Can You Rollover a 401(k) into a Roth IRA?

Roth IRA or Traditional IRA: Which Fits Your Tax Plan?

Choosing between a Roth IRA and a Traditional IRA depends on your current and future tax situation. If you prefer to defer taxes and reduce your taxable income now, a Traditional IRA might be a better fit. However, if you expect to be in a higher tax bracket during retirement and want to maximize your savings, rolling over your 401(k) into a Roth IRA allows you to lock in today’s lower tax rate and enjoy the benefits of tax-free growth.

What is a 401(k) to Roth IRA Rollover?

Rolling over a 401(k) into a Roth IRA is simply moving your savings from your work retirement plan into a Roth IRA, which allows your money to grow tax-free. This switch changes when you’ll pay taxes on your savings.

• With a 401(k), you put money in before paying taxes.

• With a Roth IRA, you put in money after paying taxes.

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When you pay taxes really matters because it impacts how much of your money you get to keep. With a Roth IRA, you pay the taxes upfront, so you can enjoy tax-free growth and withdrawals down the line.

Direct vs Indirect Rollovers

There are two ways to rollover your 401(k) into a Roth IRA:

• Indirect Rollover: You receive a check from your 401(k) provider or employer with your retirement savings (minus 20% for federal taxes, and potentially state taxes depending on your state) which you have to deposit into a Roth IRA within a 60 day deadline. If you miss the deadline, the IRS considers the rollover a distribution, and you'll owe taxes on the amount (including the 20% that was withheld), along with possible penalties if you're under 59½.‍
• Direct Rollover: Your 401(k) provider transfers your money directly to your Roth IRA provider. No taxes are withheld during the transfer, but you’ll still owe taxes when you file your return. This method is more common because it avoids the risks of indirect rollovers, such as missing the 60-day deadline or having incorrect taxes withheld, which would require you to make up the difference to avoid penalties.

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Benefits of Converting a 401(k) to a Roth IRA

Moving your 401(k) to a Roth IRA has some big advantages that might make the upfront tax cost worthwhile:

• Tax-Free Growth: Once your money’s in a Roth IRA, investment growth and earnings won’t be taxed.
• Tax-Free Qualified Withdrawals: When you take money out in retirement, you won’t pay any taxes on qualified withdrawals. To be considered qualified, the withdrawal must meet two conditions: you must have had the Roth IRA for at least 5 years (calculated from 1 January in the year you made contributions or rolled over into the Roth IRA), and you must be at least 59½ years old at the time of the withdrawal. 
• No Required Minimum Distributions (RMDs): Unlike 401(k)s, Roth IRAs don’t force you to take money out starting at age 73, giving you more control in retirement.
• More Investment Choices: Most 401(k) plans offer a limited range of investment options, usually selected to match a certain risk level and ease of access to funds. A Roth IRA, on the other hand, gives you more flexibility with your investment choices. However, this means you’ll have more responsibility for managing your investments, which can come with higher risks or greater rewards.
• Better for Passing on Wealth: A Roth IRA allows for tax-free withdrawals for beneficiaries, making it a favorable choice for estate planning. In contrast, beneficiaries of a Traditional IRA or 401(k) may have to pay taxes on the inherited funds, potentially reducing the value of the inheritance. 
• Protection Against Future Tax Rates: If you think taxes might go up in the future, paying them now at today’s rates could save you money later on.

When Can You Rollover a 401(k) to a Roth IRA?

In most cases, you can rollover a 401(k) to a Roth IRA when you leave your job. This includes when you:

• Quit
• Get laid off
• Are fired
• Retire

Some 401(k) plans also allow what’s called an ‘in-service rollover,’ which lets you move your retirement savings while you still work at the company. You can check with your plan administrator to see if this option is available to you.

Some plans even let you do a ‘partial rollover’, which is when you convert just a portion of your 401(k) each year instead of all at once. This helps you spread the tax bill across several years, reducing the chance of going into the next tax bracket.

The 5-Year Rules for Roth IRA Contributions and Rollovers

• The 5-Year Rule for Roth IRA Contributions: To withdraw earnings from a Roth IRA tax-free, you need to wait at least five years from January 1 of the year you made your first contribution to any Roth IRA and be at least 59½ years old.‍
• The 5-Year Rule for Roth IRA Conversions: If you rollover a 401(k) into a Roth IRA, the converted amount has its own 5-year waiting period to avoid a 10% early withdrawal penalty on that specific conversion. This 5-year period starts from January 1 of the year in which the rollover is made, not from the date of the rollover. Each conversion has its own 5-year waiting period. However, if you're 59½ or older, the early withdrawal penalty won’t apply. Still, the 5-year rule remains in effect, meaning you’ll need to wait until the end of the 5-year period to withdraw the converted funds tax-free.

