5 Times a Roth 401k Conversion is a Good Idea

5 Times a Roth 401k Conversion is a Good Idea

Roth IRAs have become one of the most popular ways to build retirement savings over the years.  In fact, they’re so popular that thousands of people clamor every tax season to convert their traditional IRAs to Roth IRAs.

This conversion is one of the most popular financial planning moves, since it can reduce your tax burden and eliminates required minimum distributions (RMDs).

More recently, a new form of Roth account has emerged: Roth 401k plans.  Roth 401k plans are essentially the same alternative to traditional 401k plans that Roth IRAs are to traditional IRAs.  Contributions are made after tax, and gains and withdrawals are tax free.

And with Roth 401k plans on the scene, many sponsors are starting to allow their participants to convert their traditional, pretax 401k balances into Roth, after tax balances.  This transition is known as a Roth 401k conversion.

Roth 401k conversions are not unlike Roth IRA conversions.  The transition will create taxable income, but your assets will never leave your employer’s 401k plan.

Here’s how one might work:

  • Johnny has a $100,000 saved up in his employer’s 401k plan.  He didn’t pay any income tax on his contributions, and they will continue to grow tax free until he starts taking withdrawals.
  • When he starts taking withdrawals after age 59 1/2, he’ll owe income tax on every dollar he takes out of his account.
  • If Johnny were to convert his 401k contribution to Roth contributions, he would owe income tax on the entire $100,000 this year.  His account would continue to grow tax free as it would have otherwise.
  • But, when he begins taking withdrawals down the road, they won’t be taxable income to Johnny.  Essentially, he would be paying his tax burden now instead of later.

Conversions can be appealing.  You pay taxes on the account now, rather than in the future when you might be in a higher bracket.  But the decision is not always so cut and dry.  And since this is a question I get in my practice from time to time, I thought it’d help to share 5 circumstances where a Roth 401k conversion is a good idea.


5 Times a Roth 401k Conversion is a Good Idea:

1)  You’ll be in a higher tax bracket in the future

It’s not hard to find online resources about whether a Roth IRA conversion is a good fit for you.  Here’s some info from Charles Schwab, and some more from Jeff Rose.

If you check out both the links above, you’ll notice they both suggest that you estimate your future tax bracket to help you decide whether a Roth IRA conversion is a good idea.

Remember the difference between a traditional and Roth IRA here:

  • In a traditional IRA, your make tax deductible contributions.  Those contributions grow tax free, and your withdrawals at retirement age are added to your taxable income.  In other words less tax now, more tax later.
  • In a Roth IRA, your contributions are not tax deductible.  Instead, they grow tax free within the account and your withdrawals at retirement age are tax free.  In other words more tax now, less tax later.

If you’re deciding whether to convert your traditional IRA to a Roth IRA, you’ll probably want to consider your tax liabilities.  If you think you’ll be paying higher taxes in the future, you might want to pay taxes now by moving forward with the conversion.  This could be because you think you’ll be in a higher bracket in the future, or you think that you’ll be taxed more in general.

Of course, if you’re in the middle of your career and in your peak earnings years, the opposite might be true.  You might plan on being in a lower tax bracket in your retirement years than you are now.  In this case, you’d be better off deferring taxes now, and paying them later by keeping your money in the traditional IRA.

A Roth 401k conversion isn’t all that different from a tax perspective.  If you think you’ll be in a higher tax bracket down the road, it might sense to go ahead with the conversion.


Roth 401k Conversions Are Not the Same as Roth IRA Conversions

There is a key difference between a Roth 401k conversion and a Roth IRA conversion though.  With a Roth IRA conversion you can back out of your decision any time before your taxes are due.

This can be a very handy for tax savvy investors.  Let’s use Johnny again from our previous example (Johnny’s getting a lot of attention today).

In addition to his 401k at work, let’s assume that Johnny has $100,000 in a traditional IRA.  In November, he decides he’s going to convert the entire balance to a Roth IRA.

If Johnny is in the 25% tax bracket, he’d owe $25,000 on the conversion.  Let’s also assume that the stock market takes a tumble in March before Johnny’s taxes are due.

