Roth retirement savings accounts offer a number of different advantages over their traditional counterparts, traditional pre-tax IRAs. Consequently it's a good idea to occasionally reevaluate whether the Roth IRA should have a place in your retirement plan. However, the process of changing funds held in a traditional 401k to a Roth IRA through a Roth IRA rollover isn't right for everyone. The following are three issues about Roth IRA rollovers you must know before making your decision.
Roth IRA Rollovers - Tip #1 - Any funds changed into a Roth account via a rollover Roth 401k conversion will incur tax.
The major difference between traditional retirement accounts and Roth savings strategy is that traditional accounts are generally funded with pre-tax contributions; Roth programs are made up of post-tax funds. Although every sort of retirement savings account have their advantages and disadvantages, the major advantage and attraction of Roth IRA rollovers is converting tax deferred dollars to tax free.
When you initiate Roth IRA rollovers, you will be required to pay tax on the amount of funds converted since those funds, from a traditional IRA or traditional 401k, have never been taxed. Therefore, it's worth deciding ahead of time whether or not a Roth 401k conversion will bump an individual into a higher tax bracket for that year, as this could lead to needless taxation.
Roth IRA Rollovers - Rule #2 - Don't Convert Shares of Company Stock
Shares of employer stock are almost always best dealt with using the 'Net Unrealized Appreciation' rules (NUA rules). The NUA provision has you pay tax today on the original price of the shares, which could be rather low if purchased in years past. Then, when you sell your shares, you pay the attractive and lower capital gains rate. So although there is simply no Roth rollover rule that you are not able to place shares of company stock into a Roth IRA, you can observe how it is often tax disadvantageous to do so.
Roth IRA Rollovers - Rule #3 - Roth IRA rollovers don't make sense for everyone.
Due to the fact funds invested in a Roth accounts are able to grow tax-free over time, more youthful participants with longer time horizons ahead will benefit most from a Roth IRA rollover. If you might be nearing retirement age, you may find how the negatives outweigh the advantages of conducting a Roth IRA rollover, particularly if you require to use those funds within 5 years (observe other articles on this site concerning the Roth IRA rollovers regarding required holding periods).
Similarly, if you anticipate finding yourself in a lower tax bracket upon in the future, it may not make sense to pursue a Roth IRA rollover today and pay higher tax than either by delaying the rollover or, maintaining your retirement funds on a pre-tax account.
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