Converting Directly From a 401(k) to a Roth IRA

Back in the olden days prior to 2008, it was against the rules to convert funds directly from a 401(k) plan (or other CODA plan, like a 403(b)) to a Roth IRA.  At that time, you were required to do the “conversion two-step” wherein you would first rollover or direct-transfer your funds from the 401(k) plan to a traditional IRA, then do a conversion from the trad IRA into your Roth IRA.  This was an unnecessarily complicated process, and the IRS logically waited until it got ridiculous and then relented listened to taxpayers, allowing a direct conversion from these qualified retirement accounts into a Roth IRA.

The process is identical to the process for converting from a traditional IRA to a Roth IRA.  You can make this conversion from your or your spouse’s:

• Employer’s qualified pension, profit-sharing or stock bonus plan (including a 401(k) plan),
• Annuity plan,
• Tax-sheltered annuity plan (section 403(b) plan), or
• Governmental deferred compensation plan (section 457 plan).

You are allowed to convert all or part of the account, subject to the MAGI limitation of $100,000 that we’ve covered before, which is eliminated for 2010.  Any pre-tax amount converted must be reported as income in the year of the conversion.

The conversion can be done either via a direct trustee-to-trustee transfer or a rollover.  In general, the trustee-to-trustee transfer is the preferred method since a rollover involves making a check payable to you, which requires the payor to withhold 20% of the rollover.  Any amount that is not successfully converted within 60 days would be taxable AND subject to the 10% penalty unless other conditions applied.

So in other words, when you convert these funds over to your Roth account, in order to pay the tax on the withdrawal you’ll need to either hold out a portion and pay the 10% penalty on those funds, or pay the tax from another source.

Be Sociable, Share!

• 

I can learn from you, you can learn from me - please leave your comments and links!

 Jim Blankenship, CFP®, EA, is an expert in personal retirement, IRAs, and tax issues, with more than 25 years of experience in the industry. Read more from this author