He can actually recharacterize the conversion and back out of his decision.  If his account falls 20% after the market correction, this would make a lot of sense.  Rather than owing $25,000 (25% of $100,000), he could postpone the conversion until the following year when his account has a lower balance.  If his account stayed level after the 20% drop, this would be a tax bill of $20,000 (25% of $80,000).

This is a handy move for Roth IRA conversions, but isn’t allowed in Roth 401k conversions.


2)  You Won’t Need to Use the Money in Retirement

One of the pesky drawbacks of traditional IRAs and 401k plans are the required minimum distributions, or RMDs.  Since the IRS doesn’t want us to leave money in tax advantaged retirement accounts forever, they’ll make you take withdrawals once you turn 70 1/2.

Essentially, you’ll take the account balance on the December 31 of each year, and divide by your life expectancy.  This is the amount you’ll need to take out of the account each year and pay tax on.

With Roth accounts, you’ve already paid the tax – either on your initial contribution or when you converted the account.  Since you’ve already paid the tax due, and the IRS isn’t sitting around waiting for their money, they don’t impose RMDs on Roth IRAs.

The IRS does require RMDs on Roth 401k plans however, unless you’re still employed at the company sponsoring the retirement plan.  Fortunately there’s an easy workaround, since it’s simple to roll over your Roth 401k assets into a Roth IRA.  This can be done easily at any brokerage firm, without complications, taxes due, or fees.

This is a huge advantage of Roth 401k features.  Without RMDs, you can keep your retirement dollars in a Roth IRA and continue to let them grow tax free.

If you don’t need your 401k money to live off of in retirement, a Roth conversion might be a good idea.  It will leave you more flexibility in the future and save you from forced, taxable withdrawals.


3)  You Have Plenty of Cash in the Bank

The biggest drawback of Roth 401k conversions might be the immediate tax implications.  Any amount converted will be added to your adjusted gross income for the year.

You’ll also want to pay this bill out of pocket.  Paying the tax due directly from your newly converted 401k balance is considered a distribution subject to penalty.  Not only would you be paying tax, but the IRS would tack on an additional 10% penalty.  Long story short, you’ll only want to move forward with a Roth 401k conversion if you have enough cash to pay the taxes out of pocket.


4)  You Don’t Like the Current Market Outlook

Since a Roth 401k conversion will require a large cash outlay, it might be a good time to convert if you think the markets are entering a period of poor returns.

*Disclaimer* I am NOT a fan of trying to time the markets and predict when stocks or bonds might be headed higher or lower.  But despite my personal philosophy, many people feel very uncomfortable when they’re invested in the markets at certain times.

If this is you, and you have some cash sitting on the sidelines that you don’t feel comfortable investing, why not put it toward a Roth 401k conversion?  If you can’t find any decent investment opportunities, it might make a lot of sense to get your tax burden out of the way.


5) You Plan to Work Beyond Age 65

Working beyond the traditional retirement age can also make a Roth 401k conversion a good fit.  If you do plan to continue working, you’ll have taxable income for a longer period of time.

If you supplement your earnings with distributions from a traditional retirement account, your tax liability will be pushed even higher.  But if instead your retirement savings were in a Roth account by virtue of an in-plan conversion, your withdrawals wouldn’t be taxable.

This is a helpful way to manage your tax liabilities throughout retirement, and is known as tax diversification.


5 Times a Roth 401k Conversion is a Good Idea



Posted in Company Retirement Plans, Financial Planning, Investing, Retirement, Taxes & Accounting and tagged , , , .


  1. This is the first time I hear of Roth 401K conversions. My company has the Roth 401K contribution option, but I am not using that option, only the regular 401k. But if you are nearing retirement age and still working, I would assume it would beneficial to only add new money to Roth 401Ks as you will have a lessor tax burden.

    • Absolutely – sometimes that is certainly the case. It just depends on when you prefer to get your tax burden out of the way.

      Many people I speak with who are approaching retirement prefer to make traditional contributions as opposed to Roth. They’re in a higher bracket now than they will be in retirement, so it makes sense to postpone paying taxes until they’re in a lower bracket down the road. Conversions are a different story.

  2. Are there any restrictions or percentage requirements of how MUCH you must convert at any one conversion from Traditional-401k to Roth-401k. Our a limit as to how many times a year you can do this, etc.?


