How to Roll a 401(k) to a Roth IRA

Roth IRA plans give you benefits your pre-tax 401k can’t provide. Roth IRAs grow tax free for retirement, aren’t subject to required minimum distributions, and unused funds pass on to beneficiaries tax free. Although rolling over your Roth IRA to a 401k plan isn’t difficult, you’re going to need to pay tax on the rollover amount from a separate fund. It’s best to know a few basics before trying to roll over your 401k plan to a Roth IRA.

Calculate the tax you’ll owe. You’re going to pay tax on the amount you roll over as if you earned it today, without penalties. To compute your tax, subtract nondeductible 401k contributions from your current 401k value. Multiply this figure by your federal tax rate and state tax rate. Add these two tax amounts together to find the total amount you’re going to pay in taxes on your conversion.

Segregate the funds you’ll use to pay the tax. Because funds have to come from outside of the 401k plan to avoid taxes and penalties if you’re under age 59 ½, identify which funds you’ll use at tax time to pay for your conversion. For best results, put your money to pay the tax in a separate account so that you don’t accidentally spend this money for other goals.

Open a Roth IRA account. If you enjoy making financial decisions alone, explore online brokerage firms to save money on trading fees. If the idea of researching and managing investments isn’t appealing, look toward full-service brokerage firms. Although you’ll pay higher fees, the firm will help with investment decisions, research, and purchase orders. Before hiring a broker or advisor check out their experience and any complaints on the Financial Industry Regulatory Authority’s BrokerCheck website.

Fill out the rollover forms to move your funds to the new account. If you use a full-service broker, they’ll probably navigate this step for you, showing you which forms to use and where to sign the form. For online brokerages, use the site’s asset transfer and rollover section to find the appropriate forms to rollover your 401k plan. It may be helpful to call the 401k provider and find out if they have their own forms to complete also.

File your tax returns correctly to complete the rollover. Your 401k provider will send you a 1099-R showing your rollover. If you complete the rollover in 2010, download Form 8606 from the website. Complete the top of the form and fill out Part II, Conversions. Write the total amount of your 401k rollover on Form 1040, line 16a or Form 1040A, line 12a. This number should be identical to the one found in box 1 of your 1099-R. Subtract after-tax 401k contributions from this number and enter the remaining amount, even if zero, on Form 1040, line 16b or Form 1040A, line 12b.

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About the Author

As a former financial advisor to companies and individuals for 16 years, Joe Andrews knows financial planning and marketing from start-ups to personal budgets. He also writes on motor racing, board games and travel. Andrews received his B.A. from Michigan State University in English. He is currently working on a young adult novel.