How to Convert Your 401k to a Roth IRA

Rolling your 401k to a Roth IRA is easy, but you’ll owe taxes.

When you retire or leave your job for any reason, you’re allowed to bring your 401k funds with you. Some investors roll over their 401k money to their new employer’s 401k plan, and others move their retirement savings into an individual retirement account. One option is to convert your 401k into a Roth IRA, which allows for tax-free distributions. Such a conversion could have significant tax ramifications, so you might want to speak to a retirement planning specialist or tax expert before you make the move. Here’s a look at the process for a 401k conversion to a Roth IRA and how it can help you extend your retirement savings.

401k Rollover to Roth IRA

The procedure to roll over your retirement savings from one account type to another is straightforward. Here’s how to covert a 401k to a Roth IRA:

  1. Open a Roth IRA at a financial institution and note the account number.
  2. Contact your 401k administrator to get the proper rollover paperwork.
  3. Fill out the rollover forms with your Roth IRA account number and other identifying information about both yourself and the receiving financial institution.
  4. Submit the completed forms to your 401k administrator.
  5. Watch your Roth IRA for the arrival of your converted 401k funds.
  6. Report the transaction when you file your taxes.

Learn More: 401k Rollover Rules

401k Rollover Fees and Costs

A 401k to Roth rollover typically is a cost-free transaction. Some firms, however, might charge you money to set up a Roth IRA or to transfer money out of a 401k, so check with your providers. The major costs you’ll have to be concerned with are the tax consequences of a 401k to Roth conversion.

401k Conversion Tax Consequences

Retirement accounts like 401k plans are typically funded with pretax money; a Roth IRA is an after-tax account. Thus, you’ll likely face tax consequences on your 401k conversion to a Roth. You’ll have to report the transaction on your taxes, and the IRS will consider all of the pretax income you convert to your Roth to be fully taxable at ordinary income tax rates, which can amount to a significant hit if you have a large 401k fund.

For example, if the amount of your rollover pushes you into the highest tax bracket, you’ll owe 37 percent on the transfer, just in federal taxes. And if you live in a high-tax state, such as California, you might face as much as 13.3 percent in additional state tax, pushing your total tax burden to over 50 percent of the amount of your 401k rollover.

Also See: How to Use Your IRA as a Last-Minute Tax Deduction

Benefits of a Roth Conversion

By paying your taxes at the time of your conversion, you won’t have to worry about taxes on your Roth money in the future. Money inside a Roth IRA grows tax-free, so you won’t have to report your earnings inside the account every year when you file your taxes.

You also won’t have to pay tax on any qualified distributions you take from the account. You can’t take a qualified distribution according to Roth IRA rules unless you’ve had a Roth IRA open for at least five years. You must also either be age 59.5, disabled, a beneficiary of the Roth IRA or taking a distribution for your first home, up to $10,000.

Other benefits of a 401k to Roth conversion include increased investment options and the lack of mandatory distributions. Most 401k plans offer a roster of mutual funds to choose from but little else. In a Roth IRA, you can invest in a wide variety of stocks, bonds, mutual funds and ETFs, among other options.

After you turn age 70.5, you’re forced to withdraw money annually from most pretax retirement plans, including your 401k plan. A Roth IRA does not have that requirement; you can keep your money in a Roth IRA indefinitely, regardless of your age.

See Which Retirement Plan Is Best for You: Roth vs. Traditional IRA