    • Not from the IRS’s point of view. From their perspective you can do as many as you like without a minimum. Remember though that your plan has its own parameters, and can establish conversion minimums or frequency restrictions. Best thing to do is call your plan administrator & ask them.

  3. Interesting. I’ve been maxing out my Roth 401k ($18,500) and my Roth IRA, and I still have about another $15,000 that I can invest every year. I have about $250,000 balance in my regular 401k from Safe Harbor Matching, Roll-overs, and Discretionary Profit sharing. I’m only 46, and I wouldn’t mind moving that $250,000 to the Roth 401k category. It would probably be relatively trivial to convert about $65,000/yr for each of the next 4 years using that $15,000 excess. I’d probably just be putting it into a S&P 500 passive ETF anyway to pay taxes in 20 years. From the sound of things, I could use it to convert a quarter of my traditional 401k every year. (I suspect the amounts would work out. I might even be able to do it in 3 years with about $82,000/year.) Is my logic right?

    • The logic sounds right to me. What I typically do with my clients is run a tax projection toward the end of each year. When you know where you’ll stand tax wise you can zero in the optimal amount of Roth conversion so as not to jump into a new tax bracket. In other words, be thoughtful about filling up the bottom tax brackets with Roth conversions whenever you have the opportunity. If you’re 46, it may make sense to stretch the period out a little longer.

  4. I Recently received half of my ex spouse 401k. On own divorced. Not sure where to put it in. I’m disabled not working at the moment. Should I put it in a Roth 401k? Roth IRA?

    • Tp get a better answer, you will probably have to provide more details of your age and what government benefits you receive.

      I’m not a financial advisor but I’ve done some reading and I can take a stab. I’m assuming you said you received a 401k traditional? I’m not sure if that’s possible but if it is and you have “zero” income, you should take advantage of the low tax bracket and convert at least partially (annually) into an IRA Roth. But make sure you will be able to afford the conversion without penalty. If you don’t have “income” the partial annual conversion should be tax free.

      But if you receive disability or government benefits, that would further complicate matters and would be off topic as converting may affect your benefits. Remember, conversion is income so that would need a separate discussion with the benefits Dept.

  5. I’m trying to decide whether to convert traditional 401k funds to a Roth 401k or to convert a traditional IRA to a Roth IRA. Is one better than the other? I know that the rules changed recently. Thanks in advance.

    • Hi John, there are a lot of factors involved, including the specifics of what your 401k plan does or doesn’t allow. Feel free to reach out directly if you’d like to walk through it.

  6. Can do a 401k to 401k ROTH conversion this year ’18 even though I maxed my traditional ROTH contributions in January ’18. I retired in April ’18 at 58.
    I would like to do ~100K a year for the next view years to reduce my RMD’s in the future and impact on SS reduction.

    • I don’t believe there are any IRS restrictions, so it’ll depend on the specifics of your 401k plan document. If your plan allows Roth 401k conversions and there’s no specific language preventing same year conversions (which would be rare), you should be fine.

  7. The article should perhaps be updated for the new tax laws that don’t allow recharacterization of IRA conversions (for any conversions after Jan 1, 2018). Therefore, traditional IRA conversions are very much like 401k conversions. I’m not sure whether that change will end with the end of the lower tax brackets, though.

  8. #4 – You don’t like the current market outlook doesn’t make sense to me. By converting and paying the taxes, you are essentially buying more of the bucket of funds in the account. So if you think the price will go up, it makes sense to convert. If you think the price will go down, it makes sense to wait

  9. Hello &Blessings,
    I am considering an in plan Roth conversion with my Pre-tax 401k account and I don’t know if I should. The balance in the account is $47,500. Employer does not match it. I am 51 years old and still plan to work with my same employer for another 15 years. I am in the 24% tax bracket. I look forward to hearing from you. Have a blessed day!

  10. When a Solo 401k is converted, how is the value of the account calculated in instances where the Solo 401k has acquired a loan to make investments in real estate or private businesses? For example, if total assets of a traditional Solo 401k are $500k and liabilities are $300k (used to invest in real estate and a private company), the net asset value is $200k. What is the amount that has to be taken into income? I know this sounds simple but cannot locate a specific IRS source to answer the question.

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