Few people stay at the same job for their entire working lives. The idea that someone will work for 40 years at the same company only to get a gold watch and a pension is simply no longer realistic.
As such, most will jump between multiple jobs and even multiple industries. With that being said, it’s easy to forget some benefits from previous employers could still be a boon to you now, such as money you’ve left in retirement plans. Ty J. Young Wealth Management is one of the country’s leading wealth advisors for retirement planning. The firm’s founder and CEO, Ty Young, offered us insight into converting a retirement plan to a Roth and what one needs to consider first:
Don’t Forget that the Money Is Still Yours
If you began a 401(k) or another retirement plan with a previous employer and you didn’t roll it over, that money is rightfully yours and is waiting for you. What’s the right move, then? What will yield the best results and the most cash when you need it?
The Benefits of Roth
The basic difference between a Roth IRA/401(k) and a traditional IRA/401(k) is that Roths are taxed on the front end, meaning the money you invest in them now is taxed now. When you draw on a Roth plan at its maturity, the money is now yours, tax-free.
You might wonder if this detail truly makes a difference in how much money you’ll have in retirement. Here are some more reasons to consider a Roth.
If You’re Moving Into Higher Tax Brackets, You Want Roth
Taking the tax hit now is not a problem if you’re currently in a low tax bracket. As you advance in your career, you’ll ideally be earning more money. As this happens, the IRS will place you in higher tax brackets, which correlates to taking more money from your paychecks.
If you’ve paid lots of money in taxes while you were still in a lower tax bracket, you’ve gotten an excellent head start on your savings, and you’ll enjoy a tax-free lump sum of money later in life.
You Increase Your Investment Choices
Chances are that if you entered into an employer’s 401(k) plan, you had a few specific choices of mutual funds from a single provider. Rolling into a Roth IRA will give you far more investment opportunities, such as stocks, ETFs, and bonds.
Age Isn’t As Much of a Consideration
401(k)s and other retirement plans generally won’t let you withdraw money if you’re under 59 ½ years of age (at least, not without penalties). If you roll your old retirement plan into a Roth IRA, you can withdraw funds penalty-free for certain large expenses, such as purchasing a home or for higher education.
It Can Make Estate Planning Easier
When you pass, your old 401(k) will most likely be paid out to your beneficiary in a lump sum, and while that might sound like a positive, don’t forget that this sum will incur inheritance taxes, among other possible expenses.
If you want to ease your beneficiary’s burden, Roth IRAs will allow you to choose different payout options that won’t cause as many headaches.
Roth IRA vs. Roth 401(k)
You may be wondering whether you should roll your old account into a Roth IRA or a Roth 401(k). They both come with tax advantages regarding payments and payout, but a Roth 401(k) comes with a big disadvantage as compared to a Roth IRA.
With a Roth 401(k), you will have to take a required minimum distribution (RMD) once you turn 72 and are retired. A Roth IRA, in contrast, will allow you to withdraw any amount you like beginning at the age of 59 ½.
Be Aware of the 5-Year Rule
Finally, if you plan on rolling over to a Roth, remember that tax-free payouts begin five years after the Roth account has been opened. If you roll over your old account into a Roth, even if the previous account was also a Roth, that five-year waiting period may begin again. So if you do plan on rolling over to a Roth, make sure you can reasonably wait five years.