How To Roll Over Your 401k Into A Roth IRA

Plans & Programs

Do you plan to change jobs? Are you close to retirement?

If you choose one of the above paths, you need to develop a plan for your 401(k) savings. This is a huge decision, and you need to make it wisely because your future depends on it. One financial choice to consider is rolling over your 401(k) to a Roth IRA.

The process is pretty simple and has a few requirements. Before we move forward, here’s some information to help you understand what we are talking about. The amount moved between accounts will be tax deductible when you make the rollover. 

The amount in a traditional 401(k) account comes from your salary, which is not taxed. Meaning: The amount is directly deducted from your gross income. The money keeps earning a profit in the account without it being taxed. However, the amount will be taxed once you retire and start making withdrawals. 

The amount transferred into a Roth IRA account is taxed. What sets it apart from a traditional 401(k) account is that the profit withdrawal is not taxed. So, when you make the rollover, you owe tax only on your income.

The 5-Year Rule

When it comes to a traditional Roth account, you can only withdraw your income but not earnings, even if you have retired. On the other hand, a Roth IRA has a 5-year rule. 

To withdraw your earnings before retirement, you need to have had the account for five years. This also applies to the amount rolled over from a traditional 401(k) account to a Roth IRA.

Steps to Rolling Over 401(k) Savings into a Roth IRA Account

The rollover process is completed in four simple steps, which are explained below: 

  1. Open a traditional IRA account.
  2. Request your 401(k) plan administrator to rollover your savings into the traditional IRA account.
  3. Fill out the transfer forms.
  4. Convert the traditional IRA account to a Roth IRA account.

Why Opt for a Direct Rollover

It’s important to ensure that when your savings are being transferred from a 401(k) account, they are directly rolled over. Meaning: Your employer should either write a check in your account’s name or transfer the money into the new retirement account. 

An indirect rollover is not recommended because when your plan administrator writes a check to you, they withhold 20% in taxes on the distribution. You will have to deposit the check into your account within 60 days or risk losing the withheld tax.

Here’s an example to help you understand this:

Let’s say you have $250,000 in your 401(k) account. Your previous employer sends you a check for $20,000, withholding $5,000 (20%) in tax. If you are depositing the check in a Roth account, you must save the remaining $5,000 to deposit the complete amount into your IRA account. When the tax year rolls around, the IRS will see your account details and refund the 20% tax after finding out you rolled over the total amount. 

In conclusion, rolling over your saving into a Roth IRA account will allow you to earn profit and withdraw it without being taxed.

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