How to Convert Your 401k to a Roth IRA

Here's how to use a rollover to shift money from a 401k to a Roth IRA.

If you have contributed to your 401k plan, you can take this money when you leave a job or retire. If you are leaving an employer, you should consider a rollover. A rollover transfers your retirement nest egg to another qualified plan instead of requiring a permanent distribution.

A special rollover to consider is one that converts your money from a 401k plan to a Roth individual retirement account. The Roth IRA rules offer tax-free incentives of qualified distributions; however, you must pay taxes on the converted amount. Here’s how to convert your employer-sponsored retirement savings account into a Roth IRA so you can make the most of your retirement funds.

Steps to Convert a 401k Into a Roth IRA

Typically, you can’t withdraw money from a 401k plan until you leave your job or turn 59.5 years old. If you’re under 59.5 and still working, you’re likely ineligible to convert your account.

As long as you’re eligible to complete a direct rollover, the conversion process is simple. Here are five steps to convert your 401k into a Roth IRA:

  1. Open a Roth IRA to receive the funds.
  2. Complete the rollover form provided by your employer or financial institution managing your 401k.
  3. Submit the form to your financial institution. The forms vary depending on the institution, but you must include the account information for both your 401k and Roth IRA.
  4. Once you submit the form, the financial institution will transfer the funds.
  5. Report the conversion on your taxes.

Find Out: How to Find the Best Roth IRA

401k Conversion Options

Direct rollovers and indirect rollovers are two 401k rollover options to convert money from a 401k plan to a Roth IRA. With a direct rollover, money is transferred directly from your 401k to the Roth IRA.With an indirect rollover, you first take a distribution from your 401k plan. Then, within 60 days, you can redeposit the money in your Roth IRA.

Two reasons exist to select the direct conversion: First, 20 percent of the 401k distribution is withheld for taxes. If you don’t use your money to complete the full rollover, this money is treated as a permanent distribution. Second, if you miss the 60-day deadline, you can’t complete the rollover, and the money is considered a permanent distribution.

Benefits of a 401k Conversion

The Roth IRA typically includes income limits for its users. If you’re a higher earner, you might not be eligible for a Roth IRA unless you use a backdoor Roth IRA conversion; however, no income restrictions exist for the conversion of a 401k to a Roth IRA. A 401k conversion functions similarly to a backdoor Roth due to the lack of income restrictions.

Tax Benefits

When you convert money from your 401k to a Roth IRA, you will owe income taxes on the amount of the Roth conversion. That’s because 401k contributions are not counted toward taxable income in the years they are deposited. However, contributions to Roth IRAs are not tax-deductible. You must include the amount of the conversion as part of your ordinary income, and it will be taxed at your marginal tax bracket.

If you’re converting a substantial amount of money, consider spreading the conversion over multiple years to reduce the tax burden. You can withdraw some of the money from your 401k to pay the taxes; however, the withdrawal will require income tax payment. In addition, if you’re under 59.5 years old, you’ll pay a 10 percent additional tax penalty.

Non-Tax Benefit

Roth IRAs offer other perks in addition to tax-free withdrawals. Once money is in a Roth IRA, you can avoid an early withdrawal penalty on distributions for higher education and up to $10,000 to purchase a first home.

In addition, you’ll never be required to take minimum distributions during your lifetime. With a 401k plan, you must begin withdrawing minimum distributions when you turn 70.5 years old. Remember, when you shift money from a 401k plan to a Roth IRA, you can no longer take a loan on that money from the account.

Alternatives to Converting a 401k to a Roth IRA

If you already have a Roth 401k, you can roll the money into a Roth IRA without any income tax implications because both accounts hold after-tax money.

Two types of IRAs are available: traditional IRAs and Roth IRAs. If you want to roll money from your 401k plan to an IRA but don’t want to trigger income taxes, a rollover to a traditional IRA allows you to maintain the tax-deferred growth.

Up Next: Roth vs. Traditional IRA — Which Retirement Plan Is Better for You?