Since the advent of Roth IRAs in 1997, millions of investors have converted their traditional IRAs into Roth IRAs, or else rolled their qualified plan balances (e.g. 401k rollover) into traditional IRAs, and then converted the rollover balance into a Roth IRA. But the Pension Protection Act of 2006 allows qualified plan participants to roll their 401k plan, profit-sharing or other qualified plan balance directly into a Roth IRA, without having to roll it first into a traditional IRA (the rule is effective January 1, 2008).
Therefore, if you are retiring from your current job and want to see your 401k savings plan end up in a Roth IRA, don’t request your 401k rollover paperwork to a traditional IRA; you can soon skip the “middleman” account and move your money directly to the Roth IRA. This new rule greatly simplifies the process for qualified plan participants wishing to roll their 401k balances into Roth IRAs.
The conversion balance will be taxed as ordinary income the same as from a traditional IRA to Roth IRA conversion. So when you do your 401k rollover to a Roth IRA, be aware that this is a taxable event. Like with traditional IRAs, a full conversion may not be possible in one year; you may have to spread the conversion out over several years in order to convert the full balance. Your tax advisor will be able to help you determine the best way to do this. But for most people, it is better to pay the tax now rather than later.
One important point to remember for those who have company stock in their retirement plans is the NUA (net unrealized appreciation) rule, which allows you to sell your company stock in a separate transaction that could be taxed largely as a capital gain instead of ordinary income. If you plan on selling the stock separately, be certain not to include it in the assets or funds included in your 401k rollover to Roth IRA.
New Tax Rules Make Handling Deceased Person's Retirement Plan easier
President Bush signed the Pension Protection Act of 2006 (PPA), which includes important tax changes that will directly affect many individuals — including those who may need to roll over money from deceased person's retirement plan.
Under current rules, only a deceased person's surviving spouse can roll assets from the deceased person’s Individual Retirement Arrangement (IRA) into his or her own qualified retirement plan (provided he or she is the beneficiary of those assets, of course). Other beneficiaries of the assets (such as children and grandchildren) can't take advantage of the rollover, which is a good tax strategy, as it prevents the recipient from immediately paying taxes on the money.
Now, thanks to the PPA, beginning in tax year 2007, a non-spousal beneficiary can rollover 401k or other qualified assets from a deceased person into his or her own retirement account (again, provided he or she is the beneficiary of those assets).
Also starting in 2007, the rule doesn’t apply to just the deceased person's IRA; assets can be rolled from his or her Section 403(a) tax-deferred annuity, Section 403(b) annuity, or governmental Section 457 plan into a beneficiary’s IRA.
There are some rules that have to be adhered to in order for this taxpayer-friendly treatment to apply, however. First, the money must go directly into the receiving IRA via a trustee-to-trustee transfer. So if you’re planning on dying soon, don’t write a check to your favorite grandchild, little Susie; she’ll owe taxes on what she receives. Also, once the money is in Susie’s IRA, it will fall under the required annual minimum withdrawal rules for inherited IRAs — which means you may want the receiving IRA to be a new account, opened up just to accept the 401k rollover.