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Tax Implications of Rolling Over Into a Roth IRA

The key thing to consider is the immediate tax bill. Since you’re moving money from a pre-tax account (where you haven’t paid taxes yet) to an after-tax account (where taxes have already been paid), you’ll have to pay income tax on the amount you convert that year.

For example, if you rollover $100,000 from your 401(k) to a Roth IRA, the full $100,000 will be treated as taxable income for the year. This means you may owe both federal and state taxes on the amount you convert, depending on your income and the tax rates in your state.

This can potentially result in a big tax bill, so it’s important to plan ahead. Some people choose to convert their 401(k) in chunks over several years to spread out the tax payments with the goal of staying in a lower tax bracket each year.

Who Should Consider Rolling Their 401(k) to a Roth IRA?

Rolling a 401(k) to a Roth IRA can be a great option for many. It’s worth considering if:

• You Expect Higher Taxes in Retirement: If you expect your state and federal tax rate to be higher in retirement than it is for you today, paying taxes now could save you money later.
• You’re Years Away from Retiring: The longer your money can grow tax-free in a Roth IRA, the more potentially beneficial from a tax perspective rolling over your 401(k) becomes.
• You Want More Flexibility: With tax-free withdrawals and no age limit for when you have to start taking money out, you get more freedom to decide how and when to use your savings.
• You Want to Leave Tax-Free Money to Your Loved Ones: A Roth IRA allows more of your retirement savings to pass on to your family tax-free, unlike a traditional IRA or a 401(k) plan, which could be subject to taxes.

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Who Shouldn't Consider Rolling Their 401(k) to a Roth IRA?

While rolling over a 401(k) to a Roth IRA offers several benefits, it might not be the right move for everyone. Here’s who might want to think twice before making the switch:

• You’re in a High Tax Bracket Now: If you’re currently in a high tax bracket and expect to be in a lower tax bracket in retirement, paying taxes on the full rollover amount now could result in a hefty tax bill. In such cases, a Traditional IRA might be a better fit for the tax benefits you need now.
  
• You Need Access to Your Funds Soon: Roth IRA earnings require a five-year holding period for tax-free withdrawals. If you need quick access to your savings, a Traditional IRA might be more flexible, as you can make qualified withdrawals anytime without penalties. 
• You’re Near Retirement: If you’re close to retirement and don’t have many years left to grow your savings, the immediate tax hit of rolling over a 401(k) to a Roth IRA may outweigh the long-term benefits. This is especially true if you're likely to withdraw from your retirement funds soon after the rollover.
  
• You’re Concerned About Estate Planning: Although Roth IRAs offer tax-free withdrawals for beneficiaries, some may prefer the structure of a 401(k) or Traditional IRA for passing on retirement savings, as Roth IRAs have specific rules that could limit beneficiaries' access.

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If you fall into one of these categories, it might be worth exploring other options, such as rolling over your 401(k) to a Traditional IRA or staying in your current plan.

Simplify Your Retirement Planning with PensionBee

Rolling over retirement accounts the traditional way can involve lots of paperwork, tracking multiple accounts and having to make big choices that could leave you paying more tax than necessary. It can feel overwhelming, especially if you have several 401(k)s from previous jobs to rollover.

At PensionBee, we simplify rolling over your retirement accounts into a new, easy-to-manage IRA (Traditional or Roth) . Combine your savings, manage transfers, and keep saving while staying informed about your progress. 

Every customer gets a personal rollover manager – we call them BeeKeepers – to help guide you through a simple, stress-free process, so you can feel confident about your retirement.

Frequently Ask Questions (FAQs)

Is there a limit to rollover 401k to Roth IRA?

No, there’s no dollar limit on how much you can rollover. However, you’ll have to pay taxes on the amount you convert. It is important to consider whether you can afford the tax bill on a large conversion or whether you need to split up your conversions and the taxes attached to each conversion.

Can I roll my 401k into a Roth IRA without leaving my job?

It depends on your employer’s 401(k) plan rules. Some plans allow ‘in-service rollovers,’ which let you move funds while you’re still employed. To find out if your plan allows it, speak with your plan administrator.

How much tax will I pay if I convert my 401k to a Roth IRA?

The amount of tax you’ll pay depends on your current income tax bracket and the amount you convert. The converted amount (i.e. the amount you rollover from your 401k to a Roth IRA) gets added to your taxable income for the year. For example, if you’re in the 22% federal tax bracket and convert $50,000, you could owe about $11,000 in federal taxes, plus any state taxes.

Can I rollover a pre-tax 401k to a Roth IRA?

Yes, you can rollover a pre-tax 401(k) to a Roth IRA. However, you’ll owe income tax (federal and state) on the amount you convert that year. This happens because you’re moving money from a pre-tax account to an after-tax account. The taxes you pay now are the trade-off for tax-free withdrawals later.