Note: This article is about rolling a 401(k) account into a Roth IRA. For information about rolling your 401(k) into a traditional IRA, see this article.
Previously (prior to 2008) to rollover your 401(k) into a Roth IRA you had to use the following process:
- Open a traditional IRA
- Rollover your 401(k) to the traditional IRA
- Open a Roth IRA
- Convert the amount in the traditional IRA to the Roth IRA.
Now, however, the process has been simplified. After you’ve left your job, you can directly roll your 401(k), 403(b), or 457 account into a Roth IRA.
The Rollover Process
Step 1: Open a Roth IRA (if you don’t have one open already).
Step 2: Request rollover paperwork from your 401(k) administrator. Fill it out, indicating that you want to roll your account into your Roth IRA. (If your plan administrator does not provide this option, you’ll have to follow the old process of rolling it into a traditional IRA, then converting it to a Roth.)
Step 3: Include the amount of the rollover in your gross income on Form 1040 (lines 16a and 16b) for the year in which the rollover occurred. (Note: If your rollover occurs in 2010, you have the option of deferring the tax on the rollover–paying half of it in 2011, and half of it in 2012.)
Am I Eligible to Roll My 401(k) into a Roth IRA?
For tax years prior to 2010, you could only roll your 401(k) into a Roth IRA if your Adjusted Gross Income was below a certain limit ($100,000 for 2009). Beginning in 2010, however, the income limit disappears.
Should I Rollover My 401(k) to a Roth IRA?
After you leave your job, rolling your 401(k) into an IRA is almost always a good idea. Whether you should roll it into a Roth IRA is more debatable. The decision is basically the same as deciding whether you should convert your traditional IRA to a Roth IRA. Specifically, if you:
- Expect to be in a lower tax bracket in retirement than you’re in now, or
- You don’t have the cash on hand to pay the tax on the amount of the rollover,
…then it’s probably better to roll it into a traditional IRA rather than a Roth IRA.
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{ 5 comments… read them below or add one }
Hi Mike – It doesn’t seem to make sense to me for anybody to roll over to a ROTH. Do most people believe when they are old and grey they will be making MORE money then, than in their prime earning years of 30-50 years old? I thought we Americans have a savings/investing problem?
Also, question on 401K. Is there a guide as to how much is the MINIMUM one needs to take out starting at age 60? For example, let’s say I’m 60 and have $1 million in my 401K. B/c I want to pay minimal taxes, I want to take out the least amount. Is it based on an actuarial age where they say the normal person lives til 80, so 1 mil divided by 20 =$50,000 a year or something?
thnx!
Financial Samurai:
First, I’d agree that Roth IRAs are generally overrated. Many people invest in them (or convert to them) who probably should go for tax-deferred rather than tax-free. They just don’t understand the math.
That said, there are many times in which it does make sense:
For example, in my own situation, I fully expect to be earning more in my 60s than I am now. Health permitting, I intend to continue running a business.
Second example: Many people believe that while their taxable income may not go up, their tax rate may go up anyway due to legislative changes.
Third example: Some people already have so much invested in tax-deferred accounts (401k or traditional IRA) that their taxable income in retirement is likely to be significant, and it may make sense at this point to tax diversify.
Regarding required minimum distributions in 401k plans, this article from IRS.gov explains it pretty clearly.
Hi Mike,
I still don’t think a ROTH is good. I can just retire in Nevada, Washington, or any of the other 5 states to save on state income tax of 10% (CA) when I retire.
Let’s say I earn $500,000 a year now, and retire at 60. I highly doubt I will have $10,000,000 in liquid assets to earn 5% interest off of to replicate the $500,000/yr income I make now.
Most people are lucky to have 10X their salary in capital ($500K X 10 = $5mil) let alone 20X as required in this case.
Hence, I think people are fooling themslves if they think they’ll have much more money in their 60’s. The government is smart, and is proposing this conversion to take people’s tax dollars now. Smart gov’t.
Hmmm, I may have to write a post about this!
Financial Samurai,
I understand your points, and I agree with you and Mike that a Roth is often overrated.
Realize, however, that there are those of us who lurk in the shadows of these blogs, who are not even in the highest tax brackets right now, and we’re putting more than $50k per year (combined) into 401k’s. (Yes, it’s possible with profit sharing 401k arrangements). And we’re still young, in our early 30’s. So I definitely expect to be taxed on alot of income in retirement, and I have a feeling it will be at a higher rate than 35%.
We skim through all the posts on Get Rich Slowly about saving your rubber bands and cutting back on Netflix to save $5 per month because we’re looking for some of the good discussions that show up occasionally (more often here, BTW).
Mike,
I’d love to see you write about tax efficient investing for when the sheltered accounts are already maxed out.
Specifically, what’s your take on Vanguard’s tax efficient stock funds? What are your thoughts on their tax-free muni bond funds? What if you don’t live in one of the designated states, and therefore (I assume) would still have to pay the state income tax on it?
Right now all tax sheltered money goes to Vanguard’s Target Retirement 2050. Free cash after that has been eliminating the mortgage, but we’re getting to the end of that.
Hi Regular Lurker.
I’d be happy to write a post about that for next week. (It’s a broad enough topic that I’d prefer to cover it with a post rather than simply write thoughts off the top of my head.)