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Dear Dr. Don,
I have a Roth IRA account and my current employer is about to lay me off. Will I be able to roll my 401(k) into a Roth IRA or do I have to roll the money into a traditional IRA?
-- Gillmore Grapple
Dear Gillmore,
The rules have changed for 2008 and future tax years. Prior to the current tax year, you would have to do an IRA rollover and then do a Roth IRA conversion. You can now skip the first step and roll the 401(k) monies directly into a Roth IRA.
Here's the notice from the IRS concerning this change:
Prior to 2008, you could only rollover (convert) amounts from either a traditional, SEP, or SIMPLE IRA into a Roth IRA. After 2007, you can rollover amounts from the following plans into a Roth IRA.
- A qualified pension, profit-sharing or stock bonus plan (including a 401(k) plan),
- An annuity plan,
- A tax-sheltered annuity plan (section 403(b) plan),
- A deferred compensation plan of a state or local government (section 457 plan), or
- An IRA.
Any amount rolled over is subject to the same rules for converting a traditional IRA into a Roth IRA. See "Converting From Any Traditional IRA Into a Roth IRA" in Chapter 1 of Publication 590. Also, the rollover contribution must meet the rollover requirements that apply to the specific type of retirement plan.
Here's the Chapter 1 conversion information from IRS Publication 590, "Individual Retirement Arrangements":
Converting From Any Traditional IRA Into a Roth IRA
You can convert amounts from a traditional IRA into a Roth IRA if, for the tax year you make the withdrawal from the traditional IRA, both of the following requirements are met.
- Your modified AGI for Roth IRA purposes (explained in Chapter 2) is not more than $100,000.
- You are not a married individual filing a separate return.
Note. If you did not live with your spouse at any time during the year and you file a separate return, your filing status, for this purpose, is single.
In your shoes, I'd discuss this with a tax professional before deciding to roll the 401(k) monies into a Roth IRA. That's especially true if you have any company stock in your 401(k) plan.
Professional tax advice concerning the net unrealized appreciation impact of these holdings could save you a bundle in taxes.
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