Reader Question – Rollover A 401k Retirement Plan Or Fund A Roth IRA?

by Hank Coleman

I recently received this question from a reader through the contact page of the site about a 401k rollover. If you have questions that you would like me to tackle, feel free to contact me through the site or send an email. I appreciate the chance to answer anyone’s question.

My husband recently switched jobs, and we have around $115,000 in his old job’s 401k. I’m not sure if we should switch it over to our new company’s 401k or into a Roth IRA. We have just purchased a large piece of land to build a house and do not have the money to pay the taxes out of our pocket on the money that will go into the Roth IRA. If we were going to pay the taxes on it, it seems like we should just withdraw the money and put down on our land and house payment.

There are a couple of options that you have, and a few things that you should consider.

You Should Not Withdraw Money To Pay For Taxes

Is it time to retire?You should not withdraw money from your retirement accounts to pay for the taxes that will be imposed on you when you convert a pretax retirement plan such as a 401k rollover to an after tax plan like the Roth IRA. The best possible thing to do is to pay the taxes that you will owe on the conversion with savings and not dip into your retirement funds. From your question, I understand that you are not in favor of that method. Do not tap your 401k or Traditional IRA to pay the conversion tax. You will lose a lot of future earnings if you pay the taxes out of your 401k plan income. Also, if you pay for the tax bill out of the proceeds from your 401k plan, you could be charged with the 10% penalty for early withdraw if you are not 59 ½ years-old.

There Is Nothing Wrong With A 401k Rollover

Your 401k retirement plan is your money. It is your asset. There is nothing wrong with taking your investment with you to a new employer. If you think that you will be in the same tax bracket or even a lower one in retirement, a 401k retirement plan may be a good choice for you. And, a 401k retirement plan that has an employer match is always the best investment and the first place people should put their money to work for them. It is like earning a guaranteed 100% return on your money. While you can leave your old 401k plan with your former employer as long as you like, I am a big fan of the idea of a 401k rollover into a new 401k in your new employer’s 401k retirement plan. I like having it close. I like having investments as centralized as possible. It helps me manage all of my investments. Also, if you have a problem, your human resources department should be able to help you or get you help. That wouldn’t be the case if you left your plan with your old employer.

Consider Paying Off One Mortgage Before Moving On To Another

I am not a big fan of withdrawing money from retirement plans to pay for real estate and land. That is not what the money and the accounts were designed for. They were meant for your retirement. You can borrow money for your home, but you cannot borrow money for your retirement. You are putting your future at risk by dipping into your retirement accounts for real estate. Do not use the tax bill as an excuse to withdraw your money for your real estate purchases or down payment if at all possible. Also, I am concerned that you will have or have multiple mortgages outstanding. If at all possible, you should sell one home before taking out a mortgage on another home. Having two mortgages unexpectedly without being able to quickly sell the old home is a speedy recipe for foreclosure.

You definitely have a tough choice, but I don’t think that the negative consequences of making the least preferred choice are anything to have total anxiety about. In your email, you sounded very concerned about whether to keep the money in a new 401k retirement plan, conduct a rollover 401k, or even roll it over to a Roth IRA. Each is a great option, but your best choice may depend on your tax situation as well. The Roth IRA is a great option if you can pay the tax bill out of savings. A 401k retirement plan 401k rollover is a great option of taking your money with you, and you may find your tax bracket could be lower in retirement negating the benefits of the Roth IRA altogether.

I think that you are on the right track, and I hope that answered your question. If not, feel free to leave a comment in the comment section below for more discussion.

(photo credit: Shutterstock)

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Working Mom of 2 December 20, 2010 at 12:06 pm

In “The Gospel of Roth- The Good News About Roth IRA Conversions and How They Can Make You Money” by John Bledsoe it clearly states in the book that NO ANALYSIS is needed and that everyone should convert to a Roth IRA regardless of income. There is NO risk! The IRS is giving us a year to recharacterize or “undo” the conversion. This book gives the ins and outs for Roth IRAS! It really helped answer all my questions.

Hank Coleman December 20, 2010 at 12:25 pm

“No Analysis” and “No Risk” are pretty bold statements and hard to believe in the investing world in almost every context. While I have heard good things about Mr. Bledsoe and his book, I would not go so far as to characterize Roth IRA conversions as no risk with no analysis needed. Mr. Bledsoe recommends recharacterizing the IRA is things go wrong, but remember that the recharacterization deadline is October 17, 2011.

Converting Traditional IRAs to Roths are a great option, but my one concern is what account people pay their tax bill from. Most will not have the taxes required from their savings. Most will pull it out of their investments at a detrimental price years down the road

Leon Coutinho December 25, 2010 at 3:16 pm

Praise the lord for pension plans. Don’t know what I would do without it!!

ramiro villarreal January 20, 2011 at 2:57 pm

Hi I had my 401 transfered from my job when we were layed off so it went to Fidelity investments into the mutual funds as a rollover ira.I am 61 years old so can I take the money out and put it in my bank without penalty.I have a hard time trusting the stock market though lately my funds have done fairly well.

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