Can I roll my 401(k) to a Roth IRA? - Case Study

Why Should I Roll My 401(k) to a Roth IRA?

Rob works for a company that offers a 401(k) plan. He has decided to leave his current job, accepting a new job offer with a different employer. He now has some decisions to make regarding his current 401(k) plan. Rob has some options that are available. He can cash it out and take what is in the account, minus taxes, but this is not advised. He asked his advisor the question, "can I roll my 401(k) to a Roth IRA?" The answer is yes, and it is probably the best thing to do. If Rob does decide to go ahead with the rollover, he must already have an existing Roth IRA account. If he does not, he will have to open a new account before proceeding with the rollover process.

Types of Rollovers:

Direct Rollover from 401(k) to Roth IRA

In regards to his 401(k) plan, Rob has two types of rollover options to choose from. The first is a direct rollover. This is usually the best option. With a direct rollover, the funds from Rob's current 401(k) account will simply be sent over to the existing Roth IRA account. The only requirement is that Rob must already have an open Roth IRA account. With this type of rollover, there will be no IRA penalties or taxes involved. It is a simple matter of transferring the funds from one account to the other and the process moves very quickly.

Indirect Rollover from 401(k) to Roth IRA

The other type of rollover Rob can elect is indirect. This can be a bit complicated than the direct rollover. Rob has been trying to find the answer to whether he can roll his 401(k) over to a Roth IRA. Now that he has determined that is possible, some valuable time may have already been wasted, especially if he is opting for the indirect rollover. An indirect rollover occurs when there were distributions made from the 401(k). For example, Rob will receive a check for the amount from his 401(k) account. When he receives this check, he will immediately notice that the amount does not coincide with his recent statement. This is because 20% has been taken out of the amount to pay for taxes. This is where things can get complicated. For Rob to complete a rollover, he must follow all IRA rules. First of all, the rollover must consist of the entire amount that was in your 401(k). For example, if Rob has $100,000 in the account, he will receive a check for $80,000. When he goes to perform the indirect rollover, he will have to find a way to produce that 20% that was taken for taxes. This means that it is his responsibility to add $20,000 to the amount of the check. This may sound like a lot of money, and it is, seeing as he has to come up with it quickly, but as long as Rob follows the rules, he will receive that 20% in his tax returns at the end of the year.

Indirect Rollover: 60 Days to Complete the Transfer of Funds

As if that is not complicated enough, there is more! In addition to the 20% subtraction for taxes, Rob must now abide by a set timeframe in which to complete the rollover. From the date the he receives a check for the distribution from his 401(k), he will have only 60 days to complete the rollover. If Rob does not currently have a Roth IRA, he will have to take the time to open a new account. Upon making the transfer when the account is ready, Rob will have to make sure to include the $20,000 taken for taxes. So, he has 60 days to come up with the money, open a Roth IRA account and complete the transfer.

Requirements for a Roth IRA

Now that Rob has received all of the information he needs to determine that he can roll his 401(k) to a Roth IRA, he now must make sure that all eligibility guidelines for the Roth IRA are met. Of course, if Rob already had an existing account, he does not have to worry about this. However, if he does have to open a new Roth IRA, it is important for him to be aware of the Roth IRA rules. One of the most important factors will be the amount of Rob's income. According to Roth IRA rules, Rob's current adjusted gross income cannot exceed $120,000 per year. If Rob's income exceeds this amount, he will not be able to open a Roth IRA account, in which case, he will have to roll his 401(k) over to a different type of retirement account.

Since Rob is leaving his current job, he must make a decision regarding his 401(k) plan. Rolling over his plan to an IRA retirement account is his best option. A direct rollover is preferred, because it is a faster and simpler process, but it is not always possible. The entire process of rolling over your 401(k) to a Roth IRA, regardless of what type of rollover is conducted, is not overly complicated as long as you abide by IRA rollover chart rules. Rob no longer needs to ask his advisor, "can I roll my 401(k) to a Roth IRA?"

Rocco Beatrice, CPA, MST (Master of Science in Taxation), MBA (Master of Business Administration), BSBA (Management/Accounting), CWPP (Certified Wealth Preservation Planner), CMMB (Certified Mortgage Broker), CAPP (Certified Asset Protection Planner), Managing Director, Estate Street Partners, LLC. Mr. Beatrice is an asset protection, award-winning trust, estate planning and tax expert.

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