Should I Transfer My 401(k) To a Roth IRA?

When you leave a job, it’s generally a good idea to take your 401(k) plan with you. This doesn’t mean you should cash it out, as that could leave you on the hook for early withdrawal penalties. Rather, it means rolling your 401(k) into a new retirement account, whether it’s the 401(k) plan your new company offers or an IRA you open yourself.

If you leave your money in an old 401(k), you risk forgetting about it. And also, you never know what changes your old employer might make to its plan that are unfavorable. So it’s best to take that money with you when you go and put it into a new retirement plan you’re actively watching.

In this Reddit post, we have an employee who’s leaving their job for an  extended period of time to go back to school. Because they’re not moving on to another employer, they don’t have access to a new 401(k) plan to transfer the funds into. So they’re wondering if it pays to set up an IRA — specifically, a Roth.

I think there are plenty of good reasons to roll that money into a Roth IRA. But the poster, and anyone else in a similar situation, needs to go about that carefully.

The upside of having a Roth IRA

There are a number of key benefits that Roth IRAs offer over traditional IRAs. With a traditional IRA, your investments get to grow on a tax-deferred basis, which means you only pay taxes on your gains once you begin taking withdrawals from your account.

But with a Roth IRA, your gains are completely tax-free. So if you contribute $100,000 to a Roth IRA over time and your balance grows to $1.1 million, you get to walk away with $1 million in gains without owing the IRS a penny.

Roth IRA withdrawals are also tax-free, whereas with a traditional IRA, you’ll pay taxes on your withdrawals. Now, picture yourself retired and no longer earning a paycheck. Would you rather have to not worry about taxes at that stage of life? If so, then a Roth IRA is a great plan to save in.

Finally, Roth IRAs do not force savers to take required minimum distributions. This means you can let your money in that account grow indefinitely. So if you’re moving on from a job and want to roll the money in your 401(k) into a new plan, a Roth IRA could be a solid bet.

Be careful with a Roth conversion

You’re allowed to roll funds from a traditional 401(k) — or IRA — into a Roth IRA. But if you go this route, you’ll need to prepare for a tax bill — and a potentially large one, depending on the size of your account.

Remember, traditional 401(k)s are funded with pre-tax dollars, whereas Roth IRAs are funded with after-tax dollars. So when you do your conversion, the amount of money you roll into a Roth IRA is a sum you’ll be taxed on.

That’s why if you’re interested in a Roth IRA conversion, it’s smart to consult a tax professional or a financial advisor for guidance. Either one can help you plan for the tax implications of a Roth conversion and also help you time your conversion accordingly.

For example, depending on your situation, they may advise you to only roll a portion of your 401(k) into a Roth IRA this year and then wait until the following year to complete the conversion, depending on your expected income and tax bracket. So it’s a good idea to get that guidance before jumping in. Overall, though, moving an old 401(k) into a Roth IRA is a smart plan that could work out really well.