Must-Know Rules for Converting Your 401(k) to a Roth IRA

If you are considering leaving a job and have a 401(k) plan, you need to stay on top of the various rollover options for your workplace retirement account. One of those options is rolling over a traditional pretax 401(k) into a Roth individual retirement account (Roth IRA). This can be a very attractive option, especially if your future earnings will be high enough to knock into the ceiling placed on Roth account contributions by the Internal Revenue Service (IRS).

Regardless of the size of your earnings, you need to do the rollover strictly by the rules to avoid an unexpected tax burden. Since you haven’t paid income taxes on that money in your traditional pretax 401(k) account, you will owe taxes for the year when you roll it over into a Roth IRA. However, once you’ve paid the taxes and your money is in the Roth IRA, you won’t pay taxes on it again at withdrawal time.

Converting a Traditional 401(k) to a Roth IRA

You’ll owe some taxes in the year when you make the rollover because of the crucial differences between a traditional 401(k) and a Roth IRA.

• A traditional 401(k) is funded with the salary from your pretax income. Your taxable income for that year is reduced by the amount of your contribution. You can deduct that amount from your taxable gross income. You pay no taxes on the money that you contribute or the profit that it earns until you withdraw the money, presumably after you retire. You will then owe taxes on the withdrawals.
• A Roth IRA is funded with post-tax dollars. You pay income tax upfront on your full salary, and then the contribution is deposited in your account. You won’t owe taxes on that money. You also will not owe taxes on earnings inside that account once the money has been inside the Roth IRA for five years or more and you’ve reached age 59½, presumably in retirement.

So, when you roll over a traditional 401(k) to a Roth IRA, you’ll owe income taxes on that money in the year when you make the switch.

The total amount transferred will be taxed at your ordinary income rate, just like your salary. Federal tax brackets range from 10% to 37% for 2025.

How to Reduce the Tax Hit

If you contributed more than the maximum deductible amount to your 401(k), you have some post-tax money in there. You may be able to avoid some immediate taxes by allocating the after-tax funds in your retirement plan to a Roth IRA and the pretax funds to a traditional IRA. You should see a qualified tax professional to determine exactly how this will affect your tax bill for the year.

Roth 401(k) to Roth IRA Conversions

If your 401(k) plan were a Roth account, then it could only be rolled over to a Roth IRA. The rollover process is straightforward. The transferred funds have the same tax basis, composed of after-tax dollars. This is not, to use IRS parlance, a taxable event.

However, you should check how to handle any employer matching contributions because those will be in a companion regular 401(k) account, and taxes may be due on them. You can establish a new Roth IRA for your regular 401(k) funds or roll them over into an existing Roth.

The Five-Year Rule

You can withdraw contributions, but not earnings, from your Roth at any time without penalty or taxes, no matter your age. Remember, you’ve already paid income taxes on that money.

However, Roth IRAs are subject to the five-year rule. This rule states that you must have held the Roth IRA for at least five years to withdraw earnings—that is, interest or profits—from a Roth IRA. The same rule applies to withdrawing converted funds—such as funds from a traditional 401(k) that have been deposited in a Roth IRA.

When the Five-Year Rule Applies

When funds are rolled over from a Roth 401(k) to an existing Roth IRA, the rolled-over funds inherit the exact timing as the Roth IRA. In other words, the holding period for the IRA applies to all of the funds in the account, including those rolled over from the Roth 401(k) account.

If you do not have an existing Roth IRA and need to establish one for the rollover, the five-year period begins the year the new Roth IRA is opened, regardless of how long you have been contributing to the Roth 401(k).

If you roll a traditional 401(k) over to a Roth IRA, the clock starts ticking from the date when those funds hit the Roth. Withdrawing earnings early, typically before age 59½, could incur taxes and a 10% penalty. Withdrawing converted funds early could incur a 10% penalty.

The rules governing the early withdrawal of funds in a converted Roth IRA can be confusing. There are exceptions to the tax and penalty consequences related to whether you are withdrawing earnings rather than your original after-tax contributions. There are also certain qualifying life events, notably a job loss, that can change the picture. Check the rules before withdrawing funds early.

How to Do a Rollover

The mechanics of a rollover from a 401(k) plan are fairly straightforward. Your first step is to contact your company’s plan administrator, explain exactly what you want to do, and get the necessary forms.

Then, open the new Roth IRA through a bank, a broker, or an online discount brokerage. (Investopedia has lists of the best brokers for IRAs and best brokers for Roth IRAs.)

Finally, use the forms supplied by your plan administrator to request a direct rollover, also known as a trustee-to-trustee rollover. Your plan administrator will send the money directly to the IRA you opened at a bank or brokerage.

