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Question: Should I convert my company 401(k) plan directly to a Roth IRA?
Answer: As you approach retirement, you may consider converting your company’s defined contribution plan to an IRA. Your own IRA generally gives you a wider investment choice and more control over your money than a company plan does. But, now, you can convert directly to a Roth IRA rather to a traditional IRA first. Should you?
Roth IRAs are a tax-advantaged qualified plan. What’s unique about them is their earnings and any withdrawals you make from them are tax free. But you fund them with “after tax” income. So there’s no deduction for contributions as there are with traditional IRAs.
Another important aspect of a Roth IRA is that, as owner, you never have to make a minimum required distribution as you do with other plans. This truly makes it the ideal “tax-free” investment vehicle for growing wealth.
The Pension Protection Act of 2006 permits you to convert your company retirement plan assets, including a 401(k), 403(b), and 457 plans, directly to a Roth IRA. Normal Roth conversion rules apply, such as penalties if you withdraw money within five years of conversion, and if you’re younger than 59 and a half.
Should you convert from your company plan to a Roth IRA?
One issue is you’ll need extra money to pay the taxes on your company’s plan money you convert to the Roth IRA. These taxes arise from the higher marginal income tax rates on all that extra income attributed to your company plan money that goes on top of your regular income.
If you’re nearing or beginning retirement, I would wait until you’ve stopped working so your “regular income,” now from pensions and Social Security, is much lower. That’ll help keep those marginal taxes attributed to the conversion somewhat lower.
You always can roll your plan into a traditional IRA. This triggers no tax – and therefore no significant cost to you. You can then map out your approach to retirement and convert the traditional IRA to a Roth IRA when it’s financially convenient.
Make sure you always do a direct rollover or conversion from the company plan to the IRA plan to eliminate any possibility of triggering unnecessary tax payments or tax withholding.
Wm. Steve Wright is managing member of The Wright Legacy Group LLC.
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