How does a Roth IRA work

Rollover 401k to Roth IRA: What are the benefits, drawbacks and how do you do it?

Before we look at why a rollover of your 401k to a Roth IRA might be the best option for you lets explain exactly what both a Roth IRA and a 401k are.

A Roth IRA is a special type of retirement investment account provided for you that allows you to set aside a certain amount each year. It is exempt from taxation, assuming certain conditions are met. In the Roth IRA you can have a variety of investment options ranging from standard savings, real estate and also stocks and bonds. There are more intricate details on how does a Roth IRA work but the idea is essentially that it is a big bucket account that holds all of your retirement money and can be easily invested in a big portfolio of different investment opportunities. A 401k is an alternative means of retirement funding that is commonly taken up with now about 60% of all households nearing retirement age holding an account. The money raised to be placed into a 401k account is taken straight from the salary of the worker and is not subject to income tax until it is withdrawn later in retirement. This is an excellent feature as it means you can earn the most amount of cumulative interest over a period of years due to the compound interest effect.

Why you need to consider planning ahead with your retirement fund

With the increasingly expensive world that we live in there is an evident need for an increasing supply of money to provide for ourselves. Coupled together with the fact we are living longer it gives a difficult proposition for many people approaching retirement age. The truth is the quicker you can get prepared for your retirement account; the better position you will be in when retirement age comes. So it’s time to stop ignoring the fact that retirement will come one day and start considering.  Your options. Whether it is 10 years or 40 years away you won’t regret starting your planning now.  We can no longer get by on just a standard social security pension if we want to live any sort of expansive lifestyle so it is up to us to get into gear and prepare properly for the future. There is no shortage of options and all have their own benefits, so whether you are looking at starting a 401k at work, considering a rollover 401k to Roth IRA or even just starting up a Roth IRA there is no better time than now to begin preparing; simply talk to your employer regarding the 401k and a bank or brokerage regarding the available Roth IRA options.

Why choosing to rollover 401k to Roth IRA could be the right choice for you.

When it comes time to leave your job, you will have to make a decision regarding whether or not to rollover 401k to Roth IRA. In the majority of cases the answer is a simple one; yes. It simply makes straightforward financial sense to rollover your existing 401k fund into a Roth IRA. There are two key reasons why in most cases it is an easy decision.

Firstly, you will experience lower account management fees. As well as the fact that a lot of 401k plans limit you to using high-cost funds, in 2009 a study was carried out that found the average administration fee on a 401k was 0.72%. Contrary to this many brokerage firms have no yearly charges at all. While 0.72% may seem to be a trivial amount when you stack it up against the whole of your retirement fund you find that you are just burning off money that need not be wasted.

Also, by keeping your money in a 401k you are limiting your investment opportunities massively. By sticking with a 401k you will find that a lot of plans only have one option for low-cost investments and this is an S&P 500 index fund (indeed this isn’t even available on some plans!).

This means that you have either the option of using high cost lower performing mutual funds for the remainder of your portfolio, or over strengthen your position on the S&P index fund leaving your asset allocation out of whack. Conversely, with an IRA you get access to a wide range of low-cost investment opportunities.

Are there any reasons why a rollover of 401k to Roth IRA may not be the right choice?

As with any choice there is always an alternative that applies in a few specific situations, where it doesn’t make sense to move your 401k fund into a Roth IRA; with these situations it makes sense either to put off moving it across or withdraw some parts of the 401k into a taxable account.

If you find yourself either leaving your job or being laid off after the age of 55 and you plan to retire before the age of 59 ½ then it makes perfect sense to hold off a while with your rollover until you are passed the age of 59 ½. This is because any withdrawals from the 401k in this period will not be subject to the 10% tax that usually comes with account distributions before this time. This means if you have to spend any of the money you can do so without the worry of losing part of it to taxes.

If your 401k includes any company stock then you should look to seek advice from an account regarding the situation. It may be possible, and indeed is likely, that you can save yourself some tax costs by converting the amount into a taxable account saving any costs as only the initial amount will be taxed, not any appreciation in value potentially saving you a lot of money – however this can be risky as losing out on stock value is possible.

How to rollover 401k to Roth IRA

A rollover 401k to Roth IRA is a fairly straightforward process. Simply open an IRA account, request the appropriate paperwork from the administrator, fill out the paperwork hand it back in. Once the money has been transferred you may invest it as you wish.