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How to convert a 401(k) to a Roth IRA

A 401(k) to Roth IRA conversion gives you tax-free withdrawals in retirement, but you’ll need to pay taxes on the conversion.

You may have left your job recently and want to convert your 401(k) to an individual retirement account (IRA).

If you choose to convert your 401(k) to a Roth IRA, you get the benefit of withdrawing your retirement funds tax-free once you’re over the age of 59 and a half, which is great if you think you’ll be in a higher tax bracket when you retire.

However, the conversion is a taxable event, so you’ll want to approach it methodically and possibly with the help of a tax professional.

401(k) to Roth IRA at a glance

  • A 401(k) to Roth IRA conversion is a taxable event.
  • This type of rollover is a good option if you want a retirement account where you can withdraw funds tax-free.
  • You may want to consult a tax professional to understand if a conversion is right for you and to potentially minimize the amount of taxes owed.

How to convert a 401(k) to a Roth IRA

First, check if your 401(k) administrator allows for a 401(k) to Roth IRA conversion. If so, you can complete the conversion in two ways: direct rollover or indirect rollover.

A direct rollover means your 401(k) plan administrator makes a payment directly to your Roth IRA administrator. Your 401(k) administrator may send the payment directly to your IRA administrator, or they may send you a check payable to the administrator. In either case, no taxes will be withheld from your distribution.

If you opt for an indirect rollover, you’ll receive a check from your 401(k) that’s made payable to you. You’ll have 60 days to deposit all or a portion of the distribution into your Roth IRA, but you will be subject to a mandatory 20% tax. If you miss the 60-day rollover deadline, the entire distribution will be subject to income taxes.

Follow these steps to convert your 401(k) to a Roth IRA:

  1. Check to see if you can make the conversion. Make sure your 401(k) plan administrator allows 401(k)-to-Roth IRA conversions.
  2. Decide how much you want to convert. You may choose to convert your whole 401(k) or a portion. Consider planning with a financial advisor to see how much you want to convert and over what period of time.
  3. Calculate the tax of converting. Estimate how much in taxes you’ll owe on the conversion to determine if it makes sense for you.
  4. Save enough to pay the taxes. Taxes on the conversion are due come tax time, not upon converting the funds from one account to the other. It’s recommended that you have enough cash to cover the tax bill instead of selling assets in your account to cover the expense.
  5. Open a Roth IRA. You’ll need a Roth IRA if you don’t already have one. Be sure to compare brokers to find the one that best suits your needs.
  6. Coordinate the conversion with your 401(k) administrator. Contact your 401(k) administrator and request and complete the paperwork necessary for the conversion process. The conversion deadline is December 31.

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How a 401(k) to a Roth IRA conversion works

A traditional 401(k) is funded with pre-tax dollars, while a Roth IRA is funded with after-tax dollars. Because of this, you’ll have to pay taxes on the funds you roll over in the year in which you make the conversion. You pay taxes today so that your money can grow tax-free and so that you can enjoy tax-free withdrawals in retirement. We outline some strategies later to help minimize taxes on the conversion.

Anyone can convert a 401(k) to a Roth IRA — even if your income exceeds the limits for contributing to a Roth IRA directly. Known as a “mega backdoor Roth IRA,” this is a common strategy for those whose modified adjusted gross income (MAGI) disqualifies them from contributing to a Roth IRA. There are no limits to the amount you can convert to a Roth IRA — the IRA contribution limit does not apply to rollover contributions.

The taxes owed and the 10% early-withdrawal penalty that typically applies to distributions taken before the age of 59 and a half do not apply when transferring funds directly from one retirement account to another. This is called a direct rollover.

The five-year rule and when it applies

You can withdraw contributions to your Roth IRA at any time, tax- and penalty-free, since you’ve already paid taxes on these contributions. But the IRS’s 5-taxable-year-period, more commonly called the five-year rule, stipulates that you must have held the Roth IRA for at least five years to withdraw earnings on your investments without penalty.

Following the conversion, if you take a distribution before the end of the five-year period that includes earnings, those earnings are subject to income tax. If you’re also under the age of 59 and a half, you must pay an additional 10% early-withdrawal penalty.

The five-year period begins on the first day of the taxable year that you made your Roth IRA conversion. So even if you convert your 401(k) to a Roth IRA in, say, June, the clock starts as of January 1 of that year.

How to minimize taxes on the conversion

There are a number of ways to potentially minimize the taxes you’ll have to pay if you convert your 401(k) to a Roth IRA.

One such strategy is to convert the funds over the course of several years. The idea here is to pay the taxes over a few years instead of all in one year.

