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The Roth IRA is one of the most useful retirement vehicles available, but many retirement savers don’t start with one as their first account. A traditional IRA or 401(k) are the primary retirement vehicles for many Americans, providing tax-deferred savings on contributions. If you contribute to your IRA or 401(k), you can write off the amount on your taxes up to a certain level.

A Roth IRA works in reverse – contributions are made with dollars that have already been taxed, but then grow completely tax-free once in the account. Both vehicles function primarily the same way, but the tax bills just arrive at opposite ends of the process. Many tax-conscious savers consider the Roth IRA at some point in order to spread out their tax burden.

If you want to transfer funds from one retirement account to a Roth IRA, here are a few rollover methods available where you can do so without paying penalties. And in some situations, you can minimize taxes, too.

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Roth IRA Rollover Considerations

A Roth IRA rollover occurs when funds from a different qualified account (like a traditional IRA) are ‘rolled over’ into a new Roth IRA without the usual withdrawal and deposit procedure. Instead, the funds are simply transferred from the new account to the old without penalty, provided all tax obligations are met.

Why execute a Roth IRA rollover? Here are a few considerations:

●      Future tax rate – Do you expect your tax rate to be higher in the future than it is now? A Roth IRA will allow you access to tax-free growth at the expense of taxes paid now.

●      Roth IRA advantages – A Roth IRA has a few other features that make it attractive. After five years, your principal can be withdrawn at any time. Plus, you won’t face required minimum distributions when you reach age 72.

●      Ability to pay taxes now – You’ll need to pay taxes incurred during the rollover with funds outside the account you’re transferring. Otherwise, you’ll have to pay the 10% penalty for early withdrawal.

For example, suppose you want to roll $10,000 over from your traditional IRA to a Roth. You owe $2,500 in taxes on the contributions. However, you can’t use a portion of the $10,000 you’re rolling over to pay the taxes without incurring a penalty. So, make sure you have enough cash on hand to pay your tax bill.

Rolling a Traditional 401(k) into a Roth IRA

Rolling a portion of your traditional 401(k) into a Roth IRA is easy thanks to the direct transfer process. When rolling over an account, you have three options: a direct transfer, a trustee-to-trustee transfer, or a 60-day transfer. A direct transfer is when your retirement plan administrator simply sends your distribution to the administrator of the new Roth IRA. You just need to point your 401(k) administrator in the direction of your new account.

You’ll need to pay all taxes upfront since the traditional 401(k) is funded with pre-tax dollars. And don’t dip into your retirement funds to pay your tax bills unless you’re okay with the 10% penalty hit! Certain distributions from a 401(k) cannot be rolled over into a Roth, such as hardship distributions, loans, or required minimum distributions.

Also note that your employer is required to withhold 20% of your distribution for tax purposes if you don’t choose a direct rollover.

Rolling a Traditional IRA into a Roth IRA

Traditional and Roth IRAs are both administered by the individual funding them. If you want to rollover a traditional distribution into a Roth IRA and both are held at the same broker, the trustee-to-trustee transfer is your best bet since you won’t have to deal with the 10% mandatory tax withholding applied to IRAs. If you choose to receive your distribution via check, you’ll be subject to the withholding and have 60 days to rollover the money.

Rolling a Roth 401(k) into a Roth IRA

A Roth 401(k) is like a traditional 401(k) with the tax breaks of a Roth. Your contribution limits are the same as a traditional 401(k) and the plan must be sponsored by an employer. But you won’t fund the plan with pre-tax dollars, only after-tax dollars. All your investments grow tax-free. So why rollover a Roth 401(k) to a Roth IRA if the tax breaks are the same?

The Roth 401(k) doesn’t get the favorable treatment on contributions like Roth IRAs do. With a Roth IRA, you can withdraw principal at any time – not the case with a Roth 401(k). And while the contribution limits for a Roth IRA are much lower, the investment choices are much broader. Both traditional and Roth 401(k)s are pretty much resigned to mutual funds. On the other hand, a Roth IRA can contain ETFs, individual stocks, and even derivatives like options.

The best method for a Roth 401(k) to Roth IRA rollover is a trustee-to-trustee transfer since no taxes need to be paid for this conversion.

Final Thoughts

The Roth IRA is one of the most uniquely effective retirement vehicles available to the average American. You get tax-free growth on your investments, no taxes due in retirement, and a host of investment choices not available in 401(k) accounts. You’ll also get access to your contributions whenever you want should you find yourself needing cash before you hit 59.5.

A Roth IRA rollover is a great way to spread your tax obligations across pre- and post-tax accounts. But just be sure you have all your bases covered when making the conversion. You’ll owe taxes if rolling over a traditional IRA or 401(k) contribution and you’ll need to make sure you use the most efficient rollover method for your particular type of account.

Many investors use Roth IRA conversions to execute what’s called a backdoor Roth IRA. Because Roth IRAs have so many benefits, they are a popular investment vehicle. Roth IRA accounts face strict income limitations. If you are a single filer and your modified adjusted gross income (AGI) is above $140,000, or joint filers whose modified AGI is above $208,000, in 2021, you aren’t eligible to directly contribute to a Roth IRA. The alternative is to contribute indirectly via rollovers.

If you feel like it’s time to diversify your tax burden as well as your investments, contact an advisor to discuss a Roth IRA rollover.

Roth IRA Rollovers with the Help of Advanced Retirement Strategies

The long-term benefits of a Roth IRA can significantly improve your quality of life during retirement, stretching your savings to their full potential.

The team of retirement planners at Advanced Retirement Strategies in Bountiful, Utah has the expertise and qualifications to execute Roth IRA rollovers and design backdoor Roth IRAs – maneuvers that can create opportunities for a long and comfortable retirement.

Advanced Retirement Strategies financial planners specialize in helping diligent savers with $250,000 or more of investment and retirement assets (not counting your primary residence) prepare for and then transition into retirement.

We would love the opportunity to assist you. Just head to the get started page and set up a free 15-minute quick consult.

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