Can I roll a 401k into a Roth IRA?

If you left your job and you are wondering what to do with your 401(k), you have several rollover options with the money. The most common rollover option is to rollover from 401(k) to an IRA, where a taxpayer can continue making tax-deferred contributions to the IRA account. You may also consider rolling over to a Roth IRA. But, is this allowed?

You can rollover your 401(k) into a Roth IRA if you want to enjoy the benefits of a Roth IRA. Rolling over from 401(k) to Roth IRA is a taxable event, and you will be required to pay taxes on the contributions, employer’s match, and all investment earnings generated from the account. However, you won’t pay income taxes when you withdraw money from the Roth IRA in retirement.

How to Rollover 401(k) to IRA (Steps)

Generally, you must be separated from your employer to rollover a 401(k) to a Roth IRA. In some cases, you may be permitted to rollover when you are still employed as long as the employer supports in-service rollover.

Here are the steps involved when rolling over 401(k) to IRA:

Open a Roth IRA account

Start by opening a Roth IRA account through brokerage or Robo-advisor.

If you want to manage your investments, you can open a Roth IRA with a broker so that you can buy and sell investments on your own. An alternative is to open a Roth IRA with a Robo-advisor if you want a managed retirement service.

Ask for a direct rollover

Contact the 401(k) plan administrator and explain that you want to rollover directly to the new account provider, and get the appropriate forms. The new account provider should provide instructions of where the check or wire transfer should be made, where it will be sent, and the information to include. Once you provide this information, the plan administrator will send the funds directly to the Roth IRA.

If you do an indirect rollover, where the plan administrator sends the check to you, you must deposit the funds to the account provider's account within 60 days. However, the plan administrator may withhold 20% of the distribution for taxes. You must get back the money and make a full deposit, including the amount withheld by the plan administrator. 

Choose investments

Once the funds have been deposited into the Roth IRA, you should pick your preferred investments. The most common options include low-cost index mutual funds, ETFs, or target-date funds. If you open a Roth IRA with a Robo-advisor, the company will select investment options automatically based on your answers to its questionnaire.

Paying Taxes on your contributions

A Roth IRA is funded with post-tax dollars, and any funds added to a Roth IRA are taxed upfront. However, a 401(k) account is funded with pre-tax dollars, and this means you do not pay taxes on funds added to the account. Hence, when you rollover from 401(k) to Roth IRA, you will need to pay tax on the amount rolled over.  

The amount you rollover to a Roth IRA will be added to the taxable income for the year in which you roll over. If you are rolling over a large balance, you will pay a higher tax amount. This may happen if the rollover occurs in a year of high income, or the amount rolled over pushes you to a higher tax bracket.

When it makes sense to rollover 401(k) into Roth IRA

If you are considering rolling over 401(k) into a Roth IRA, there are several situations when it makes sense to do so. Here are several reasons why a Roth IRA is your best bet:

Expect higher taxes in future

Since you pay income taxes on the funds you contribute to a Roth IRA, you won't pay taxes on the distributions. If you expect your income to increase in the future, it means you will be in a higher tax bracket in retirement. You can decide to pay taxes now so that future withdrawals will be tax-free.

You want to avoid RMD distributions

If you have a 401(k) and you are retired, you must start taking the required minimum distributions (RMDs) when you reach age 70 ½. However, a Roth IRA does not require account holders to take RMDs, and you can delay taking distributions even after age 70 ½. 

Tax diversification

If you already have a traditional IRA, you can rollover the 401(k) money to a Roth IRA to diversify your taxes. A traditional IRA is a tax-deferred account, and you won’t pay taxes on your contributions. In comparison, Roth IRA contributions are taxed upfront, but you won’t pay taxes when you take a distribution in retirement. By having both traditional and Roth IRA, you diversify your future taxes.