Financial Advisor Insights

Should I Convert My Old 401(k) to a Roth IRA?

Updated for 2019. After changing jobs you may find that your 401(k) has stayed with your old employer. As you consider your options, you may consider converting an old 401(k) to a Roth IRA. A Roth IRA offers unique benefits unavailable in other types of retirement accounts. However, a 401(k) to Roth IRA conversion doesn't make sense in every situation. Before deciding on a strategy, review your rollover options. 

Should I Convert a 401(k) to a Roth IRARoth IRA Benefits

The strategy to convert a 401(k) to a Roth IRA is appealing for many investors because of unique Roth IRA benefits. 

  • No RMDs – unlike IRAs and qualified retirement plans, a Roth IRA is unique in that required minimum distributions are not required during the original account owner’s lifetime.
  • Five year rule - five years after the year in which you make a Roth conversion you’re able to withdraw funds for qualifying events without a penalty. Further, withdrawals are considered to be made from after-tax contributions and conversion dollars first; earnings last. Funds that have already been taxed won't be subject to double-taxation. 
  • Tax-efficient legacy gifts – a Roth IRA is an advantageous way to leave assets to beneficiaries, as the account will pass onto an heir income tax-free, assuming a five-year holding period has been met by the decedent. (Note: Roth IRAs may still be subject to estate tax).
  • Diversification – for investors facing higher income tax brackets in retirement due to the impact of RMDs on tax-deferred assets, a Roth can provide needed tax diversification and flexibility.
  • Tax-free earnings – assuming age and holding period requirements are met, withdrawals will be tax-free.

401(k) Rollover to Roth IRA

A Roth IRA can offer many unique benefits, but a complete analysis should be done prior to the Roth conversion. Some of the key retirement planning considerations are:

  • Do I expect my tax bracket to be higher in retirement than it is now?
  • Do I have non-retirement funds available to pay the tax due upon conversion?
  • Does a Roth IRA conversion fit into my overall retirement planning and wealth strategy?  

If you anticipate your tax bracket being higher in retirement due to required minimum distributions or other sources of income, then it may make sense to pay income tax now while you are in a lower tax bracket. A main reason an individual will decide not to initiate a Roth IRA rollover is cash flow: it typically does not make sense to convert to a Roth if you need to use retirement funds to pay the tax due.

Finally, consider whether a Roth fits into your overall retirement planning strategy. An isolated conversion of relatively small dollar value may not make a material impact on your overall wealth. A financial plan can help you weigh whether maintaining tax-deferred growth is a better strategy to maximize your wealth. 

Other 401(k) Rollover Options

401(k) rollover to IRA

The most common option is a 401(k) to IRA rollover. Like a Roth IRA conversion, the rollover to a traditional IRA will allow greater access to investment options compared to an employer-sponsored 401(k) plan and the flexibility to align the account with your overall investment management strategy. You will continue to defer taxes on the account like you were with the 401(k). 

Keep assets in your old 401(k) plan

Deciding what to do with an old 401(k) can be stressful, so it's alright to keep your old account while you weigh your options - or even indefinitely. Many plans allow former employees to keep their 401(k)s after they have left the company. Most investors don't typically choose to keep assets in an old 401(k) on purpose, however; it often happens when investors don't understand their rollover options. Before deciding to keep your 401(k) where it is - make sure you are happy with the investment options and plan fees.

Move assets to your new employer's 401(k) planRetirement Planning Advice and Strategies

If your new employer allows it, you may be able to rollover funds from your old plan into your new one. It can be easier to manage your investments when they are all in one place, which makes this an attractive option for some. However, it may not be the best choice for diversification, as you will still be limited in your investment options and subject to plan fees.

There is no one-size-fits-all approach to retirement planning or investing, which is important to keep in mind as Roth conversion strategies gain popularity. Roth conversions may play a large part in maximizing future wealth for some individuals, but in other situations it may carry significant tax implications in the present. Consider your next steps carefully and find a strategy that is consistent with your retirement planning goals and wealth management objectives. 

Also read: Everything you wanted to know (and some things you didn't) about your 401(k) plan

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