There are numerous potential benefits to converting funds from a traditional 401(k) or IRA to a Roth 401(k) or Roth IRA. Of course, taxes on the converted amount must be paid. However, once funds are deposited into a Roth IRA, you are exempt from paying taxes on eligible withdrawals, providing you greater freedom to control your retirement income and reduce after-tax expenses. 1 In addition, Roth IRAs do not have required minimum distributions (RMDs) while the original owner is alive, allowing for continuous tax-deferred growth and making them useful tools for estate planning.
Note: Through 2023, employer-sponsored retirement plans requiring Roth 401(k)s to have RMDs However, beginning with the 2024 tax year, employer plans will no longer require RMDs for the original account owner.
One reason to think about converting to a Roth this year is that the 2017 Tax Cuts and Jobs Act, which sunsets at the end of 2025, will result in higher tax rates in the future. If there are no other changes to the tax code, that could result in some significant adjustments to tax rates. The top bracket could revert to 39. 6% from 3%37, and some of the lower brackets could rise by as much as 4% of the total percentage points.
Intrigued? Here are answers to common Roth conversion questions. Always consult a tax advisor about your specific circumstances.
While the process of converting a 401(k) to a Roth IRA typically occurs before retirement, there are specific scenarios where it can be done after retirement. This guide will delve into the nuances of post-retirement 401(k) to Roth IRA conversions, exploring the eligibility requirements, tax implications, and potential benefits.
Eligibility for Post-Retirement Conversions
The ability to convert a 401(k) to a Roth IRA after retirement depends on several factors, including:
- Plan Provisions: Not all 401(k) plans allow in-service withdrawals or in-plan conversions after retirement. Check your plan’s rules to determine if it permits such conversions.
- Age: You must be at least 59 1/2 years old to avoid the 10% early withdrawal penalty on traditional 401(k) distributions.
- Income: If your modified adjusted gross income (MAGI) exceeds the IRS limits for Roth IRA contributions, you may not be eligible for a conversion.
Tax Implications of Post-Retirement Conversions
Converting a 401(k) to a Roth IRA after retirement triggers tax implications. The amount converted is treated as taxable income in the year of conversion, potentially pushing you into a higher tax bracket. However, future qualified withdrawals from the Roth IRA will be tax-free.
Potential Benefits of Post-Retirement Conversions
Despite the tax implications, post-retirement 401(k) to Roth IRA conversions can offer several potential benefits:
- Tax-Free Withdrawals in Retirement: By paying taxes upfront during the conversion, you can enjoy tax-free withdrawals in retirement, potentially reducing your overall tax burden.
- Estate Planning Advantages: Roth IRAs offer more flexibility for beneficiaries, allowing them to withdraw funds without paying taxes as long as they follow the five-year rule.
- Reduced Required Minimum Distributions (RMDs): Unlike traditional IRAs, Roth IRAs are not subject to RMDs during your lifetime, offering greater control over your retirement funds.
Important Considerations
Before converting a 401(k) to a Roth IRA after retirement, carefully consider the following:
- Tax Impact: Analyze the potential tax implications of the conversion, including the impact on your current tax bracket and future RMDs.
- Investment Time Horizon: Ensure you have a sufficiently long investment horizon to allow the converted funds to grow tax-free within the Roth IRA.
- Professional Guidance: Consult a financial advisor to assess your individual circumstances and determine if a post-retirement 401(k) to Roth IRA conversion is the right strategy for you.
While less common than pre-retirement conversions, converting a 401(k) to a Roth IRA after retirement can be a viable option under certain circumstances. Carefully evaluate the eligibility requirements, tax implications, and potential benefits before making a decision. By understanding these factors and seeking professional guidance, you can make an informed choice that aligns with your retirement goals.
Additional Resources:
- Fidelity Roth Conversion Q&A: https://www.fidelity.com/learning-center/personal-finance/retirement/answers-to-roth-conversion-questions
- Investopedia Must-Know Rules for Converting Your 401(k) to a Roth IRA: https://www.investopedia.com/articles/retirement/08/convert-401k-roth.asp
Keywords: 401(k), Roth IRA, retirement, conversion, tax implications, benefits, eligibility, post-retirement
How can I estimate my tax liability on an IRA conversion?
