ricky j
Occasional Visitor

I have an old work 401k with about 21k in it. The last two years it has yielded between 12-16% in return. I have been open to the idea of rolling it into a Roth IRA for the tax benefits, but am not sure if I should because of the high return it is getting. When, if ever, is a good time to roll it into a Roth IRA? I know I will not keep getting high returns like forever, but should i move it while it is yielding such high returns? Or would the non-taxed gains of the Roth IRA yield a bigger return in the end (when i retire)? Also, I am not sure if i want to contribute to it seeing I already contribute to a 401k with my new job. I am thinking of just letting it sit and hopefully accrue. Thank you.

Most Helpful

Answers (1)

Answers (1)

Thanks for reaching out with a great question, and congratulations for building up a nice nest egg in your old 401(k). There are really two main components to your question: 1) Should you rollover your old 401(k) balance to a new custodian, and 2) Should you have the funds invested in a Roth IRA? Let’s look at each of these questions.

 

1. Should you rollover your old 401(k) to a new custodian? First, consider your options regarding your old 401(k) plan:

  • Option # 1: Leave the money in your former employer’s retirement plan
  • Option # 2: Rollover to your new employer’s plan
  • Option # 3: Rollover to an IRA
  • Option # 4: Take a Cash Withdrawal and Do Not Rollover (Usually not a good idea!)

Now, let’s assume that Option #4 is out (we hope), and now the question is really whether to keep the funds in an employer 401(k) - old or new employer, or rolling the funds to a new custodian as an IRA. At this point consider some of the following questions that may be important to you as to whether or not to keep the funds in a 401(k), or roll it to an IRA:

  • Will you need to borrow from your plan? Some 401(k) plans may allow for loans, IRA’s generally do not.
  • Will you need access to your funds early? Depending on your employment status, and the type of plan, you may be able to make penalty free withdrawals from a 401(k) before age 59-1/2.
  • Will you need to annuitize part or all your retirement plan investments? Some 401(k) plans may provide advantageous annuitization options.
  • Will your fees and expenses increase if you execute a rollover? The total cost of the 401(k) versus an IRA should be carefully evaluated before making a decision.
  • Will the quality of financial advice and guidance improve with a rollover? Seeking financial advice from a reputable source who puts your best interests first should be an important consideration no matter where you maintain your account balances.
  • Will you have access to more investment choices if you execute a rollover? Although more is not always better, it may be important to some people to have a greater selection of investment alternatives than what may be available within their old retirement plan.
  • Is creditor protection important to you? Although an IRA may be protected from creditors, depending on individual state’s laws, 401(k) plans are covered under ERISA, and may offer better protection from creditors.

2. When, if ever, is a good time to roll it (401k) into a Roth IRA? If your old 401(k) is already a “Roth 401(k)”, then we can stop now, and your only decision is number one from above. If the old 401(k) is not a Roth, and is what we call a traditional 401(k), then your next decision is whether to “convert” all or part of the traditional 401(k) to a Roth account.

  • It’s important to note that when you convert a traditional IRA to a Roth IRA, you're taxed as if you received a distribution, but with one important difference — the 10% early distribution tax doesn't apply, even if you're under age 59½.
  • However, the IRS may recapture this penalty tax if you make a nonqualified withdrawal from your Roth IRA within five years of your conversion. If you've made only nondeductible (after-tax) contributions to your traditional IRA, then only the earnings, and not your own contributions, will be subject to tax at the time you convert the IRA to a Roth.
  • But if you've made both deductible and nondeductible IRA contributions to your traditional IRA, and you don't plan on converting the entire amount, things can get complicated. Under IRS rules, the amount you convert is deemed to consist of a pro rata portion of the taxable and nontaxable dollars in the IRA.
  • In your case, if we assume that all contributions were made on a pre-tax basis, and your effective tax rate for the year of conversion is say 10%, then the tax on the conversion would be 10% x $21,000 = $2,100.

Is paying the tax for the conversion worth it? As you know, a Roth account grows tax free, and qualified distributions are tax free. If your time horizon is very long, and/or you expect to be in a much higher tax bracket when you take a distribution, then the conversion may be worth it. Although you could roll-over all or part of your traditional 401(k) to a traditional IRA, another option could be to keep the 401(k) where it is, as a traditional account. Going forward, you could make contributions to a Roth 401(k) if possible, or to a Roth IRA (again, assuming you have a long-time horizon, and/or you expect your taxes to be higher in retirement than they are now). That way, in retirement you will have two retirement buckets to choose from depending on your future tax situation.

 

It’s important to note that if you decide to rollover the 401(k), that you execute a custodian to custodian transfer (from your employer to the new custodian). Otherwise, if the funds are sent directly to you, then your former plan administrator will withhold taxes and you have only 60 days to redeposit the funds into a new retirement account such as an IRA or 401(k).

 

USAA does not provide legal, accounting or tax advice. To find out how your decisions may affect your tax obligations, we encourage you to consult your own tax or legal advisor.