How To Roll Over a 401(k) to a Roth IRA

Roth IRA Conversions Explained

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A rollover of a 401(k) to a Roth IRA is the movement of funds from a 401(k) into a new or existing Roth IRA account. Many people consider making a Roth IRA conversion after they leave an employer to consolidate retirement accounts and take advantage of the benefits of a Roth IRA, which include tax-free investment growth and no required minimum distributions

Additionally, if you are in a period of earning less income than usual or believe your income will be higher in the future, there are tax benefits to converting an old 401(k) to a Roth IRA in a low-income year. Converting a 401(k) to a Roth IRA involves a few, easy steps between your former workplace 401(k) administrator and the financial institution where your Roth IRA account is located.  

With the information below, you’ll have a better understanding of what a Roth IRA rollover is, what advantages it provides, the steps it takes, and alternative rollover options.

Key Takeaways

  • A rollover from a 401(k) to a Roth IRA is a taxable event, but you can be strategic as to what year you decide to do this as it can save you money in taxes.
  • Congress is considering changing the allowance of Roth IRA conversions due to the tax-saving benefits.
  • There are many advantages to a Roth IRA rollover, such as consolidation of accounts and tax-free investment growth.

What Is a 401(k) to Roth IRA Conversion?

A Roth IRA conversion is when you roll over retirement assets from a Traditional IRA, SEP IRA, or SIMPLE IRA or a qualified former employer retirement plan, such as a 401(k), 403(b) or 457(b), to a Roth IRA. You are converting your retirement assets from a retirement account that is funded with pre-tax dollars to a retirement account that is funded with post-tax dollars. 

This process can also be called a backdoor conversion when used to avoid income limits on Roth IRAs.

In the process of converting these assets, you will have to pay income taxes. One of the biggest advantages of making a Roth IRA conversion is that your contributions and earnings are able to grow tax-free. You are then able to withdraw money tax-free from your Roth IRA in retirement after the age of 59 ½, assuming converted funds and earnings have been in the account for at least five years. 

Why Roll Over Your 401(k) to a Roth IRA?

If you keep a former workplace 401(k) plan you will have to pay taxes on your contributions and earnings in retirement. Converting to a Roth IRA may help you save money on income taxes if you expect your income to rise in the future or you have a particular year in which your income is low. When you complete a Roth IRA conversion, your pre-tax dollars from a workplace 401(k) plan are taxed at the time of the conversion, so if you are in a lower income tax bracket you will owe less in taxes. Then, in the Roth IRA, your contributions and earnings will grow tax-free.  

The US House of Representatives currently passed legislation that is pending in the Senate to prohibit the conversion of traditional 401(k)s and IRAs to Roth IRAs. They claim wealthy individuals use Roth IRA conversions to avoid paying taxes on the gains from retirement investments. 

There are other reasons to consolidate retirement accounts, such as having fewer accounts to manage and separating your accounts from old employers. A Roth IRA also offers a wider range of investment options that a workplace 401(k) likely does not. A Roth IRA has options with low expense ratios, which save you money.

Steps for Rolling Over Your 401(k) to a Roth IRA

There are a few quick steps you need to take in order to move old 401(k) funds to a Roth IRA. 

1. Determine if you’re eligible

You are eligible to roll over a 401(k) to a Roth IRA if you have left your employer. 

2. Decide which type of conversion you want

There are two types of rollovers you can make before retirement: a direct or indirect rollover.

For a direct rollover, your old 401(k) plan administrator will be able to deposit your 401(k) money directly into your new Roth IRA account once it is opened. 

If a direct rollover is not an option, or if you want an indirect rollover, this means the 401(k) plan administrator will have a check made out to you. 

With an indirect rollover, taxes will be automatically withheld and be counted toward taxes paid for that year. You will have to use other funds you have on hand to replace the tax amount lost. If you do not replace the money that was sent to the IRS, it will be considered taxable income on which you will pay regular income taxes plus an additional 10% tax penalty.

3. Open your Roth IRA

You can open a Roth IRA at a bank, credit union, or investment brokerage. Once you figure out where you want to open a Roth IRA account, the financial institution will be able to walk you through the necessary paperwork.

4. Roll over your money

You will submit to your 401(k) plan provider that you want to roll over your money and your preference for what type of conversion you want. You will have to denote what financial institution you have a Roth IRA account at if you want to do a direct rollover. If you do an indirect conversion, you have 60 days from when you receive the 401(k) distribution to put the funds into the Roth IRA or another plan. 

5. Pay your taxes

A 401(k) rollover to a Roth IRA is considered a taxable event. Your 401(k) is a traditional account and was funded with pre-tax dollars, while a Roth IRA is funded with post-tax dollars, so you must pay income tax on the money you roll over. If you were moving funds from a Roth 401(k) to a Roth IRA, this is not considered a taxable event, as both are funded with after-tax dollars.

Alternatives to Roth IRA Rollovers

If you want to move your old 401(k) account, there are other options that are available to you besides a Roth IRA. 

 If you have a new 401(k) plan offered to you at your new employer, you could roll the old 401(k) plan into your new plan. Similar to opening a Roth IRA, there are a few easy steps to take to move your old 401(k) into a new employer’s plan.

You could also roll over your 401(k) into a Traditional IRA. You won’t pay taxes when you convert the money to a Traditional IRA, as you will be taxed when you withdraw the money in retirement. You may want to do this, as Traditional IRAs typically offer more investment choices than workplace 401(k)s.

If you own your own business, then you could open a self-employed 401(k) plan and convert an old workplace 401(k) to this account. A self-employed 401(k) plan offers many of the same benefits as a traditional 401(k), except that, as a business owner, you could make contributions both as an employee and employer. This helps minimize your business income and maximize your retirement contributions.

Frequently Asked Questions (FAQs)

What tax form do I use for a rollover from my 401(k) to a Roth IRA?

401 (k) rollover funds are reported as distributions, even if they are directly rolled over. As a result, you will receive a 1099-R to report your 401(k) distribution from your old employer.

How much can I roll over into a Roth IRA?

A rollover is considered a balance transfer from one retirement plan to another retirement plan and does not count toward the annual Roth IRA contribution limits. 

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