If you have after-tax money in your traditional 401(k), 403(b), or other workplace retirement savings account, you can roll over the original contribution amounts to a Roth IRA without paying taxes, as long as certain rules are met. (Note: Your plan's terms will determine when and how money is distributable.
The benefits of having your retirement funds moved from a traditional account to a Roth should be pretty obvious by now: You get tax-free growth on your retirement savings. Once that money is converted to a Roth, it can keep growing for years . . . and none of that growth will be taxed. That's huge.
You can shift money into a Roth IRA from a traditional IRA or 401(k) by doing a Roth IRA conversion. The amount you convert is added to your gross income for the tax year in which you make the switch. Tax rates in 2025 range from 10% to 37%, and the conversion amount could push you into a higher tax bracket.
Many people roll over their 401(k) savings when they change jobs or retire. However, numerous 401(k) plans allow employees to transfer funds to an IRA while they are still with their employer. A lot of people only think about rolling over their 401(k) savings into an IRA when they change jobs.
The simple version says the Roth account needs to have been funded for five years before you withdraw any earnings—even after you've reached age 59½—or you could owe taxes. In addition, nonqualified withdrawals before that age could also trigger a 10% penalty.
Deferring Social Security payments, rolling over old 401(k)s, setting up IRAs to avoid the mandatory 20% federal income tax, and keeping your capital gains taxes low are among the best strategies for reducing taxes on your 401(k) withdrawal.
The key disadvantage of a Roth conversion is that taxes are due on the converted value. There are also factors to consider specifically for the year of conversion.
Let's say you open a Roth IRA and contribute the maximum amount each year. If the base contribution limit remains at $7,000 per year, you'd amass over $100,000 (assuming a 8.77% annual growth rate) after 10 years. After 30 years, you would accumulate over $900,000.
Although they are perfectly legal, retirement account conversions have complicated tax rules, and the timing can be tricky. The ideal candidate for rolling an employer-sponsored retirement fund into a Roth IRA is someone who does not expect to take a distribution from the account for at least five years.
As a general rule, if you withdraw funds before age 59 ½, you'll trigger an IRS tax penalty of 10%. The good news is that there's a way to take your distributions a few years early without incurring this penalty. This is known as the rule of 55.
Key Takeaways
There is usually no transfer fee for rolling over your 401(k) into a new tax-advantaged retirement account. Account fees for your new account might be higher than the ones for your old account. Rolling over a 401(k) to an individual retirement account (IRA) is often the way to go to reduce fees.
If you're a single filer and your MAGI is $161,000 or more, or if you're a joint filer and your MAGI is $240,000 or more, you're ineligible to contribute to a Roth IRA. Still, you can make contributions to a traditional IRA.
For those who are self-employed in a one-person business, a solo 401(k) can be an excellent option. A Roth solo 401(k) offers higher contribution limits than a Roth IRA without the income limitations that accompany a Roth IRA.
While you may have made an initial Roth contribution that satisfies the 5-year aging period required to withdraw earnings tax free, conversions must be withdrawn first, and if they have not met their own 5-year aging requirement, they may be subject to a 10% penalty.
An obvious disadvantage of a Roth IRA is its non-tax-deductible contributions. However, it can be offset by its tax-free distributions, especially when the future marginal tax rate is expected to be higher than the current marginal tax rate.
The amount you can contribute to a Roth IRA depends on your annual income. The Roth IRA contribution limit for 2024 is $7,000 in 2024 and 2025 ($8,000 if age 50 and older). At certain incomes, the contribution amount is lowered until it is eliminated completely.
As previously noted, the 5-year aging rule applies to inherited Roth IRAs as well, and rules around them can be complicated. To make qualified distributions, it must be 5 years since the beginning of the tax year when the original account owner made the initial contribution, even if the new owner is 59½ or older.
A Roth IRA conversion may not be appropriate if you:
Are pushed into a higher tax bracket due to the amount you convert. Will be in a lower tax bracket in retirement. Will be relocating to a state with no or lower state income tax. Are wanting to convert your RMD because RMDs cannot be converted.
A backdoor Roth can be created by first contributing to a traditional IRA and then immediately converting it to a Roth IRA to avoid paying taxes on any earnings or having earnings that put you over the contribution limit.
A Roth conversion might benefit those who anticipate being in a higher tax bracket in the future, as it allows you to pay taxes on the converted amount now, rather than in retirement. This can lead to significant tax savings down the line.
The short answer is that yes, you can withdraw money from your 401(k) before age 59 ½. However, early withdrawals often come with hefty penalties and tax consequences.
If you're at least age 59½ and your Roth IRA has been open for at least five years, you can withdraw money tax- and penalty-free. See Roth IRA withdrawal rules.
This is where the rule of 55 comes in. If you turn 55 (or older) during the calendar year you lose or leave your job, you can begin taking distributions from your 401(k) without paying the early withdrawal penalty. However, you must still pay taxes on your withdrawals.