I Have $640k in a 401(k). How Do I Avoid Paying Taxes When Converting to a Roth IRA? (2024)

Mark Henricks

March 6, 2024 at 1:48 PM·5 min read

I Have $640k in a 401(k). How Do I Avoid Paying Taxes When Converting to a Roth IRA? (1)

Converting a 401(k) to a Roth IRA can potentially provide valuable long-term benefits, but it also triggers a tax bill that you’ll need to plan for. While the taxes on a Roth conversion can’t be avoided, savers can reduce the burden through several strategies like gradual conversions and timing adjustments. Those nearing retirement can weigh whether they have enough time left to offset conversion taxes through decades of future tax-free growth.

Roth Conversion Mechanics

When moving savings from a traditional IRA or 401(k) to a Roth IRA, savers must pay income tax on the converted amount since this money was originally contributed pre-tax. These conversion taxes are unavoidable, so there’s no way to completely get around paying income taxes on a Roth conversion. Taxes are levied on Roth conversions as if the money were ordinary income, meaning that a large Roth conversion can trigger a large tax payment in the year of the conversion.

Despite the potential for a significant tax bill, the benefit of tax-free growth going forward may make it worthwhile. Depending on an investor’s time horizon, income sources and other factors, the upfront tax hit may pay off over the long term. (If you have additional questions concerning Roth conversions and other retirement planning topics, consider working with a financial advisor.)

Tax Strategies for Roth Conversions

I Have $640k in a 401(k). How Do I Avoid Paying Taxes When Converting to a Roth IRA? (2)

How you carry out your Roth conversion can impact the taxes you'll pay on it. One way to reduce conversion taxes is to spread the conversion over multiple years rather than all at once. By gradually converting smaller chunks, taxpayers may avoid getting bumped into higher marginal income tax brackets. Spreading a $640,000 conversion over four years, for example, may help utilize more space under lower tax brackets.

Another strategy is to time your conversions for years in which you have lower income from other sources. As with the gradual conversion strategy, this can keep your income from rising into higher tax brackets and potentially limit your tax liability.

401(k)-to-Roth Conversion in Action

Imagine you’re a 60-year-old single filer with $640,000 in a 401(k) and an annual income that places you, at the highest, in the 24% federal tax bracket in 2024. Converting the entire 401(k) this year would add $640,000 to your income, pushing you into the top 37% bracket on every dollar over $609,350.

Instead, let's consider a gradual conversion. Converting just $128,000 of your 401(k) balance per year over five years would push every dollar over $191,950 into the next-highest bracket of 32%, helping you avoid the 35% and 37% brackets in the process. (Actual results will vary based on annual tax bracket changes and the inclusion of state-level taxes.)

Now let's look at what might happen if you converted your 401(k) in a year when the market was down 10%. The $640,000 balance might decline an equivalent amount, falling to $576,000. While this would still put you in the top 37% bracket, taxes on the converted amount would decline quite a bit. (If you need help running projections like these, consider working with a financial advisor.)

Making the Call

I Have $640k in a 401(k). How Do I Avoid Paying Taxes When Converting to a Roth IRA? (3)

Converting a 401(k) to a Roth IRA may not always be the right move. Before converting, savers should consider their retirement timeline and anticipate whether decades of future Roth growth could outweigh conversion taxes owed now.

Generally speaking, those nearing retirement may not benefit as much as someone who converted earlier in their career when they were in a lower tax bracket. It's also key to work out projections with a financial advisor mapping out various partial conversion scenarios. This analysis can reveal the optimal pace and amounts to convert each year to maximize outcomes.

Bottom Line

Converting a 401(k) to a Roth IRA triggers unavoidable taxes, but paced-out partial conversions may reduce the burden. Converting in years when income is down or the market has declined significantly may also help lower the overall tax bill. Generally speaking, weighing time horizons and projecting tax bracket impacts can inform conversion decisions. Consulting a financial advisor can be helpful when planning major retirement account moves.

Retirement Planning Tips

A financial advisor can help build a long-term retirement plan. Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.
Use SmartAsset's retirement calculator to estimate how much money you could have by the time you retire. The tool also shows you how much you may want to save every month to support your lifestyle in retirement.

Photo credit: ©iStock.com/Vadym Pastukh, ©iStock.com/Kameleon007, ©iStock.com/annebaek

The post I Have $640k in a 401(k). How Do I Avoid Paying Taxes When Converting to a Roth IRA? appeared first on SmartReads by SmartAsset.

I Have $640k in a 401(k). How Do I Avoid Paying Taxes When Converting to a Roth IRA? (2024)

FAQs

How do I convert my 401k to a Roth IRA without paying taxes? ›

If you decide to roll over your entire 401(k) balance, you can roll all your pre-tax dollars into a traditional IRA and all your nondeductible contributions into a Roth IRA. You wouldn't pay taxes on this type of conversion because you already paid taxes on your nondeductible contributions the year you made them.

