Can You Roll a Retirement Fund Into a Roth?
If you're an employee who worked for several employers during your career, you may have one or more 401k plans from previous jobs waiting for you to retire to be tapped. Although you can continue to let those old retirement accounts lay dormant, you can also roll their funds over into a Roth IRA, consolidating your retirement savings and enjoying the advantages of Roth IRAs. If performed correctly, you'll incur no penalties for rolling retirement funds into a Roth.
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Rollover Basics
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Most employers' retirement plans are 401k plans, and when you leave that employer, you're likely to start making contributions into another employer's 401k. Rather than ignoring the original 401k until it matures, you can consolidate retirement funds into Roth IRAs without incurring penalties for prematurely accessing the funds -- if you handle the rollover according to IRS procedure and never directly access the funds yourself. If you handle your rollover incorrectly, you incur a 20 percent penalty on all funds in the rollover.
Trustee-to-Trustee Rollover
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The IRS doesn't want retirement account holders to withdraw their funds and then, weeks after tapping those funds, reinvest the same amount into a Roth to avoid taxes. Because of this, you must arrange for a direct transfer -- also known as a trustee-to-trustee rollover -- that transfers funds directly from your retirement account into your Roth IRA. If you close your 401k and take possession of funds -- even if only long enough to transfer them from your personal account into a Roth -- you'll be liable for the 20 percent penalty on retirement disbursement.
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Taxes on Rollovers
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Although a direct transfer avoids penalties for premature disbursement, you must be prepared to pay taxes on the amount rolled over from the 401k plan. You are liable for taxes on all tax-free contributions you made to the original retirement plan; any contributions above the tax-free contribution limits -- the ones you previously paid taxes on -- may be transferred directly without incurring additional taxes. These transfers are taxed as income at the rate for your tax bracket, and, if large enough, may raise your gross income levels into a higher tax bracket, which may incur a higher tax rate. Because of this, you may have a tax advantage by rolling over small portions of a large account over multiple tax years, rather than rolling over the entire balance immediately.
Advantages of Roth IRAs
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Although you face income taxes on funds transferred into a Roth the year the transfer is made, the transfer isn't without its benefits. Your funds are likely to be in a fund with smaller maintenance fees than those often used by employers for retirement accounts. Qualified distributions (withdrawals) -- those made five years after you opened the Roth and made after you turn 59 1/2 years old -- aren't taxed. If you roll a 401k over into a traditional IRA, you are taxed on the funds when you withdraw them.
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