Moving funds from a 401k or executing an ira rollover from a traditional or ‘simple’ arrangement to a Roth IRA will enable your money to continue growing, if you follow the rules for rollovers, and after it is taxed, that is.
Conversion to Roth
The Roth has a few benefits not available through other retirement arrangements, such as tax free distributions and no age limit for starting them. If you are rolling over funds from a 401k, the reasons usually have to do with no longer being employed. Contributions can no longer be made when you stop working, so it makes sense to move the money. In the case of rolling over a traditional ira, the reasons may be different.
In the traditional arrangement, money is not taxed going into the account, but is taxed as regular income when distributions begin. Statistically, the Roth fares better on average because of the difference in taxation, but results can vary depending on how the account is handled. It also has advantages for estate planning, however. While the traditional account is penalized 50 percent if the funds are not distributed by the 70 ½ year of the owner, the Roth has no such limitations. Money in this account can grow and be passed on to the next generation.
Taxation and Contribution
The income from a 401 (k) or traditional ira will be taxed as regular income in the year it is rolled over. If the account is a Roth 401 (k) being put into a Roth IRA, the funds will not be taxed if the transaction is completed within the allotted time period. This arrangement has other advantages, however; contributions from a rollover may be withdrawn tax free and without additional penalties after a period of five years, as can direct deposits after this same time period.
There is no limit to the amount the individual can move in an ira rollover, but contributions for both traditional and Roth are fixed at $5,000 for both arrangements in 2010. If the participant is over fifty years of age, the total is $6,000. Also, although converted money is taxed, the law allows for the tax to be split in half over two years.
Limitations
The major drawback to rollover ira’s is being taxed on the income, which may reduce retirement income depending on your age at the time. This is especially true with the Roth, which requires a five-year waiting period on earnings before they can be taken out. There are also adjusted gross income eligibility limits with the Roth. Anyone making over $120,000 if they are single, or over $177,000 for people in a marriage with a joint return, is not eligible.
A rollover ira is a useful tool when someone retires early and is not ready to use the money from an employer-sponsored plan. In addition, the money is in an environment where it can grow, and still be accessed for buying a new home, or to support un-reimbursed medical expenses. By moving the funds into another tax-deferred account, they can continue to work and still build a large nest egg for themselves or future generations.
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