401k Rollover to IRA: Roth or Traditional
If you leave your employer, rolling your 401k into an IRA allows you to continue investing and control your retirement funds. Choosing the type of IRA, either a traditional or a Roth, can be difficult because they both offer different features. The biggest difference between the two types of IRA is the tax treatment, but there are also a few other factors to consider.
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Function
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The traditional IRA allows you to keep the same tax status you had with your 401k. The contributions that you make are tax-deductible and the gains from investing are not taxed. With the Roth IRA, you contribute money on an after-tax basis. The gains from investing are never taxed and when you start withdrawing money during your retirement years, you will not have to pay any taxes. Deciding between a Roth and a traditional IRA, you can choose whether you want to pay your taxes now or later.
Conversion
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When you are trying to decide what type of account you want, the conversion process should also play a role in your decision. If you convert to a traditional IRA, the 401k money can be directly rolled over to your new IRA without any issues. If you convert to a Roth IRA, the money that is converted will count as income for you. You will then have to pay taxes on the money at the marginal tax rate.
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Income Limits
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Income limits are another factor that can play a role in your decision. With a traditional IRA, there are no income limits that you need to be concerned with. You can always make the maximum contribution to this type of account. With Roth IRAs, there are income limits that could play a role in your decision. If you earn more than the limit, you cannot contribute to your Roth IRA. For example, as of 2010, if you are single, you can only make a full contribution to a Roth IRA if you earn less than $105,000 per year.
Time Frame
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Another factor that could play a role in your decision is the time frame. When you convert to a traditional IRA, you can start taking distributions from the account as soon as you turn 59 1/2. With a Roth IRA, this is also usually the case, except there is also a five-year rule that must be met. You have to wait five years after contributing to a Roth IRA for the first time to access your money. This means that if you open your Roth IRA when you are 58, you will have to wait until you turn 63 to access the money.
Considerations
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When trying to decide between a Roth IRA and a traditional IRA, you need to look at all of the factors involved, including tax status and contribution limits. The biggest factor is the way that you want to handle the taxes. With a Roth IRA, you can protect yourself from uncertainty since no one knows what the tax rates will be in the future. If you prefer to avoid the taxes now because you are in a high tax bracket, the traditional IRA might make more sense.
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References
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