Can I Rollover My 401K Directly Into a Roth IRA?
401k plans are employer-sponsored retirement plans. These plans allow you to contribute money to your retirement on a pre-tax basis. The money can be invested into mutual funds, but when you retire, you may roll this money over into an IRA. One type of IRA to choose from is a Roth IRA.
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Identification
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A Roth IRA is a special type of IRA. This IRA plan only allows you to make cash contributions on an after-tax basis. You must pay ordinary income tax on whatever contributions you make to the plan. Contributions are limited to $5,000 per year if you are under age 50 and $6,000 if you are 50 or older. These contribution limits do not apply when rolling over a 401k to a Roth IRA.
Process
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You must get a transfer request form from your new Roth IRA custodian. A transfer request form allows you to liquidate your 401k and move the funds to the Roth IRA. Once you submit the transfer form to the 401k plan administrator, the administrator will send you the balance of your 401k account. The plan administrator will withhold 20 percent of your account balance for tax purposes. You must then deposit your funds into your Roth IRA within 60 days. If you do not, the IRS treats the rollover as a distribution. If this happens, you will be assessed a penalty of 10 percent on your distribution if you are under age 59-1/2. Regardless, you will pay income tax on the entire rollover amount since Roth IRAs only accept after-tax contributions.
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Benefit
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The benefit of rolling a 401k plan into a Roth IRA is that you won't have to worry about future tax rates. Since Roth IRAs are tax free during retirement, you won't pay any income taxes when you withdraw money after age 59-1/2.
Disadvantage
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The disadvantage to rolling money over to a Roth IRA is that you must pay taxes on the money you are rolling over. This may dramatically reduce the amount of money you have in your retirement account if you have a substantial 401k balance.
Considerations
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Before you roll your 401k into a Roth, make sure that you are able to recover any losses you've incurred through taxes before you are scheduled to retire. If you are retiring soon and you've lost a substantial amount of money by paying income taxes, you may not be able to afford to retire. You may not have enough savings to draw a sustainable income.
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