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Rolling Over a 401(k) to a Roth IRA: Should You Convert to a Roth?

Updated for 2024. What are your 401(k) rollover options? You may consider rolling over an old 401(k) to a Roth IRA, which is properly described as a Roth conversion. Converting your old 401(k) or 403(b) to a Roth IRA is worth considering. A Roth IRA offers unique benefits unavailable in other types of retirement accounts: no RMDs, tax-deferred growth and tax-free withdrawals. But a 401(k) to Roth IRA conversion doesn’t make sense in every situation. For high-earners, it may not make sense to pay tax on your retirement savings now.

401(k) Conversion to a Roth IRA

Anyone can convert a 401(k) to a Roth IRA once a year – there are no income limits like there are with regular Roth IRA contributions. You also don’t have to convert your entire 401(k) to a Roth IRA at once or even at all. You can split the rollover between an IRA and a Roth IRA if you wish.

Rollover 401(k) to Roth IRAA Roth IRA offers unique benefits, but a complete analysis should be done prior to the Roth conversion. Some of the key retirement planning considerations are:

  • Do I expect my tax bracket to be higher in retirement than it is now?
  • Do I have cash available to pay the tax without dipping into my Roth IRA or other retirement money?
  • Does a Roth IRA conversion fit into my overall retirement planning and wealth strategy?

When to consider converting a 401(k) to a Roth IRA

If you anticipate your tax bracket being higher in retirement due to required minimum distributions or other sources of income, then it may make sense to pay income tax now while you are in a lower tax bracket.

Another reason to convert to a Roth is when you have a sizable pool of tax-free Roth assets relative to your tax-deferred retirement accounts. The tax benefits of a Roth IRA are most significant in this case. If your Roth IRA savings are only 5% or 10% of your entire retirement savings, it may not be enough to justify the loss of tax deferral.

Keep this in mind as an isolated conversion of relatively small dollar value may not make a material impact on your overall wealth. A financial plan can help you weigh whether maintaining tax-deferred growth is a better strategy to maximize your wealth.

In-plan 401(k) to Roth Conversions: Enter the Mega Backdoor Roth 401(k)

Tax consequences of rolling a 401(k) to a Roth IRA

A Roth conversion means you recognize income on the amount you convert. So you convert a $100,000 401(k) to a Roth IRA, your ordinary taxable income will increase by $100,000 that year.

There are many cases where it doesn’t make sense to increase your regular income with a Roth conversion. If you don’t have the cash on hand to pay the tax, then you should consider rolling your 401(k) over to a traditional IRA instead. Using money from your Roth IRA to pay the tax has been shown to make workers worse off in the long run.

Again, the main reason to convert to a Roth is the assumption that your tax rate will be higher in retirement. If you are in the highest marginal tax bracket (or close to it) now, there’s a good chance your tax rate will be lower in retirement.

Is Retirement the Best Time for Roth Conversions? 

Why convert your 401(k) to a Roth IRA? Unique Roth IRA benefits

The strategy to convert a 401(k) to a Roth IRA is appealing for many investors because of unique Roth IRA benefits.

  • No mandatory withdrawals in retirement. Unlike IRAs and qualified retirement plans, a Roth IRA is unique in that required minimum distributions are not required during the original account owner’s lifetime.
  • Tax-free withdrawals! Five year rule for Roth IRAs says 5 years after the year in which you make a Roth conversion you’re able to withdraw funds for qualifying events without a penalty. Further, withdrawals are considered to be made from after-tax contributions and conversion dollars first; earnings last. Funds that have already been taxed won’t be subject to double-taxation.
  • Tax-efficient legacy gifts. A Roth IRA is an advantageous way to leave assets to beneficiaries, as the account will pass onto an heir income tax-free, assuming a five-year holding period has been met by the decedent. Note: Roth IRAs may still be subject to estate tax.
  • Tax planning for tax savings during retirement. For investors facing higher income tax brackets in retirement due to the impact of RMDs on tax-deferred assets, a Roth can provide needed tax diversification and flexibility.
  • Tax-free earnings. Assuming age and holding period requirements are met, withdrawals will be tax-free.

Other 401(k) Rollover Options

401(k) rollover to IRA

The most common option is a 401(k) to IRA rollover. Like a Roth IRA conversion, the rollover to a traditional IRA will allow greater access to investment options compared to an employer-sponsored 401(k) plan and the flexibility to align the account with your overall investment management strategy. You will continue to defer taxes on the account like you were with the 401(k).

Keep the money in your old 401(k) plan

Deciding what to do with an old 401(k) can be stressful, so it’s alright to keep your old account while you weigh your options. Many plans allow former employees to keep their 401(k)s after they have left the company. Before deciding to keep your 401(k), make sure you are happy with the investment options and plan fees.

Transfer to your new employer’s 401(k) plan

If your new employer allows it, you can move the funds from your old plan into your new one. It can be easier to manage your investments when they are all in one place, which makes this a good option for some. Keep in mind, you still may be limiting yourself regarding investment choices and expenses could be higher too.

There is no one-size-fits-all approach to retirement planning or investing, which is important to keep in mind as Roth conversion strategies gain popularity. Roth conversions may play a large part in maximizing future wealth for some investors. Consider your next steps carefully and find a strategy that is consistent with your retirement planning goals and wealth management objectives.

For a more complete discussion on the various options for an old 401(k), please see this article.

Does it make sense to convert your 401(k) to a Roth? Do the math

In working with clients, we use tools to simulate the impact of converting different amounts from an IRA or 401(k) to a Roth account. There are strategies to try and stay under the next highest marginal tax bracket or do multi-year conversions to minimize the tax hit. This also helps illustrate the breakeven period and potential reduction of RMDs. After all, when you do a Roth conversion, you’re paying tax now, which means giving up additional tax-deferred growth.

Often, especially for clients in retirement, a key goal is gaining tax savings for beneficiaries. Whether it’ll be worthwhile depends in large part on assumptions for tax rates for heirs and the account owner. As with any financial decision, there are many factors to consider, so discuss your situation with your wealth advisor.

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