Many employers offer some type of retirement savings plan to help employees build their nest egg. Depending on your plan, you may be able to borrow against your account balance, but you generally won't be able to make withdrawals unless you retire or leave your job. If you're planning a career change or you're ready to leave the workforce altogether, converting your retirement savings to a Roth IRA has some potential tax advantages.
The IRS allows Roth IRA rollovers from a number of retirement savings plans. Generally, you can convert distributions from qualified plans, including 401(k)s, profit-sharing plans, money purchase plans, employee stock ownership plans, Keogh plans, defined benefit pensions, 403(b) plans, 457 accounts, SEP IRAs, SIMPLE IRAs and designated Roth accounts. Conversions of SIMPLE IRA distributions can only be completed if it's been two years since you received a contribution through the employer's plan. Although the IRS permits these types of conversions, you'll need to check with your plan administrator for any additional eligibility requirements. For example, if you're changing jobs, conversions may be limited to the part of your account balance that's vested.
There are three basic ways to convert your retirement plan savings to a Roth IRA. First, you can request a direct rollover, which means your plan administrator transfers the money out of your employee savings plan and into your Roth IRA for you. Second, you can complete an indirect rollover, which means the plan administrator sends the money to you and you're responsible for depositing it into your Roth account. Finally, if your plan doesn't allow for rollovers into a Roth IRA, you can deposit the money in a traditional IRA and convert it to a Roth later on.
If you opt for a direct rollover of your retirement funds into a Roth IRA, you won't pay any taxes on the money because qualified withdrawals are tax-free. If you choose an indirect rollover, your plan administrator will automatically withhold 20 percent for taxes. The 20 percent that's withheld will be counted as a taxable distribution unless you make up the difference when you complete the rollover. If you don't complete the rollover within 60 days, you'll have to pay income taxes on the total distribution. If you roll the money into a traditional IRA and then convert it to a Roth, you'll have to pay taxes on the distribution, but qualified withdrawals will still be tax-free.
If your retirement plan requires you to take minimum distributions once you reach a certain age, you can't convert the money to a Roth IRA even if you're still working. You also can't roll over distributions of excess contributions and related earnings. If you make a withdrawal from your Roth after a conversion but you're younger than 59 1/2, you may have to pay a 10 percent early withdrawal penalty on the money.
Rebecca Lake is a freelance writer and virtual assistant living in the southeast. She has been writing professionally since 2009 for various websites. Lake received her master's degree in criminal justice from Charleston Southern University.