A: Yes, the tax law allows funds in a company retirement plan such as your 401(k) to be converted to your Roth IRA.
Assuming you are eligible to move the funds out of your 401(k), you should first ask the company if it will allow you to do two separate direct rollovers. One would be from the 401(k) to your traditional IRA. That rollover will be tax-free.
The other direct rollover would be for the remaining funds you want to convert to your Roth IRA. That direct rollover would be a taxable Roth conversion.
It's important that these be direct rollovers, and not 60-day (indirect) rollovers. A direct rollover means that your 401(k) funds will be transferred directly from your 401(k) to your traditional IRA and Roth IRA without you touching the funds in between. You should not get a check made out to you personally. If you do, the company will be required to withhold 20 percent for federal taxes, and you will only receive a check for the remaining 80 percent.
That means you'll only have 80 percent to complete the rollover. If the other 20 percent is not rolled over, it will be a taxable distribution to you. In addition, if you were under age 55 when you retired from your company, there could be a 10 percent penalty for an early distribution for the 20 percent withheld and not rolled over.
The only way to avoid this 20 percent withholding tax trap is by using other personal funds to complete the rollovers, but you may not have those funds available. Many people don't.
Now for another twist. Your 401(k) plan may not allow two direct rollovers. That's up to them, and some companies only allow one direct rollover. If that is the case, then just do one direct rollover of your 401(k) funds all to your traditional IRA. Then from there you can convert any amount you wish to your Roth IRA. This is an easy way to accomplish both a tax-free rollover of some funds and a Roth conversion for the rest. The funds converted to your Roth IRA, whether they come from the 401(k) or your IRA, will generally be taxable.
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Before you decide how much to convert, make sure you will have the funds available to pay the tax. Roth conversions are permanent. They cannot be undone. Once you do the Roth conversion, the tax will be owed, even if your financial circumstances change. If you can pay it, this once-and-done tax bill should not deter you from doing the Roth conversion, because your Roth IRA funds will be growing tax-free for the rest of your life. In addition, there are no Roth IRA required minimum distributions (RMDs) during your lifetime, so the funds can keep growing tax-free if you don't need them. And if you do need the funds in retirement, you'll be able to withdraw them tax-free, keeping your tax bill down. So, you get something for the tax money you paid when you converted.
You should do a projection of how much tax would be owed based on the other income you expect to have for this year. A tax adviser could help you with this projection and to set up estimated tax payments, so you'll have the tax properly paid in.
There may be one other issue when you do the rollover from your 401(k) — required minimum distributions (RMDs). If you are over age 72 and have left your company, you will be subject to RMDs from your 401(k) funds. Your RMD cannot be rolled over to your IRA or converted to your Roth IRA. That RMD amount would first have to be withdrawn from the 401(k) and only the balance would be available to be rolled over or converted.
As you can see, when you have funds in a company retirement plan like your 401(k), it's not as easy to do a Roth conversion as if you had the funds in your traditional IRA. But even with an IRA, if you are subject to RMDs, you still could not convert those RMDs to your Roth IRA. The main difference between converting your 401(k) and your own IRA is that the 401(k) is subject to company plan distribution rules, whereas with your own IRA you could easily withdraw or convert without going through the company's plan bureaucracy.
A: Good question. Like everything else when it comes to RMDs, there's always a tax rule twist. This is one of those issues, but only for this year. Here's why. The SECURE Act raised the RMD age to 72 from 70 1/2, but only for those who turned 70 1/2 in 2020 or later. And then the CARES Act waived RMDs for 2020. This combination of tax rules creates a bit of RMD confusion for IRA owners who turned age 72 this year (like you) who want to know what the 2021 RMD rules are.
The general rule when it comes to RMDs is that you must take your first RMD by April 1 of the year following the year you turned age 72, so it seems like you would have until April 1, 2022, to take your first RMD.
But that is only the case if you turned 72 after June 30, 2021. If you were 72 earlier in the year, then you must take your RMD by Dec. 31, 2021. You don't get to use the April 1, 2022, date because that is only for your first RMD. If you turned 72 in the first half of 2021, then you are subject to the age 70 1/2 RMD rules because you turned 70 1/2 in 2019. Your first RMD was due by April 1, 2020, but the CARES Act relief law waived RMDs in 2020 (including those for 2019 that were delayed until April 1, 2020). Only the RMD for the first year can be delayed until the following April 1. Nothing is easy!
Ed Slott, CPA, is a nationally recognized IRA expert, public television personality, author and media resource who has dedicated his life to educating Americans (and their financial professionals) on protecting retirement accounts from unnecessary taxes. His most recent book is The New Retirement Savings Time Bomb (Penguin Random House, 2021), Visit www.IRAHelp.com to learn more.