For years, I have told my clients regardless of income to rollover their 401k plan into an IRA when they change jobs.
Main Advantages to Rolling Over Your 401k Plan to an IRA:
- Consolidates all of your retirement assets in one place (especially if you have several jobs all with 401k plans)
- You control your investments especially important if your old employer had poor investment choices in their plan
Now for some higher income earners you may be better off keeping the money in your old plan or rolling directly to your new employers plan.
Here’s why:
- Beginning in 2010 the $100,000 income limit to convert a Traditional IRA to a Roth IRA is lifted.
- But if you do convert your Traditional IRA to a Roth all of your Traditional IRAs are treated as one IRA for the purposes of conversion. If you have a large Rollover IRA with no basis, and a smaller Traditional IRA that no made non-deductible contributions to they will be treated as one IRA and you will have to pay tax on most of the conversion.
- If you don’t rollover your 401k to a IRA the only Traditional IRA you would have is the one you made non-deductible contributions to. When you convert to a Roth IRA you would only pay taxes on the earnings of your Traditional IRA.
Example 1:
Jane has a 401k worth $200,000 and a Traditional IRA that she made non-deductible contributions to of $20,000. She rolls the 401k into a Traditional IRA so now she has:
Rollover IRA $200,000 (Basis = 0) All of her 401k contributions were tax deductible
Traditional IRA $20,000 (Basis = $18,000) Non-deductible contributions =$18,000, earnings = $2,000
She decides to convert $20,000 to a Roth IRA in 2010.
Since all of her IRAs are added together for the purpose of conversions $18,000 of the conversion will come from her Rollover IRA and $2,000 will come from her Traditional IRA.
Assume Jane is in the 25% tax bracket.
Taxes = $18,000 X 25% (Rollover IRA) + $2,000 X 10% (portion of Traditional IRA that is taxable) X 25% = $4,500+50 or $4,550
Example 2:
Jane does not rollover her 401k into a Rollover IRA but either leaves it in her old employer plan or rolls it into her new employer plan. Therefore she only has her Traditional IRA
She decides to convert her $20,000 Traditional IRA to a Roth IRA
Taxes = $20,000 X 10% (Portion of Traditional IRA that is taxable) X 25% =
$500
By not rolling over her 401k into an IRA Jane would save over $4,000 in taxes.