals at retirement and in retirement. By rolling your traditional 401k to a Roth 401k, you will be taxed on your income when you make the conversion, but you will benefit from tax-free withdrawals when you start to take required distributions at age 70.5. The good news is that there are no Roth IRA income restrictions as there are with Roth IRAs.

4 Signs It Makes Sense to Roll Your 401(k) into a Roth IRA

When most people think about a traditional IRA, they’re thinking about a Roth IRA. For a relatively small fee, a traditional IRA allows you to invest your retirement money in stocks, bonds, mutual funds, etc. You only owe taxes ONCE you pay the money out at retirement time.

The tradeoff is that with a traditional IRA, your withdrawal penalty is a 10% tax penalty if you are not past retirement age.

The Roth IRA is a different animal. Instead of being taxed, the money put in a Roth is taxed on the way in, but qualified withdrawals are tax free at retirement. So why would anyone want a traditional IRA?

One possible reason is that if you’re already in a high tax bracket now, the benefit of having the tax-free payouts at retirement time may outweigh the current tax advantage.

Another possible scenario is if you can pay the taxes on the contributions now at a low income level (say 10% or 12% bracket) and save the tax penalty for when you’re making multiple six-figures. It’s almost like a tax arbitrage.

You expect to pay higher taxes in the future.

If you think you’ll be in a higher tax bracket when you retire, then a Traditional 401k is the best choice for you. Taxes are deducted from your paycheck, and are usually at a lower rate than the tax you’ll pay when you withdraw money in retirement.

The only downside to this arrangement is that you’ll have to pay taxes on your 401k money when you withdraw it, and you’re required to pay taxes on your capital gains when you sell the asset.

If you think that’s a good deal, then you should open a Traditional 401k.

You want to take withdrawals when you’re ready, and not a minute before.

If you are a young person with a lot of time until retirement, you may want to cash out your 401k. You get a big tax free check and don’t have to worry about losing money to the stock market. If you’re an older worker with fewer years to retirement, on the other hand, you may want to roll over your 401k into a Roth IRA, where you pay no taxes when you take your distributions. And whether you are taking money out of your 401k or converting it into a Roth IRA, you have to pay taxes on it when you withdraw the money at retirement.

Want to get a jump start on your retirement? If so, there’s a way to do this that can make sense for your specific financial situation. You can roll over your 401k into a Roth IRA. But there’s a catch. Rollovers to Roth IRAs aren’t always advantageous.

Before you decide whether a rollover is the right move for you, ask yourself three important questions about your situation.

When will you need the money?

You expect to earn more money in the future.

Wasn’t that what retirement was about? When you stop working, you can’t save money anymore. You lose your chance to build a nest egg, another reason to feel more concerned about your retirement income than you did when you had a lifetime ahead of you. That’s why many people roll over their 401(k)s to a Roth IRA. You can still contribute to your traditional IRA, but once you’re out of the workforce, you can’t save more money, so you might as well go for the tax-free money now. It’s a good move, but not a harbinger of a brave new world. It’s in the same league with other good moves, a good move that makes sense if you can afford to do it.

When you roll your 401(k) savings into a Roth IRA, you become eligible to take advantage of the tax-free investment. You’ll pay taxes when you withdraw the money, but you see the money now, it’s not locked up forever, and you don’t have to pay taxes on the growth of the money while it’s in the Roth.

You want to increase your tax diversification.

Research shows that a 401(k) works best for people under 30 years old and a Roth IRA works best for people over 30 years old. If you are in between those two, you may be in the middle of a tug-of-war between the tax savings of the 401(k), and the tax diversification of the Roth IRA.

The key to make such a decision is to see if you will get a tax savings at your age by contributing to your 401(k). If you’re already in your 30s, then you’ll need to see if you can make up the tax savings by converting your 401(k) to a Roth IRA.

The Bottom Line

A standard 401k plan allows you to roll over your 401k balance into a traditional IRA when you quit your job or retire. However, there is no rollover provision with a Roth 401k, and that’s been the source of a lot of confusion amongst current and former participants.

Most of these questions revolve around the issue of taxes. When you route your money into a Roth IRA, the earnings are tax deferred, but the money is taxed when you’re in retirement. Plus, a rollover into a traditional IRA comes with the additional advantage of not having to pay the 10% early withdrawal penalty.

The main concern, however, among potential 401k to IRA rollover candidates is the penalty for non-compliance. To put it plainly, no one wants to pay a huge penalty in the event that they need access to their funds in the future.

About the Author

Richard Baker is a passionate student of personal finance. Mr. Baker always had an interest in economics, and he finally pursued this passion in his college years, and graduated from the University of Southern California with a Bachelor’s degree in Economics and a minor in Corporate Finance.

Follow Richard on Google+, Facebook, Twitter, and Linkedin.

In today’s climate where many savers are talking about the need to shelter income in 401(k) personal retirement accounts, it is increasingly important that people learn about strategies for converting their 401(k) into another retirement account, such as a Rollover to a Roth IRA.

In some cases, you may be able to withdraw money from a 401(k) without paying taxes or a 10% penalty. This situation applies if the money in your 401(k) came to you as a type of distribution. An example of a distribution is a 401(k) loan that is later repaid. Since the money was withdrawn for temporary purposes, it is classified as a qualified distribution.

Before you can make a Rollover to a Roth IRA, you must first convert your 401(k) into a regular IRA account. This is actually a two-step process. First you must roll the money over from your 401(k) to a traditional IRA with a bank or a brokerage firm. You can then convert the traditional IRA to a Roth IRA.

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If your 401k plan has a savings option, you might be tempted to roll your savings over to a Roth IRA.

After all, you may have heard that you should always put your money in the Roth, which would enable you to avoid paying off taxes later. And the investment industry loves to tell a compelling story that a Roth IRA is a one-way ticket to tax freedom.

Unfortunately, many in the industry are both too lazy and too busy making money off commissions to provide an adequate level of advice. So let’s take a deeper dive and explore the real truth about Roth IRAs.

The Basics

Although the investment industry and the IRS may disagree on many things, they do agree when it comes to the basics.

If your retirement account is custodial, you won’t pay taxes on the money you put in the account. But if you start to take it out, you will be taxed.

That’s because retirement accounts are a bundle that includes two different tax breaks. The tax break for contributions is called a deduction, and if you don’t have a retirement account, you get no deductions until retirement.