Roth Rules for Retirees: When to Rollover


To rollover or not to rollover: That’s the question for millions of people who change jobs or retire in any given year. They must decide what to do with their defined-contribution retirement plans like 401(k)s, 402(b)s or 457(b)s.

The issue has always been complex, but now it’s even trickier for people who will have access to Roth IRAs after the first of the year repeal of the $100,000 income limit on “rollovers.”

In most cases there are four options: Leave your money in the former-employer’s 401(k) or similar plan, transfer it into the new employer’s or shift the money into a traditional or Roth IRA.

All but the Roth option can be done without triggering income tax. The Roth move can be expensive because of the upfront tax bill, but it may pay off in the long run, since Roth withdrawals are tax-free.

Here’s a quick run-down on the pros and cons of each move.

Keep the old plan. If you have at least $5,000 in the old plan, you can just keep it there, which is obviously the easiest option. It’s a good approach if you are happy with the plan’s investment offerings, especially if any aren’t available outside the plan. Note that once you leave the firm, you probably won’t be allowed to borrow against your plan assets or make new contributions. You’ll probably have to roll over to an IRA if you have less than $5,000 in the plan.

Shift your money to the new employer’s plan. This is a good choice if you like the new employer’s investment options or want to be able to borrow against plan assets. (Loans can severely damage investment gains.)

Shift to a traditional, tax-deferred IRA. Although you won’t be able to borrow against your account, an IRA rollover would give you virtually unlimited investment options, compared to one or two dozen mutual funds in the typical employer plan. You could invest in individual stocks or bonds, for example. A move to a traditional IRA (or a Roth) might allow you to choose investments with smaller fees than you’d pay in the employer plan.

Shift to a Roth IRA. In addition to getting a wider investment choice, this would allow you to make withdrawals in retirement without paying the income tax you would with an employer plan or traditional IRA, and you would not be required to start taking minimum distributions after turning 70 ½. The drawback is you would have to pay tax for the year you do the rollover. Tax would apply to all money that had not been taxed earlier, such as investment gains and original contributions that were tax deductible at the time. For a rollover done in 2010 the tax can be divided between 2011 and 2012.

Whether it's better to pay tax to do a rollover or to keep the employer plan and pay tax later largely depends on your tax bracket. A rollover to a Roth may not make sense if your tax bracket is higher now than it’s likely to be in retirement, since the tax bite would be smaller later.

For many years, rolling a 401(k) into a Roth was a cumbersome, two-step process of converting to a traditional IRA, then to a Roth. Now, it can be done in one step. Also, beginning in 2010, Roth conversions will no longer be restricted to taxpayers with incomes below $100,000.

Use the Roth IRA Conversion Calculator to determine whether a rollover to a Roth would make sense for you. And check with your employer plan provider, brokerage and mutual fund company for help with the nuts and bolts of a conversion. Many financial firms provide guidance on their Web sites. T. Rowe Price (Stock Quote: TROW) and Charles Schwab (Stock Quote: SCHW) have good ones, as do Vanguard Group and American Funds.

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