When leaving or changing jobs, an important decision that you will be facing is what to do with your 401k plan. There are many options for the use of your funds in your 401k, but you should be aware that many of the withdrawal options carry steep tax penalties if you are below the age of 59½.
After researching your options you may be wondering, can I rollover my 401k to a Roth IRA? Roth IRAs are excellent tax-deferred investment vehicles, with many positive attributes. There are certain stipulations for investing in Roth IRAs, including income requirements and contribution limits, however, the benefits are enough to make converting your 401k plan to a Roth IRA worthwhile.
Roth IRAs Offer Better Investment Options
One of the most certain ways to improve your returns on your investments is to lower your investment costs. An S&P 500 index fund may be the only low-cost investment option offered by your 401k.
You are then forced to choose between either a high-cost mutual fund, or invest too heavily in the index fund to keep costs low.
In a Roth IRA, by contrast, you have access to a larger selection of low-cost options for investment across a wide range of asset classes.
Roth IRAs Offer Lower Fees
401k plans often include administrative fees, in addition to restricting you to expensive mutual funds. Studies have shown that the average administrative fee charged by most 401k plans can reach close to 1% of assets yearly.
Most discount brokerage firms charge no yearly fees for Roth IRAs, making these tools an affordable option. You can lower your investment costs by as much as 1% annually by rolling over your 401k to a Roth IRA due to lower fees and investment options that are less expensive.
While this may not seem like much at first, by improving your investment gains by 1% you can make a dramatic impact on the longevity of your retirement funds when compounded over the life of your retirement.
Drawbacks To Rolling Over Your 401k
In a handful of situations, rolling over your 401k to a Roth IRA is not the best course of action. 401K plans carry significant tax penalties for early withdrawal, and in certain situations, a lump-sum distribution may be the best course of action.
In the event that you will be retiring early, converting a traditional IRA into a Roth IRA, or your 401k account holds company stock that has appreciated significantly in value, you may want to explore other options for your funds to avoid these heavy tax penalties.
How To Convert To A Roth IRA
For most people, rolling over a 401k plan to a Roth IRA is easy. You must first choose a brokerage to open your Roth IRA account. You can open a Roth IRA through a mutual fund company, a discount brokerage firm such as ETrade, or you may choose to use a full service brokerage.
Once you have chosen a brokerage, you must then open a Roth IRA and request rollover paperwork from the administrator of the plan. You will want to initiate a “trustee-to-trustee”, or “direct rollover”, and have the check made out to and sent to the brokerage firm handling your Roth IRA.
When the funds have arrived in your Roth IRA, you can then invest it as you see fit. If you receive the check yourself, simply forward the check immediately to your new brokerage firm. You have 60 days to rollover your 401k into your new Roth IRA before the whole amount counts as taxable distributions for the year.
Carefully consider your age, investment objectives and time frame for investing before committing any capital to a Roth IRA or other retirement instrument.
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