How a 401k Roth Rollover Impacts Roth IRA Taxes

With life expectancies higher than ever and the cost of skilled medical care on the rise, saving for retirement has become more important than ever. Fewer and fewer of us can count on corporate or government pensions to pay for 100% of our living expenses in retirement, which means the burden is on us to sock away the necessary funds.

However, saving for retirement isn't as simple as it might sound. Should you put your money in a traditional 401k plan? An IRA? A Roth account? The 401k Roth rollover, which deals with the subject of retirement savings, is getting a lot of media attention. Let's study in detail about Roth IRA taxes, what this means, and whether this tax planning tool is the right one for you.

Retirement savings accounts come in two models, i.e. Roth and traditional. Traditional retirement accounts (401k or IRA) are funded with pre-tax contributions and are taxed upon taking out money during your retirement years. Roth IRA accounts are the opposite. They are funded with the post-tax contributions and, therefore, withdrawals need not be taxed. A 401k Roth rollover takes place when a traditional 401k account is changed into a Roth IRA.

There are a number of benefits that are associated with a 401k to Roth IRA rollover.

As the funds in a Roth account are not taxed upon retirement, this type of account is a good choice if you anticipate being in a higher tax bracket upon retirement, or if you believe overall tax rates will increase before you enter retirement. Given the fact that the US has staggering budget deficits and needs to relieve the pressure on the already overburdened Social Security and Medicare programs, it seems a certainty that future tax rates will be higher. This supports the argument to pay tax today and avoid Roth IRA taxes later. For many people, this belief stems from the idea that the US government will have to raise taxes in order.

Additionally, being able to remove funds from a Roth account during the retirement years and have no Roth IRA tax, a retiree will have no adverse impact on:

a. the taxation of their social security benefits
b. deductibility of medical expenses
c. any other tax item that is negatively impacted by an increase inn the retiree's adjusted gross income

From the estate planning facet of it, a 401k Roth rollover makes a lot of sense. It is more convenient to leave the funds in a Roth IRA account to your heirs because the money in this account is already taxed. Alternately, tax has to be paid on the funds present in the traditional 401k accounts as your beneficiaries withdraw them. This can considerably decrease the "net inheritance" you transfer to your loved ones.

But there are certain warnings that come along with the 401k Roth rollover which should be considered before going for any such transaction. The money in the 401k accounts is taxable, therefore you need to settle the tax payments before you decide to move them into post-tax accounts through a 401k Roth rollover. In other words, you need to have cash available to pay the Roth IRA tax on funds you move from the 401k. If you don;t have loose cash, this conversion may not be practical.