How to Convert a 401(k) into a Roth IRA

The 401(k) is one of the most popular employee retirement plans offered by employers across the county. 401(k) plans allow pre-tax contributions to be made and the growth in the account grows at a tax-deferred rate. Withdrawals from the plan are taxed at the individual’s income tax rates. A Roth IRA, on the other hand, is the direct opposite, so contributions are made after-tax dollars, the account grows on a tax deferred basis and withdrawals from the account are not taxed (because the money was taxed before it was put into the account). The more optimal tax treatment of Roth IRAs urges many 401(k) plan holders to convert to a Roth IRA.

Contact the 401(k) financial institution. In order to initiate a conversion from a 401(k) plan to a Roth IRA, use the 401(k) statement to identify and contact the financial institution that holds the account.

Roll over your 401(k) to a Traditional IRA. Since funds cannot be directly transferred from a 401(k) plan to a Roth, you first have to convert your 401(k) to a Traditional IRA. Tell the financial institution that you want to convert the funds in your 401(k) account to cash and then transfer the cash into a Traditional IRA.
Convert the traditional IRA to a Roth. After the Traditional IRA account is funded with the cash from your 401(k), contact the financial institution again and request that the Traditional IRA account be converted to a Roth.

Invest in the Roth account. Since the cash from the Traditional IRA is used to fund the Roth account, once the cash is sitting in the Roth account, work with the investment advisor at the financial institution that holds your account to make investment decisions.

Pay taxes. When you convert the Traditional IRA into a Roth, this act generates a tax liability for the current tax year. You have to pay the taxes on this amount with your own cash – not cash from the retirement account.

Tips

Before you convert a 401(k) or a Traditional IRA to a Roth, speak with your tax advisor to make sure this is a financially sounds decision for your personal financial situation. The tax advisor can also help you calculate the amount of tax liability you will incur when you transition to the account. It’s important that you can afford to pay the taxes out of your own pocket because you are not allowed to use cash from the retirement account to pay for the tax liability.