What Tax Issues Might You Run Into When Converting a 401k to a Roth IRA?


Quick Answer

When converting money from a pre-tax retirement account, such as a 401k, to a Roth IRA, the investor must pay income tax on that money, according to RothIRA.com. If the investor receives the funds himself rather sending them directly to his financial institution, he loses 20 percent of the account balance. Additionally, he must roll over the funds into a Roth IRA within 60 days or else he may owe a 10 percent early withdrawal penalty depending on his age.

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Full Answer

Converting a 401k to a Roth IRA carries tax benefits for those who expect to fall into a higher tax bracket during their retirement, says RothIRA.com. A retiree may withdraw funds from his Roth IRA without paying income taxes, so a conversion allows an investor to pay a lower tax rate during his working years and enjoy a tax-free income during retirement. If the investor's income is too high to make a direct contribution to a Roth IRA, a conversion acts as a legal backdoor allowing him to place his retirement funds into a Roth IRA despite his income. The investor should make certain that the amount of income he is converting, when combined with his other income for that year, does not place him in a higher tax bracket or trigger other taxes he would not owe otherwise.

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