Transferring your 401k To A Roth IRA

What Is a Roth 401k?

The arena of employer-sponsored retirement plans has been dominated by 401k plans that are funded by pre-tax contributions, which effectively defers taxes until distributions begin. However, the recently created Roth 401k is funded with after-tax money just like a Roth IRA, allowing retirees to enjoy qualified tax-free distributions once they reach age 59½ and have held their accounts for at least five years.

It might be smart to invest in a Roth 401k if you believe that you will be in a higher tax bracket during retirement. This is always a possibility, especially if you end up with fewer tax deductions during your post-working years. On the other hand, if you expect to be in a lower tax bracket during retirement, then deferring taxes by investing in a traditional 401k may be the answer for you. If you have not been able to contribute to a Roth IRA because of the income restrictions, you will be happy to know that there are no income limits with a Roth 401k.

Employers may match employee contributions to a Roth 401k plan, but any matching contributions must go into a traditional 401k account. Therefore, employers must have both types of plans in place if they want to offer their workers a Roth 401k.

If an employer offers a Roth 401k plan, the employees will usually have the option of contributing to either the regular or the Roth 401k, or even both at the same time. If you do not know which type of account would be better for your financial situation, you might want to split your contributions between the two types of plans. It’s important to note that your combined annual contributions to a 401k plan cannot exceed $15,500 if you are under age 50, or $20,500 if you are 50 or older (in 2008). These amounts are indexed annually for inflation.

Upon separation of service, funds contributed to a Roth 401k plan can be rolled over to another Roth 401k, a Roth 403(b), or a Roth IRA. They cannot be rolled into a standard 401k plan. If you transition from an employer that offers a Roth 401k plan to an employer that does not, your only option would be to roll it over directly to a Roth IRA or to leave your money in your former employer’s plan (if allowed).

The required minimum distribution guidelines of a Roth 401k work like those of traditional 401k plans. You must begin taking distributions after reaching age 70½, either as a lump sum or on a required minimum distribution schedule based on your life expectancy.

If you see the advantages of having tax-free income in retirement, as you would with a Roth IRA, then you might want to consider a Roth 401k. It allows you to save much more for retirement than an IRA, and the tax-free distributions won’t add to your income tax liability. Of course, before taking any specific action, you might want to consult with your tax professional.