Discover More ›

How do I avoid taxes on Roth IRA conversion? ›

While there's no way to avoid conversion taxes completely, you can restructure them to make this much more manageable. By staggering out your conversion or timing it for years in which you have low tax liability or portfolio losses, you can reduce the impact of a Roth IRA conversion.

Learn More Now ›

How much tax will I pay if I convert my 401k to Roth IRA? ›

You'll owe income tax on the entire amount that you convert from a traditional IRA into a Roth IRA in the year you make the switch. The amount of tax will depend on your income tax bracket and income tax rate—between 10% and 37%. 1 The money you convert is added to your gross income for the tax year.

Discover More Details ›

Can I roll my 401k into a Roth IRA without penalty? ›

Roll over your 401(k) to a Roth IRA

You can roll Roth 401(k) contributions and earnings directly into a Roth IRA tax-free. Any additional contributions and earnings can grow tax-free. You are not required to take RMDs. You may have more investment choices than what was available in your former employer's 401(k).

See Details ›

Can I roll my 401k into a Roth IRA and avoid taxes? ›

If you have after-tax money in your traditional 401(k), 403(b), or other workplace retirement savings account, you can roll over the original contribution amounts to a Roth IRA without paying taxes, as long as certain rules are met. (Note: Your plan's terms will determine when and how money is distributable.

Does converting 401k to Roth IRA count as income? ›

The amount you convert from a traditional account to a Roth account is treated as income—just like all taxable distributions from pretax qualified accounts.

Discover More ›

When should you not do a Roth conversion? ›

Your time horizon. Generally, if you will need the funds within the next five years, a Roth IRA is not a good choice. This is because a five-year waiting period is required if you are under age 59 1/2 before you can distribute the converted amount without owing the 10% additional tax.

What is the downside of Roth conversion? ›

Since a Roth conversion increases taxable income in the conversion year, drawbacks can include a higher tax bracket, more taxes on Social Security benefits, higher Medicare premiums, and lower college financial aid.

Get More Info Here ›

Do you have to pay taxes immediately on Roth conversion? ›

Taxes aren't due until the tax deadline of the following year, so you may have more than 15 months to pay the taxes on your converted balances. (Note: If you pay estimated taxes, you may need to make some payments sooner.)

Read On ›

At what age is 401k withdrawal tax-free? ›

Once you reach 59½, you can take distributions from your 401(k) plan without being subject to the 10% penalty. However, that doesn't mean there are no consequences. All withdrawals from your 401(k), even those taken after age 59½, are subject to ordinary income taxes.

Keep Reading ›

What are the disadvantages of rolling over a 401k to an IRA? ›

Some of the disadvantages of rolling over a 401(k) into an IRA include no loan options, a decrease in creditor protection, possibly higher fees, and the loss of a possible earlier withdrawal without penalty.

Keep Reading ›

Can I roll my 401k into a Roth IRA while still employed? ›

Many people roll over their 401(k) savings when they change jobs or retire. However, numerous 401(k) plans allow employees to transfer funds to an IRA while they are still with their employer. A lot of people only think about rolling over their 401(k) savings into an IRA when they change jobs.

Discover More ›

Can I move 401k to CD without paying taxes? ›

You can rollover your 401(k) account into a CD without any penalties or taxes. But you need to make sure you're rolling over into an IRA CD, specifically. And always ensure to roll over into a like-kind account, whether a traditional or Roth retirement account, or you might get hit with a surprise tax bill.

View Details ›

Can I transfer my 401k to my checking account? ›

Transferring Your 401(k) to Your Bank Account

That's typically an option when you stop working, but be aware that moving money to your checking or savings account may be considered a taxable distribution. As a result, you could owe income taxes, additional penalty taxes, and other complications could arise.

See Details ›

What is the 5 year rule for Roth 401k? ›

Contributions and earnings in a Roth 401(k) can be withdrawn without paying taxes and penalties if you are at least 59½ and had your account for at least five years. Withdrawals can be made without penalty if you become disabled or by a beneficiary after your death.

Can you convert directly from 401k to Roth IRA? ›

Yes, once retired or while still working if your plan permits in-service withdrawals from your 401(k). You can convert your traditional 401(k) either through a direct rollover to a Roth IRA or by rolling funds over to a traditional IRA, and then converting to a Roth IRA.

Discover More ›

What is the 5 year rule for Roth 401k to Roth IRA? ›

“If you open a Roth IRA for the first time in order to receive Roth 401(k) rollover funds, then you must wait five years to take a distribution penalty-free.” This rule wouldn't prevent you from withdrawing your original contributions after the rollover is complete.

View Details ›