Conversion Options

• When you want to move money from your 401k plan to your Roth IRA, you can perform a rollover. In a rollover, the money is paid to you and you have 60 calendar days to put the money into your Roth IRA. However, your 401k plan financial institution will withhold 20 percent for the taxes you will owe, yet you must put 100 percent of the money into the new account or it will be considered a distribution. For example, if you are rolling over $22,000, you would only receive $17,600 from your 401k, but be responsible for redepositing $22,000 into the new Roth IRA. To avoid the withholding, you should perform a transfer, where the money is moved straight from one account to the other without being paid to you first.
  
  

Tax Reporting of 401k to Roth IRA Rollovers

• When you perform a 401k to Roth IRA rollover, you must report it on your income taxes. If you performed a direct conversion, the entire amount is reported as nontaxable pension and annuity income (Line 16a on Form 1040, Line 11a on Form 1040A). The taxable portion, which is the entire amount minus any after-tax 401k contributions you made, is then reported as taxable pension and annuity income (Line 16b on Form 1040, Line 11b on Form 1040A). If you did a rollover and had money withheld, that is reported as federal income taxes withheld and decreases your tax bill.
  
  

Benefits

• The IRS does not subject Roth IRAs to required distributions. If you are planning to leave money to your heirs in your retirement account, a Roth IRA is especially beneficial, because you never have to take the money out and it is tax-free for your heirs. In addition, if you expect to pay a higher income tax rate when you take money from your retirement plan than you do in the year you rollover your 401k to a Roth IRA, you will save money because the qualified withdrawals are tax-free.
  
  

Warnings

• The money that you move from your 401k plan to a Roth IRA increases your taxable income for the year, thus increasing your taxes due. If you have to take money out of the rollover for the taxes and you are not yet 59 1/2, you must pay a 10-percent income tax penalty. In addition, you must wait at least five tax years until you can take qualified withdrawals from the Roth IRA. This requirement is in addition to you being at least 59 1/2 years old.