How to Convert a 401k to a Roth IRA

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There are several rules you must follow when you convert a 401k to a Roth IRA. The Internal Revenue Service has very strict regulations regarding who can perform a 401k-to-Roth IRA rollover and how it is to be done. It is important to follow all of these regulations so the money in your employer-sponsored 401k plan can be moved to a Roth IRA account without suffering any tax consequences.

  • Determine if you are eligible to convert a 401k to a Roth IRA. The IRS only lets taxpayers who meet certain income requirements do so. A taxpayer's modified adjusted gross income must be $100,000 or less. Your MAGI is the figure on your tax return that is actually subject to tax. It is what is left over after all of the deductions and credits are subtracted from your gross income. If your MAGI is more than $100,000, you cannot perform the rollover during that tax year. It is possible to perform the conversion in a later tax year if your MAGI drops below $100,000. For tax years starting in 2010, the $100,000 modified AGI limit for conversions and rollovers to Roth IRAs is eliminated and married taxpayers filing a separate return can now convert and roll over amounts to a Roth IRA. For any conversions or rollovers in 2010, any amounts that are required to be included in income are included in income in equal amounts in 2011 and 2012. If you elect otherwise, you can choose to include the entire amount in income in 2010.

  • Perform the 401k-to-Roth IRA conversion at an appropriate time. Most taxpayers do it when they stop working for the employer that is hosting their 401k plan. This makes sense if you want to have more control over your retirement investments. However, most 401k plans allow you to keep your money in them indefinitely. Investors always have the option to roll over their 401k to an IRA anytime after leaving a workplace. There is no time limit. This makes sense if the taxpayer is waiting for a tax year when she is eligible for a Roth IRA rollover. The only time it does not make sense to convert 401k money to a Roth IRA is if you are still participating in the 401k plan.

  • Set up a Roth IRA account. If you already have a Roth IRA, you can use that. If you don't, you must establish one. Most major financial institutions sponsor Roth IRA accounts--including banks, stockbrokers and mutual-fund companies. Most investors choose mutual-fund companies like Fidelity, Vanguard or T. Rowe Price, because they have "no-load" funds with low fees and offer a wide range of investment options. Tell the financial institution that you want to convert a 401k to a Roth IRA. It will send you papers to fill out and sign.

  • Contact the holder of your 401k and tell them you want to "roll over" your account to a Roth IRA. Most will make you read a document, then fill out authorization papers. Sign the papers and send them back. Be sure to clearly state where you want the 401k money sent and that you want a "rollover" and not a redemption.

  • Ask the holder of your 401k to send the money directly to the Roth IRA account. This is called a direct rollover option and will save you from having to pay any taxes on the amount being rolled over. Your employer's qualified plan must give you the option to have any part of an eligible rollover distribution paid directly to a Roth IRA. Generally, no tax is withheld from any part of the designated distribution that is directly paid to the trustee of the Roth IRA. However, many financial institutions will send you a check directly. Make sure this check is made out to the Roth IRA account and not you. If it is made out to you, it will be considered a redemption and you will be forced to pay taxes on the money plus a 10 percent penalty. If the check is made out to the Roth IRA account, all you have to do is forward it to the financial institution holding your Roth IRA. Your 401k-to-Roth IRA conversion is complete.

Tips & Warnings

  • Any amount rolled over is subject to the same rules for converting a traditional IRA into a Roth IRA.
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