The best time to rollover a 401(K) into a Roth IRA

In order to understand when to rollover a 401(k) into a Roth Individual Retirement Arrangement (IRA) it may be ideal to introduce both concepts. To begin with they are both a type of retirement preparedness strategy. As the standards of living increase, life expectancy also increases. Therefore, it goes without saying that it is has become financially prudent prepare for retirement. According to the Gallup poll the average retirement age is early 60s.

A 401 (k) is defined as a qualified plan in which an employee can elect to make a portion of his earned wages contributed into the plan account. What makes them attractive is that they are contributed pre-tax and most employers match their employees’ contribution dollar for dollar up to in some cases up to five percent which in essence translates to “free-money.” This type of retirement plan is open to any employee of a sponsoring employer and there’s no income restriction.

The contribution limits for year 2013-14 are $17,500 if below 50 years of age and $23,000 if older. The choice of investment options are subject to employers’ discretion therefore the employee has no input as to fund selection. Companies will allow their employees access to their invested amounts over time on a percentage basis and full access after a number of years. Employees are also given the option of borrowing against their plans as well. While the withdrawals are taxed since the contributions going in weren’t taxed no penalties apply if the participant is older than 59 ½ years. As soon as the employee’s reach age 70½, they need to take mandatory withdrawals what is referred to as required minimum distribution.

The Roth IRA is a more recent type of retirement plan introduced through a 1997 legislation act sponsored by Senator William Roth of Delaware. For this type of plan the contributions made are after-tax. These can be opened by anyone at any time and the fund investments are at the participant’s discretion. The withdrawals are tax free and penalty free so long as they are made after one is above 59½ years of age. Since they are not tax deductible there are fewer restrictions and incur less tax liability. However there are restrictions on the income limits with an upper limit of $110,000 and partial contributions are allowed for income above $110,000 but below $125,000 if single. If married the income restriction has an upper limit of $173,000 and partial contributions are allowed for income between $173,000 but less than $183,000. For this current year i.e. 2013-14 the maximum contribution that can be made is $5,000 if contributor is less than 50 years of age. A catch up contribution is allowed for those older than 50 years which means a limit of $6,500. Once the funds have been deposited they are fully vested which means they are available. Since there is no Required Minimum Distributions (RMD) it means the account can be held for as long as the participant lives. 

With that introduction, take a look at scenarios as to why someone may choose to roll over 401(k) into a Roth IRA. Most people are more likely to embark with a 401(k) retirement plan since a job with benefits is regarded to be most future retiree’s gateway into retirement funding strategy. In this regard, most will later on come to know of the various retirement options as they progress through their professional life. Therefore when changing jobs, rather than incurring penalties and tax liabilities they can roll their funds into a Roth IRA. This not only ensures a secure place, but also allows funds to grow over time.

Since the 401(k) plans are employer based, participants may elect to have a say as to where they would like to direct their funds. While 401(k) plans are restricted to employer selection, Roth IRA funds are available and may serve to cover a multitude of risks for example aggressive portfolios in which younger participants may favor or less aggressive portfolios. Aggressive portfolios are ones that are classified high risk high returns while less aggressive ones are the opposite. If the requirements alluded above for Roth IRA is met, withdrawals are not subject to taxes or penalties.

As many people retire, most will perhaps be looking at place where they can move their money especially huge lump sums. While the 401(k) s can be held long after the participant has retired, once the individual attains age 70½ they are required to take the required minimum distributions, which are minimum amounts that a participant must withdraw with a view to depleting funds based on life expectancy. In this particular case, they can choose to invest some, if not all, of their distributions thereby extending their retirement plan. This may be a better option of retirement strategy available as Americans are on average living up to 20 years longer after they retire at age 60.

With those advantages, it would appear that maintaining both would be a great idea. If you are switching jobs, it would be great to sign up in the up for Roth IRA as a temporary point to hold your funds. Thereafter if offered another career opportunity you can sign up for 401(k) if available and take advantage of the matching contributions. In the meantime you if you are able to contribute to your existing Roth IRA and upon reaching the contribution limits you can go back to contributing to the plan by increasing your salary or wage contribution. If retiring you may channel the “excess” (RMD) into your Roth account which is a financially prudent way to invest the extra amount that is not needed.