How To Change a 401k to a Roth
The Internal Revenue Service imposes a variety of income limits on individuals wishing to invest in Roth Individual Retirement Accounts. People whose adjusted gross income exceeds these limits can create Roth IRAs by rolling over funds already invested in 401k accounts held with former employers. Company sponsored 401k plans contain pretax earnings, whereas Roth IRAs contain after tax earnings. Both accounts grow tax deferred, but funds from Roth accounts are not subject to income tax if held until age 59 1/2. Funds held in 401k accounts are subject to income tax when withdrawn regardless of the account owners age. This tax difference inspires many people to convert 401k accounts to Roth IRAs.
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Instructions
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Open a Roth IRA at your local bank or brokerage firm. You do not have to fund the account immediately. Sign paperwork allowing your bank or brokerage company to act as your Roth IRA custodian. If you are close to retirement age, or have a conservative investment outlook, you should set up a bank IRA because you can enjoy the benefit of protection from the Federal Deposit Insurance Corporation. If you are more aggressive or have a long investment time horizon, you should consider opening a brokerage account because you can buy mutual funds, stocks and bonds with the 401k proceeds.
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Contact the benefits department at your former employer. Ask for the representative or department that deals with 401k accounts. Tell the 401k representative that you want to rollover your 401k balances into a Roth IRA. Provide the representative with the name and address of the custodian bank or broker as well as your name, social security number and Roth IRA account number. The representative must provide you with a current account balance. The account value may change because 401k accounts contain investments with variable prices. Write down the estimated rollover amount and ask how long the transfer should take.
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Go to the bank or broker that holds your new Roth IRA account. The rollover process normally takes up to 45 days. Choose a certificate of deposit, mutual fund or assortment of investments to buy with your Roth IRA funds. Find out from your custodian how much the rollover was. The 401k custodian and the new Roth IRA custodian should each provide you with a written transfer confirmation.
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Contact a certified tax professional. Provide the tax professional with the rollover confirmation. Your tax adviser will calculate how much tax you must pay to the IRS for transferring the funds from the 401k to the Roth IRA. You must pay ordinary income tax on the principal and earnings but a tax professional can look at your overall financial situation and factor the taxes in with your other tax liabilities.
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Tips & Warnings
The IRS allows people who convert 401k or Traditional IRA accounts into Roth IRAs to pay taxes due over the course of 2010, 2011 and 2012. In some instances the IRS allows people to make in-service withdrawals for Roth IRA conversion purposes. These withdrawals are restricted by both the IRS and 401k custodians. Check with your plan administrator and tax professional to see if you qualify.
When you set up a Roth IRA, you may have to pay fees including mutual fund load fees, stock and bond purchase fees and IRA custodial fees. Consider the overall impact of fees and the tax consequences before rolling over your money.