Alternatives to a Rollover

As an alternative, the administrator can send the check to you, made out in the name of your account, for you to deposit. A direct rollover is a better approach. It’s faster and simpler, and it leaves no doubt that this is not a distribution of money (on which you would owe taxes).

If the administrator insists on sending the check to you, make sure that it is made out to your new account, not to you personally. Again, that’s evidence that this is not a distribution.

Another option is to take an indirect rollover. In this case, the plan administrator will send you a check made out to you after withholding taxes at a rate of 20%, and you will then record the distribution and the taxes already withheld on your income tax return.

Roth IRA Income Limits

Anyone can contribute to a traditional IRA, but the IRS imposes an income cap on eligibility for a Roth IRA. Fundamentally, the IRS does not want high earners benefiting from these tax-advantaged accounts. In 2024 and 2025, the annual contribution limit for IRAs is $7,000 or $8,000 if you are age 50 or older.

The IRS can adjust income caps annually to keep up with inflation. In 2024, eligibility to contribute to a Roth IRA phases out as your modified adjusted gross income (MAGI) rises from $146,000 to $161,000 for single and head-of-household filers. In 2025, eligibility phases out as your MAGI rises from $150,000 to $165,000 for single and head-of-household filers.

That means if your MAGI is less than $146,000, you can contribute up to the full limit of $7,000 if you are less than 50 years of age or up to $8,000 if you are age 50 or older. But the higher your MAGI is above $146,000, the lower the amount you are allowed to contribute until your maximum allowable contribution hits $0 for a MAGI of $161,000 or more. For married couples filing jointly, the income phase-out range is $230,000 to $240,000 in 2024 (or $236,000 to $246,000 in 2025).

And this is why, if you have a high income, you have another reason to roll over your 401(k) to a Roth IRA. Roth income limits for contributions do not apply to this type of conversion. Anyone, regardless of income, is allowed to fund a Roth IRA via a rollover—in fact, it is one of the only ways. The other way is to convert a traditional IRA to a Roth IRA, also known as a backdoor conversion.

Each year, investors may choose to divide their funds across traditional and Roth IRAs as long as their income is below the Roth limits. However, the annual contribution limits apply to any combined contribution. For example, in 2024 and 2025, you can kick in up to a maximum of $7,000 (if you are younger than age 50), and it does not matter whether you put it all into one or more traditional IRAs or one or more Roth IRAs or any combination of them.

A Few Other Options for Your 401(k)

There are a few other options to consider if you are exploring ways to roll over your 401(k).

401(k) to 401(k) Rollovers

If you’re taking a new job, there is no tax bite when you roll over your traditional 401(k) balance to another traditional 401(k) at a new job or, alternatively, roll over a Roth balance to another Roth balance. However, rollovers are subject to the rules that govern your new company’s plan.

It might not be feasible if the assets in your old plan are invested in proprietary funds from a certain investment company and the new plan only offers funds from another company. Similarly, if your account contains your old employer’s company stock, you might have to sell it before the transfer.

A transfer also won’t work if your old account is a Roth 401(k) and the new employer only offers a traditional 401(k). If this is the case, then you need to roll your Roth 401(k) into a Roth IRA that you open on your own—or leave it in your current employer’s plan, if the plan rules permit that.

The optimal scenario would be to roll your old Roth 401(k) into a new Roth 401(k) at your new employer. The number of years when the funds were in the old plan should count toward the five-year period for qualified distributions.

The previous employer must contact the new employer concerning the amount of employee contributions that are being rolled over and confirm the first year when they were made. To avoid a bookkeeping headache and tax hassle in the future, you—the account holder—should transfer the entire account, not just a part of it.

Avoid Cashing Out

Cashing out your account, in whole or in part—whether the account is traditional or Roth—is usually a mistake.

• On a traditional 401(k) plan, you will owe taxes on all of your contributions, plus the 10% for early withdrawals if you are under age 59½.
• On a Roth 401(k), you will owe taxes on any earnings that you withdraw and be subject to the 10% early withdrawal penalty if you’re under age 59½ and have not had the account for five years.

The Bottom Line

Although they are perfectly legal, retirement account conversions have complicated tax rules, and the timing can be tricky. The ideal candidate for rolling an employer-sponsored retirement fund into a Roth IRA is someone who does not expect to take a distribution from the account for at least five years.

Those account owners who are age 59½ or older are exempt from the 10% early withdrawal penalty, as are those who transfer the 401(k) funds into an existing Roth IRA that was opened five or more years ago. This exemption allows the rolled-over 401(k) funds to be withdrawn without penalty.