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If investments in a 401(k) have lost money, can you use the current value to convert to a Roth?

Investing, 401(k), IRAs
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April 2017

Converting your 401(k) retirement account to a Roth IRA when the value of your investments are down is a compelling tax strategy since you will only pay taxes on the current value.  Although there are some restrictions:

  • You must be separated from your employer to roll your 401(k) into a Roth IRA. You may not do this if you are still working for the same company and/or employer, unless you’re already older than 59.5.
  • Prior to January 2008, you weren’t able to roll your 401(k) into a Roth IRA. If you wanted to do so you had to open a traditional IRA then convert the traditional IRA to a Roth IRA. It all depends on your plan administrator.

Currently, most anyone can take all of their traditional IRAs and retirement plans and convert them to a Roth IRA. The amount you convert will be taxed.

You will want to do a rollover and not a distribution, otherwise your 401(k) provider will send you a distribution check from your 401(k), then they will hold around 20% for taxes. If you prefer a direct 401(k) rollover to a Roth IRA, you will want to indicate that you want a rollover and provide all the appropriate forms. If you do receive a distribution check, you will have 60 days to redeposit the check back into an IRA or convert to a Roth IRA.

If you employer offers a Roth 401(k), the rollover will be much easier. When you are converting one Roth product to another, there is simply no need for a conversion. You would simply roll the Roth 401(k) directly into the Roth IRA with the help of your plan provider.

Also, please consider the following before making the decision:

  • Do you expect to pay higher taxes in the future.
  • Roth IRAs use after-tax dollars, so you will have to pay taxes upfront on any funds you rollover. With a Roth IRA, your withdrawals will be tax-free.
  • You want to take withdrawals at your own discretion. Traditional IRAs force you to begin taking withdrawals at age 70.5, Roth IRAs do not have the required minimum distribution (RMD).
  • Keep in mind that if you do a Roth IRA conversion from a traditional IRA you may re-characterize your conversion if you decide to undo the conversion due to your investments going down even lower or if you do not have the funds to pay the taxes that year. When converting directly from a 401(k) to a Roth IRA the re-characterization is not an option.

Rolling your 401(k) into a Roth IRA, especially while your investments are down in value, makes sense but it is still wise to consult with your CPA and Financial Advisor to make certain taking into consideration your personal financial situation.

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