Three Items You Should Know About Roth Rollover Rules for Moving Your 401k
Roth accounts offer a few different advantages over their classic counterparts (i.e. the traditional 401k plan or traditional IRA), so it's a good idea to at times reevaluate whether or not they should have an area in your retirement plan design. Nonetheless, the process of converting funds in a traditional 401k account to a Roth Individual Retirement Arrangement through a rollover Roth 401k rollover isn't befitting for everyone. The following are 3 Roth rollover rules you need to know before you make your decision. These are the most important Roth rollover rules for the upcoming year.
Roth Rollover Rule #1
Any funds converted to a new Roth account via a Roth 401k rollover will incur tax.
The most important difference between traditional retirement balances and Roth savings plans is the fact that contributions to traditional accounts are with pre-tax dollars, while Roth plans are made up of post-tax funds. Although each type of retirement savings account has its benefits and drawbacks, you aren't simply able to transfer funds from one type of plan to another because of the different way that traditional plans and Roth plans are funded and taxed.
Whenever you initiate a 401k rollover to a Roth IRA, you will be required to claim the quantity of funds converted as taxable income on your annual tax return. In this manner, the IRS makes sure that the pre-tax contributions you have made to your 401k get taxed.. Therefore, it's worth determining beforehand whether or not a rollover to Roth IRA will bump you right into a higher tax bracket and additionally, if the conversion makes sense. Get the help of a tax accountant if you need assistance comparing your current and future estimated tax brackets.
Roth Rollover Rule #2 - Don't Convert Shares of employer stock to a Roth IRA
The above Roth rollover rule is likely to be accurate most of the time but not always. It applies when there is significant appreciation in the employer shares since purchased.
When that appreciation exists, shares of employer investment are almost always best handled while using the 'Net Unrealized Appreciation' rules (NUA rules). Use of the NUA rules has you pay tax presenlty on the original cost of the shares, which could be quite reduced if purchased years ago. And then, when you sell the shares at some future time, you pay the preferable capital gains tax rate. So although there is no Roth rollover rule that you cannot move shares of employer stock from a 401k into a Roth IRA, you can see how it's often tax disadvantageous to do so.
Roth Rollover Rule #3 - A Roth rollover does not make sense for everyone.
Because money invested in a Roth account has the ability to grow tax-free over time, younger participants with longer many years of savings ahead will benefit most from a 401k to Roth IRA conversion. If you are approaching retirement age, you may find that the constraints outweigh the advantages of performing a rollover, particularly if you need to use that cash within 5 years (see various other articles on this site about the Roth rollover rules regarding holding times).
Similarly, if you anticipate finding myself in a lower tax bracket upon retirement, performing a rollover is not beneficial. If this is the case, you'll ultimately wind up paying out more in taxes in the end. Again, consult a tax accountant.
Roth rollover rules are very important to know as taking advantage of them can put a lot of money in your pocket.
Lose a Fortune on Your 401k Rollover
If you do not do any of these correctly:
- Opt for a distribution rather than direct transfer
- Rollover company stock to an IRA
- Choose to rollover to a Roth IRA
- Rollover to your new employer’s 401k
- Rollover post-tax contributions
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