Roth IRA Rules for 401(k) Rollovers

by Michael Keenan

If you have money in a 401(k) plan with your employer but would prefer to convert the money to an after-tax Roth IRA, you need to know the Internal Revenue Service (IRS) rules for completing the rollover as well as the tax implications. Though you eventually get the benefits of tax-free distributions, you may have a significantly heavier tax burden in the short term.

401(k) Distributions Allowed to be Rolled Over

The IRS limits when you can take a distribution from your 401(k) plan and which of those distributions can be rolled over into a Roth IRA. You can only remove the money from your 401(k) plan if you suffer a severe financial hardship, leave your job or are at least 59 1/2 years old. However, you cannot roll over money distributed for a financial hardship into a Roth IRA. In addition, you cannot roll over required minimum distributions from your 401(k) plan into a Roth IRA.

Rollover Process

To roll over money from your 401(k) plan to your Roth IRA, you first take a distribution from your 401(k) plan. Your employer will withhold money from the distribution for taxes, but you are responsible for depositing the entire amount into a Roth IRA. For example, if you take a $10,000 distribution, your employer may withhold $2,000 for taxes but you would still be required to put $10,000 in your Roth IRA. If you do not put the full amount in, any undeposited amount counts as a withdrawal from your 401(k) plan. After you receive the distribution, you have 60 days to complete the rollover by depositing the amount in your Roth IRA.

Tax Implications

The amount of your rollover from your 401(k) plan to your Roth IRA counts as taxable income for the year that you make the rollover. The IRS does not prescribe a specific income tax rate for conversions. Instead, the income is added to your other taxable income for the year. If the amount of the rollover pushes you into a higher tax rate, only the part of the rollover that falls in that bracket is taxed at the higher rate.

Tax Reporting

When you file your income taxes for the year, you need to use Form 1040 or Form 1040A. Enter the amount of your rollover as a nontaxable pension and annuity distribution on line 16a of Form 1040 or line 12a of Form 1040A. Next, complete Form 8606 and report the taxable portion on line 16b of Form 1040 or line 12b of Form 1040A. If your employer withheld money when you took the money out of the 401(k) plan, report that amount on line 38 of Form 1040A or line 61 of Form 1040. If you are unsure how much was withheld, check box 4 of your Form 1099-R.

About the Author

Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."