Can Assets in a Regular 401(k) Be Converted Into a Roth 401(k)?

by Herb Kirchhoff

You may be able to convert the assets in a employer-sponsored, tax-deferred 401k retirement plan into a Roth 401k program, depending on your circumstances. Although Roth 401k plans were authorized by law in 2006, conversion of regular 401k accounts into Roth 401k accounts was not allowed until September 2010. But there are some qualifications.

Employer Plans

You can convert your traditional 401k into a Roth 401k if both plans are offered by your current employer and your employer’s 401k plan permits such conversions. You also can convert a traditional 401k left at a former employer into a Roth 401k plan at your current employer. But you can't if your present employer doesn’t offer a Roth 401k plan or doesn’t permit conversions. Your employer must offer the Roth 401k conversion option to all employees, not just to those wanting to do a conversion. To avoid tax penalty complications, most 401k plans require you to be older than 59 1/2 to perform a Roth conversion, but plans can permit earlier conversions.

Tax Consequences

You can only convert traditional 401k funds that would be eligible for a rollover. That means you can only convert your own contributions, the vested contributions from your employer and earnings on those amounts. You will have to pay income taxes on the amount you convert. Money in your traditional 401k was deposited on a tax-deferred basis, so the taxes normally would come due upon withdrawal at retirement. Instead, by converting to a tax-free Roth 401k, you will owe tax on the entire conversion amount in the year you make the conversion. You’ll want to have a source of funds from outside the conversion to pay the taxes. If you have to take money from the conversion amount for taxes, converting to a Roth 401k may not be the right choice for your situation.

Why Convert?

Converting a traditional 401k to a Roth 401k makes sense if you want to keep receiving employer contributions, but believe your post-retirement tax rate will be higher after retirement than it is currently. Another reason to convert is if you believe the value of your 401k retirement investments is depressed now, but will see major appreciation by the time you retire. In that case, converting to a Roth 401k now means you pay taxes on the depressed value, while subsequent appreciation of your investments will be tax free.

Avoiding Minimums

Another reason to convert would be to avoid the mandatory required minimum distributions from both traditional and Roth 401k plans once you reach age 70 1/2. You would avoid that requirement by doing a tax-free rollover of your Roth 401k into a Roth individual retirement arrangement (IRA), which has no minimum distribution requirement. This way, you could continue to build your retirement savings if you keep working after age 70 1/2. You can also retire just on the account’s earnings and leave the principal to your heirs.

Photo Credits

  • Comstock/Comstock/Getty Images