Recall that regardless of the number of accounts you have, all of your traditional IRAs—aside from inherited traditional IRAs—are treated as a single traditional IRA for tax purposes. Your applicable tax rate and the taxable income from the conversion determine how much tax you will owe.
You must know the kinds of contributions you made to each and every one of your traditional IRAs (not just the ones that are being converted) in order to calculate the potential tax liability on conversions from traditional to Roth IRAs. There are 2 types of contributions.
1. Pre-tax, or deductible contributions. These are the contributions that, for the tax year in which they were made, are subtracted from your taxable income.
2. After-tax, or nondeductible contributions. A contribution is considered nondeductible if you choose not to claim a tax deduction for it. In a traditional IRA, these contributions establish what’s sometimes referred to as “basis.” When converting a Roth IRA, the amount of these contributions is not counted against taxable income.
It is simple to estimate the taxable income from a conversion if you have never contributed nondeductible funds to a traditional IRA. If so, the entire amount you convert will be considered taxable income.
You can think of your balances as falling into just two categories for the purposes of calculating taxes on a conversion: (1) nondeductible contributions, and (2) everything else. This is because earnings are always taxable when converted, regardless of whether they are attributable to deductible or nondeductible contributions.
As per IRS regulations, you are unable to selectively convert only nondeductible contributions while keeping deductible contributions and earnings in the account to evade taxes. Rather, you will need to determine what percentage of your total traditional IRA balance is made up of nondeductible contributions. Then, you can use that percentage to determine the amount of your conversion that will be free from taxes. Note that inherited IRAs are excluded in this calculation.
This hypothetical example is for illustrative purposes only. It demonstrates how to determine the amount of taxable income from an IRA conversion.
Keep state taxes in mind too. A Roth IRA conversion is a taxable event. In the event that your state levies income taxes, both your state and the federal government will typically consider the conversion to be taxable income.
Advice: To lessen the possible tax impact of conversion, you might think about converting your spouse’s IRAs before your own if you have IRAs with primarily deductible contributions and your spouse has IRAs with mostly nondeductible contributions. Regarding the computation above, the IRS considers both your spouse’s and your own IRAs separately.
Can I convert to a Roth IRA even if I earn too much to contribute?
Yes, there are no income limits on conversion. Additionally, if you do not already have a traditional IRA and you and/or your spouse have high income levels that prevent you from directly contributing to a Roth IRA, you might want to think about opening a traditional IRA, making a nondeductible contribution, and then converting it to a Roth IRA. This strategy is sometimes called a back-door Roth contribution.
Read Viewpoints on Fidelity. com: Do you earn too much for a Roth IRA?.
Can I Convert My Whole 401(k) to Roth IRA? | YMYW Podcast
FAQ
Is there a penalty for converting 401k to Roth?
How much tax will I pay if I convert my 401k to Roth IRA?
What are the disadvantages of rolling over a 401k to a Roth IRA?
Can you move money from 401k to Roth IRA without paying taxes?
Can a 401(k) be converted to a Roth IRA?
If you have a traditional IRA or old 401 (k), you have the option to turn it into a Roth IRA. We can help. What’s a Roth IRA conversion?
Can I convert a traditional IRA to a Roth IRA?
Yes, there are no income limits on conversion. Also, if you and/or your spouse have high income levels and are not eligible to contribute directly to a Roth IRA, and you do not already have a traditional IRA, you may want to consider opening a traditional IRA and making a nondeductible contribution, then converting it to a Roth IRA.
Will a 401(k) roll over to a Roth IRA?
So, when you roll over a traditional 401 (k) to a Roth IRA, you’ll owe income taxes on that money in the year when you make the switch. The total amount transferred will be taxed at your ordinary income rate, just like your salary. Tax brackets range from 10% to 37% for 2023, and 12% to 35% for 2024.
Is a Roth 401(k) better than a traditional 401 (k)?
A Roth 401 (k) offers a better deal and should be used first; earnings are tax-free rather than tax-deferred, and you can roll the money into a Roth IRA, tax-free, when you retire. But it comes with lower contribution limits than after-tax contributions to a traditional 401 (k).