When moving on to a new job, it may be difficult to keep track of the 401(k) left behind at your last job.
You’ll need to keep after it to make sure it’s balanced and earning the money you’ll need for retirement. What’s more, administrative fees on the account that may have been covered by your employer might now shift to you—making it more expensive to maintain the 401(k) account once you’ve left the company.
For these reasons and more, some people consider rolling over their old 401(k) retirement plans into a 401(k) with their current employer, a traditional IRA, or a Roth IRA.
This article will explore the benefits, restrictions, and ways to roll over a 401(k) into a Roth IRA, so that you can decide if that’s the right financial move for you.
What is a 401(k) Rollover?
A rollover simply means taking your money out of one retirement fund and placing it into a new one—one that provides more opportunity for your money to grow and/or consolidates your money into one location for more streamlined management.
There are a few different ways to roll over a 401(k):
1. You can roll it over into a 401(k) plan you set up with your new employer.
2. You can roll it over into a new traditional or Roth IRA that you set up directly.
In this article, we will focus on rolling over a 401(k) into a Roth IRA. This is also known as a Roth IRA conversion.
How Does a 401(k) Rollover Work?
There are two ways to roll over a 401(k) account—either directly or indirectly.
With a direct transfer, you will fill out paperwork to transfer funds from your old 401(k) account into a new retirement account (such as a Roth IRA). The money will get transferred from one account to another, with no further involvement from you.
With an indirect transfer, you would close, or cash out, the 401(k) account with the intention of immediately reinvesting it into another retirement fund. To make sure you actually do transfer the money into another retirement account, the government requires your account custodian to withhold a mandatory 20% tax—which you’ll get back in the form of a tax exemption when you file taxes.
The hitch: You will have to make up the 20% out of pocket and deposit the full amount into your new retirement account within 60 days. If you retain any funds from the rollover, they may be subject to an additional 10% penalty for early withdrawal.
401(k) vs Roth IRA
Both a 401(k) account and a Roth IRA can be an important part of retirement planning. Each offers distinct benefits and advantages, as well as some key differences and restrictions. If you already have a 401(k) that you’re considering rolling over, you’re likely familiar with the plan details. But for comparison, here are some of the highlights of each account.
| 401(k) | Roth IRA |
|---|---|
| No income limits on who can contribute to a 401(k) plan. | Though Roth IRAs typically have income limits, those limits are waived when someone rolls over a 401(k) into a new Roth IRA account. | Contributions can be made to the account at any age, as long as you are still working for the company | Contributions can be made to the account at any age |
| Subject to required minimum distributions (RMDs); the account holder must start withdrawing money | There are no required minimum distributions (RMDs). Account holders can withdraw at their discretion. |
| The maximum contribution for 2022 is $20,500 with an additional $6,500 for those over age 50. | The maximum contribution for 2022 is $6,000, with an additional $1,000 for those over age 50. |
| Contributions are made with pre-tax dollars, and withdrawals are taxed at the individual’s income tax rate at time of withdrawal. | Contributions are made with post-tax dollars, and withdrawals are not taxed. |
| Except in a few hardship situations, any money withdrawn before age 59.5 is subject to both income tax and a 10% penalty. | After five years, any earnings withdrawn through a non-qualified distribution is subject to income tax only, with no penalties. |
Recommended: Comparing a Traditional IRA and 401(k)
How to Roll Over a 401(k) to Roth IRA
Though a Roth IRA has yearly contribution limits (for 2022, $6,000, with an additional $1,000 for those over age 50), there is no limit to the amount of money you can roll over from your 401(k) into a Roth IRA.
If you decide it is the right move for you and your circumstances, rolling your 401(k) into a Roth IRA is relatively simple:
1. Open a new Roth IRA account.
2. Contact the company that currently holds your current 401(k) and request a transfer. You’ll most likely have to fill out a few forms.
3. Keep an eye out to make sure the transfer happens.
4. Take another look at your overall retirement plan strategy.
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401(k) to Roth IRA Rollover Rules
There are a few rules to consider when rolling over 401(k) assets to a Roth IRA.
Rollover Amount Will be Taxed
Since your 401(k) account was funded with pre-tax dollars and a Roth IRA is funded with post-tax dollars, you will need to pay income tax on the 401(k) balance in the same tax year in which your rollover takes place.
A Roth IRA is Subject to the Five-Year Rule
Once you transfer money into your new Roth IRA, it pays to keep it there. If you withdraw any earnings that have been in the account for less than five years, you will likely be required to pay income tax and an additional 10% penalty. This is known as the five-year rule .
The Takeaway
One way to handle a 401(k) account from a previous employer is by rolling it over into a Roth IRA. For some individuals, it might be the only way to take advantage of a Roth IRA, which typically has an income limit. With a Roth IRA, account holders can contribute post-tax dollars now, and enjoy tax-free withdrawals in retirement.
If you’re looking to roll a 401(k) into a Roth IRA, SoFi Invest® can help. SoFi offers both Roth and traditional IRA accounts.
And if you’re simply looking to refine your own retirement plan (or start one!), SoFi Invest can help you figure out a retirement savings strategy that works with your goals.
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