401(K) Rollover for Tax-Free Growth

401(K) Rollover for Tax-free GrowthThe scenarios vary widely. You might be a Baby Boomer set to retire, or perhaps you left or lost your job and are looking for a new one. Regardless, there is one common denominator each scenario shares. What do you do with that 401(k) you diligently funded to save for your nest egg?

You have three basic options: cash out, stay with your current plan or do a 401(k) rollover to a traditional or Roth Individual Retirement Account (IRA). Before you decide, a Regions calculator can help clarify your options.

Reasons for 401(K) Rollover

Cashing out means you will be taxed (both state and federal) on the withdrawal, and unless you are 59-1/2 years old, you might be subject to a 10 percent early withdrawal penalty — a clearly unappealing option. Unless your current employer's plan is fantastic, a 401(k) rollover to an IRA arguably offers the greatest investment options, free from the restrictions of your workplace plan and opening access to a range of mutual funds, stocks and other investments.

401(K) Rollover to IRA

Unlike a traditional IRA, a contribution to a Roth IRA is not tax deductible; however, when you eventually withdraw the money from the Roth IRA, none of the funds are taxed, earnings included, as long as it has been open for at least five years and you are older than 59-1/2 (the greater of the two). A Roth means tax-exempt savings, so you never pay taxes on your gains, a tremendous advantage.

Of course, if you do a direct rollover to a traditional IRA, taxes are not paid on any portion of the funds until they are withdrawn from the traditional IRA.

When moving assets from a 401(k) or WRP (workplace retirement plan) into a Roth IRA, contributions that have already been taxed will not be taxed again when the funds are moved. In contrast, contributions made with pre-tax earnings will be taxed when the funds are rolled over. However, these funds will not be taxed again when the funds are withdrawn as long as the Roth IRA has been open for at least five years and you are older than 59-1/2. Also, with a Roth, you do not have to take required minimum distribution at age 70-1/2.

How to 401(K) Rollover for Tax-free Growth

You can rollover funds from your 401(k) directly into a Roth IRA — just be sure that your employer makes the check payable to the investment company so that you can avoid the steep 20 percent tax withholding. You can do it without converting to a traditional IRA first.

The process is fairly straightforward: open your Roth IRA account, request a distribution from your former plan, roll over these assets, and then choose your investments. In terms of taxes, be aware that you'll usually owe on the 401(k) you convert to the Roth only if you made pretax contributions.

When Can I Make Roth IRA Contributions?

You can contribute to your new Roth IRA any time during the year and up until the day your taxes are due. This means you can start your Roth IRA or make contributions until April 15th.

The possibility of federal tax-free growth and tax-free withdrawals is a powerful appeal for those considering a 401(k) rollover to an IRA. Run any of our retirement calculators to learn more.

Tips icon
  • Save Time - Call it the "two-minute rule": when an item at work or at home comes up that takes two minutes or less to complete, do it immediately. It's one less thing to add to your list.
  • Save Money - Track every expense to save money (spreadsheet, online banking tools, budget software, etc.). By knowing where all your money goes, you can begin to prioritize where you can save.
  • Save for the Future - Make a serious effort to define your goals today. How much will college cost? When are you buying a house and what is your realistic budget? When do you want to retire? How much will you need in retirement?
  • Save Time - Two words for you: meal planning. If your family eats dinner at home seven nights a week, it's easier to plan and shop for those meals all at once. It saves time and money, too, as you are more inclined to stick to your list at the grocery store rather than splurging on impulse items.
  • Save Money - A radical idea: if you think of saving as priority, a central goal in itself, every time you rent a movie, eat at a restaurant, buy a coffee or luxury item, you are delaying your goal. Alternately, if it helps make you save money, when you do spend money on luxury items, transfer an equal amount into your savings at the same time.
  • Save for the Future - Spend less than you earn. Crazy idea, right? How do you achieve this? Start with a budget. Knowing your income vs. your expenses will help you reduce the need to borrow (credit cards, loans) and allow you to save for the future.
This information is general in nature, is provided for educational purposes only, and should not be relied on or interpreted as accounting, financial planning, investment, legal or tax advice. Regions neither endorses nor guarantees this information, and encourages you to consult a professional for advice applicable to your specific situation.

FDIC disclosures