About 401K to Roth IRA Conversion Rules

The IRS only allows 401k to Roth IRA conversions for taxpayers who meet their income requirements. If an investor's modified adjusted gross income is more than $100,000 then the 401k to Roth IRA conversion can not take place in that tax year. Many taxpayers with flexible incomes choose to delay some income so that they can perform a 401k to Roth IRA conversion in a particular tax year. The rules do not require you to maintain an income below $100,000. They only say your income must be below that in the tax year when you perform the 401k to Roth IRA conversion.

401k to Roth IRA conversion usually happens when taxpayers change employers. Most employees are allowed to keep their 401k at the same place even though they don't work there anymore. However, many people prefer to hold that money themselves in a Roth IRA. There is no time limit on when you can do this. You can convert a 401k from any former employer into a Roth IRA years after leaving a job as long as you are eligible for the 401k to Roth IRA conversion.

In order to perform a 401k to Roth IRA conversion, you must first set up a Roth IRA account. You can also use an existing one or establish a new at a financial institution. Tell them that a 401k to Roth IRA conversion is coming. Next, contact the holder of the 401k and ask for "rollover" authorization papers. Tell them that you want to send the money to your Roth IRA account. You will need to sign these and send them back. Some financial institutions will make you read a pamphlet first so that you understand your options. This is a stalling tactic designed to discourage you from taking your money away from them. Don't fall for it. It is your retirement money and you can put it anywhere you like.

Some financial institutions will arrange all the details with each other once you authorize the conversion. They will transfer the money between the 401k and Roth IRA without you ever having to touch it. Others will issue you a check. It is very important that they make this check out to the Roth IRA account and not you. If the check is in your name it is considered a redemption and all your 401k money will be taxed and is subject to a 10% penalty. If the check is made out to the Roth IRA account, all you have to do is forward it to the holder of your Roth IRA and the money maintains its tax free status.

Roth IRAs offer more investment options than 401k plans. While 401k plans might offer a handful of mutual fund options, you can invest a Roth IRA any way you want. Most investors put the money in a mutual fund, but you can also use stocks, bonds, money market accounts or certificates of deposit. If you have a long time until retirement then aggressive growth stocks and mutual funds offer attractive long term returns. If retirement is just a few years away, then the Roth IRA should be in more conservative stocks, bonds and cash. Date targeted mutual funds establish an approximate year of your retirement and automatically adjust investments as that time approaches.