And you can further capitalize on this strategy if you convert during years when your other income is low, as Jay Mota, certified financial planner at SVP Wealth Management, suggests. “A conversion will add to your income and increase your marginal tax rate,” explains Mota. “In years where income is lower, and you will fall into a lower marginal tax rate, then adding income from the Roth conversion might not put you in a much higher tax bracket.”

Another way to potentially lower your tax bill is to make the conversion during years when you’ve lost money in other investments.

“If you have investments that have lost value, you can use those losses to offset gains and reduce your taxable income,” shares Baruch Silvermann, CEO of the Smart Investor.

You may also keep your tax bill low on the conversion if you do so while the market is down. By converting during a down market, you’ll have fewer gains in your account to be taxed on.

Who should convert a 401(k) to a Roth IRA?

A 401(k) to Roth IRA conversion, even a partial conversion, may be a good idea if you want tax-free assets to draw from in retirement.

“A key advantage of converting some of a traditional 401(k) to a Roth IRA is the financial flexibility it affords you in retirement,” says Thomas Brock, chartered financial analyst and expert contributor to Annuity.org. “Having the ability to draw from either a tax-deferred vehicle (traditional 401(k) plan) or a tax-exempt vehicle (Roth IRA) enables you to take income distributions in a tax-efficient manner.”

Also, if you plan to keep investing during retirement, you can use your Roth IRA to do so in a tax-efficient manner.

“Another big advantage of converting [a traditional 401(k)] to a Roth IRA is that you can continue to contribute to it, even after you’ve retired,” explains George Blake, CFO of Life Part 2. “This can be a great way to supplement your income in retirement.”

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Roth 401(k) to Roth IRA conversion

A Roth 401(k) is an employer-sponsored retirement account similar to a traditional 401(k), except it’s funded with post-tax dollars.

Moving your funds from a Roth 401(k) to a Roth IRA is not a taxable event because the funds for both accounts are contributed post-tax.

That said, employer contributions to a tax-advantaged retirement account, even a Roth 401(k), are made with pre-tax dollars. So, while moving funds from a Roth 401(k) to a Roth IRA is not a taxable event, expect to pay taxes on any matching contributions.

Other options for your 401(k) funds

You have more 401(k) rollover options if you don’t want to convert your traditional 401(k) to a Roth IRA because of the tax bill or other reasons.

If you have a new retirement plan at your current employer, one option would be to transfer your old 401(k) to the new plan without triggering taxes. You can also convert your traditional 401(k) to a traditional IRA without being taxed, as both types of accounts are funded with pre-tax dollars. However, you must complete the rollover within 60 days.

You may also have the option of converting your traditional 401(k) to a Roth 401(k) if your plan administrator permits. This is known as an in-plan Roth conversion. And similar to a Roth IRA conversion, you must pay taxes on any pre-tax money you convert.

Lastly, you can also cash out your 401(k). However, this isn’t recommended because the distribution is taxable, and you’ll have to pay a 10% early-withdrawal penalty if you’re below the age of 59 and a half.

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Shifting from a 401K to IRA

Do you have an IRA?

Response% of Americans
I do not have this, but plan on getting it in the next 6 months13%
I do not have this nor plan on getting it56%
I currently have this31%
Source: Finder survey by Qualtrics of 2,033 Americans

While 401Ks are the most popular savings option for American adults (44%) about a third (31%) have an IRA, with a further 13% saying they plan on opening an IRA in the next 6 months.

Bottom line

Converting your traditional 401(k) to a Roth IRA may be a smart move if you plan to be in a higher tax bracket when you hit retirement age and want to withdraw your savings tax-free.

You can also convert your traditional 401(k) to other types of retirement accounts as well.

Keep in mind that converting your 401(k) to a Roth IRA is a taxable event. If you decide to make the conversion, it’s best to consult your tax advisor and take certain steps to minimize your tax burden in the process.

Frequently asked questions about a 401(k) to Roth IRA conversion

Written by

Frank Corva

Frank Corva is business-to-business (B2B) correspondent for Bitcoin Magazine and formerly the cryptocurrency writer and analyst for digital assets at Finder. Frank has turned his hobby of studying and writing about crypto into a career with a mission of educating the world about this burgeoning sector of finance. He worked in Ghana and Venezuela before earning a degree in applied linguistics at Teachers College, Columbia University. He also taught writing and entertainment business courses in Japan and worked with UNICEF in Namibia before returning to the US to teach at universities in New York City. Earlier in his career, he spent years working as a publicist and graphic designer for record labels like Warner Music Group and Triple Crown Records. During that time, he was also a music journalist whose writing and photography was in published in Alternative Press, Spin and other outlets. See full profile

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