Can You Do A 401k Rollover To A Roth IRA?
A question that many qualified plan holders ask when leaving their job is whether or not they can do a 401k rollover to a Roth IRA. And up until 2008, the answer was much stickier and involved a number of lengthy steps, restrictions, and hurdles. But beginning in 2008 and if certain guidelines are followed, the 401k rollover to Roth IRA is a distinct possibility.
The History of the 401k Rollover to Roth IRA
The biggest hurdle for politicians to overcome in allowing this type of rollover came in the tax functionality of the two accounts. The 401k account is a tax-deferred account in which contribution are made pretax and distributions are taxable upon receipt by the beneficiary. In contrast, the Roth IRA account allows for taxable contributions into the account, but then provides both tax-free growth and distribution.
There is also the matter of required minimum distributions with the qualified plan that the Roth IRA does not share. The IRS (read: politicians) were concerned that if you transferred tax-free dollars into an account that provides tax-free distributions, where will the government get their money?
The answer to this came quite simply. Only some of the dollars could be rolled over from the 401k to the Roth IRA tax-free. Each dollar in the 401k has a portion that is considered taxable and a portion that is considered tax-free. In order to do a 401k rollover to Roth IRA, the taxable portion of the funds must be taxed upon transfer.
Who Should Do The Rollover (and How To Do It)
This tax liability from a 401k rollover has made this type of transfer discouraging to potential investors. However, the tax benefits of the Roth IRA in areas of growth, distribution, and longevity (ability to pass the account to future generations) can create a mighty incentive to rollover to Roth IRA. And as such, more and more financial planners are recommending that if their clients are able to take the initial tax hit, the rollover to a Roth IRA is well worth the trouble.
Similar to a 401k rollover to traditional IRA (see information center), the rollover to a Roth IRA must be completed within 60 days of the distribution out of the account. Rollovers done after this time-frame will be subject to hefty penalties.
Also similar to traditional IRA rollovers, direct rollovers and trustee to trustee transfers of retirement funds are also often possible.
Determining when and if you should do 401k rollover to Roth IRA is an important question, and likely one that you should discuss at length with your financial advisor. The implications, both tax and otherwise need to be considered before making this type of transition. The IRS has a history of being unforgiving with mistakes and misunderstandings.