Converting from a 401k to a Roth IRA

401(k), IRA
on July 12, 2012

Throughout the twentieth century, most Americans had to depend on a defined-benefit pension plan provided by their employer to provide their income for them during their retirement. Today, however, it is very rare to work for an employer with a pension plan. In fact, most American employees have a 401(k) account that they contribute to on their own, in conjunction with their employer.

A 401(k) account is usually set up to allow both an employer and its employee to contribute money to the account. In most of these accounts, an employee is allowed to choose from a variety of common investment options. A Roth IRA, on the other hand, is an account that is owned by one person, who is solely responsible for all contributions. There are several advantages to rolling over or converting a 401(k) into a Roth IRA.

For example, one of the biggest complaints many people have about their 401(k) account is the lack of investment choices. When they first set up their plans, the majority of companies choose a single bank or brokerage to administer its 401(k) plans. Of course, individual employees are hardly ever consulted about this choice. In many cases, the brokerage firm that is chosen gives the company’s employees a choice between only a handful of funds to invest all of their retirement portfolio in.

This limited choice of funds may not be right for every employee. Furthermore, these funds usually consist of common investments such as stocks and bonds, usually meant for beginning investors. If an employee wants to invest in commodities or even a different type of stock fund from the ones he or she has been offered, they are out of luck. Furthermore, employees have virtually no say in the amount they pay in brokerage fees for their 401(k) account. Unfortunately, several studies on these fees have shown that the fees in some 401(k) plans are a lot higher than what an individual investors would typically pay by investing by his or her self.

Additionally, rolling over a 401(k) account into a Roth IRA can potentially have several tax advantages. Under the current tax code, all money (up to a limit based on company rank and investor age) that is invested in a 401(k) account is not subject to federal income tax. On the other hand, money that is withdrawn from a Roth IRA is not subject to federal income tax. If a person believes that he or she will most likely pay more in federal income tax after he or she retires than that person currently pays now, a conversion or roll over could save them a lot of money.

By converting their 401(k) account into a Roth IRA, an individual investor can avoid high fees and have the chance to invest their money in whatever investment vehicle he or she chooses. Fortunately, this conversion is relatively simple. To do this, start by requesting a form from the company you choose to hold your Roth IRA account. Filling out and submitting this form will start the process of transferring money.

Unfortunately, since the money used to fund the 401(k) was not taxed, the money coming out the account must be taxed before getting deposited into the Roth IRA. Fortunately, there are several different ways to do this and lower or eliminate your tax burden on the money. Since all of these methods are dependent on your exact financial situation, however, it is best to consult an accountant to learn the best way to go about this conversion.

It may take several years to complete convert a 401(k) into a Roth IRA, but many people state that it is worth it. A Roth IRA is easier to manage and is better for many different tax situations than a 401(k).

Found in: 401(k), IRA
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