Many people want to know whether or not they should keep their 401(k) or convert it into a Roth when they change jobs, and for good reason.
Choosing to keep your money in a 401(k) or convert to a Roth can make or lose you a lot of money in the future.
Before I get into your options, here is an explanation of the basics:
A 401(k) in-plan Roth conversion (also called an “in-plan Roth rollover”) transfers the non-Roth portion of your 401(k) account into a designated Roth account within the same plan.
The amount you convert is subject to federal income tax in the year of the conversion (except for any nontaxable basis you have in the amount transferred), but qualified distributions from the Roth account in the future are entirely income tax-free.
The 10% early distribution penalty doesn’t apply to amounts you convert (but that tax may be reclaimed by the IRS if you take a nonqualified distribution from your Roth account within five years of the conversion).
Here are some points to keep in mind about 401(k) in-plan Roth conversions.
What Part of Your Account Can You Convert?
Assuming your 401(k) allows in-plan conversions (they aren’t required to), you can convert any vested part of your 401(k) plan account into a designated Roth account regardless of whether you’re otherwise eligible for a plan distribution.
Keep in mind that if you’re entitled to an eligible rollover distribution, you can always roll those dollars into a Roth IRA instead of using an in-plan conversion.
So, the first thing to check is whether or not your plan allows it. If they do, then the good news is that you can convert as much of it as you want. But then the question arises, how much should you contribute? And how should you go about it?
What to Keep in Mind
If you have the choice of an in-plan conversion or a rollover to a Roth IRA, which should you choose? Here are some facts to consider:
- In general, the investments available in an employer 401(k) plan may be fairly limited.
- Virtually any type of investment is available in an IRA, but your 401(k) plan may offer investments that you can’t replicate in an IRA, or not at a similar cost. If you like what your 401(k) offers and don’t want to manage your own money that closely, make sure that the IRA you’re looking at has similar offerings.
- An IRA may give you more flexibility with distributions. Your distribution options in a 401(k) plan depend on the terms of that particular plan, and your options may be limited.
- Finally, 401(k) plans typically enjoy more protection from creditors under federal law than IRAs. Consult a professional before you convert if creditor protection is important to you.
Always be sure to ask about possible surrender charges that may be imposed by your employer plan or new surrender charges that your IRA may impose.
Compare investment fees and expenses charged by your IRA (and investment funds) with those charged by your employer plan (if any).
Read and understand any accumulated rights or guarantees that you may be giving up by transferring funds out of your employer plan.
Deciding whether or not an in-plan Roth conversion makes sense depends on your specific situation, including your current and anticipated future tax rates, the availability of funds with which to pay the current tax bill, and when you plan to begin receiving distributions.
You will also want to consider that the additional income from a conversion may impact tax credits, deductions, phaseouts, marginal tax rates, alternative minimum tax liability, and eligibility for college financial aid.
Given how complex it is, it can help to have someone knowledgeable to advise you on the best path forward.
As experienced financial professionals, we help clients like you figure out the best retirement plan for their situation, so that when they’re ready, they can retire gracefully with peace of mind.
Please connect with us and let us help you plan for your dream retirement. We would be delighted to go on the journey with you.