Rollovers

[Guest frodo]

I apologize because I am sure this topic has been covered, but have yet to find all the answers to my questions.

I currently have a 401k worth about 50-60k from the company I worked at until 2005, when I went back to school. Since I am currently in school with no income, I want to rollover my 401k to a Roth IRA before the year is over because I have no income this year. A few questions:

1) Could someone tell me the logistics of getting this done; I have the appropriate forms to fill out from my old company and will fill out the forms from my new institution. Will my old company send the money directly to the new institution where the IRA will be held? More importantly how are the taxes paid when this rollover occurs? I would assume I owe 10% of the first $8000 (or so), 15% on the next $20000, etc.... but how do I know the exact amount and can I take this amount owed out of my 401k? Otherwise I don't have the money to cover the taxes.

2) I understand that the rollover must first go to a traditional IRA and then from the traditional IRA it can go to the Roth. When are the taxes subtracted, at the time of the 401k rollover to the traditional IRA, or is that tax free and the taxes are subtracted when the money is transferred from the traditional IRA to the Roth IRA?

3) Does my money have to remain in the traditional IRA for a certain amount of time before it is rolled over to the Roth IRA?

4) Am I allowed to start up a Roth IRA with this amount of money, or can I only transfer $4000 to the Roth IRA?

Any other simple logistical information that you can provide is greatly appreciated. Please contact me if I left out any pertinent information.

Thank you in advance.

[Michael Devault]

Here's my attempt at answering your questions using the same reference numbers as your original post:

1. The administrator of the 401(k) plan will send the entire amount of the distribution to the IRA custodian. Because this will be handled as a direct rollover, there will be no income tax liability as a result of the direct rollover. It's important to make sure the money is sent in this manner, otherwise the 401(k) plan will be required to withhold 20% for federal income taxes, much like withholding from earnings is made by an employer.

2. For the remainder of 2007, the rollover must first go into a Traditional IRA. Once there, it may be converted to a Roth IRA. That conversion is what triggers a taxable event. The amount converted will be included in your ordinary income in the year converted. (It may be a consideration to convert part in 2007 and part in 2008 if you want to spread taxes over a couple of years.) If you need to withhold money to pay the taxes, you can withdraw enough from the Traditional IRA before converting it to the Roth IRA. However, keep in mind that the amount withdrawn in cash from the Traditional IRA will likely be subject also to an additional 10% penalty. For example, if you withdraw $1,000, you'll have to pay taxes on that $1,000 PLUS a $100 penalty.

3. No. The Traditional IRA can be converted to a Roth IRA on the same day the Traditional IRA is established.

4. You may convert all or any portion of the Traditional IRA to a Roth IRA, just as long as your adjusted gross income is $100,000 or less and you don't file a separate return if you're married.

Hope this helps. Good luck!

[Guest frodo]

Thank you, very helpful.

Is there any way that I can pay the taxes from the amount I am transferring without paying the 10% early withdraw penalty?

Thanks again.

[Michael Devault]

Not of which I'm aware. If you withdraw money from the Traditional IRA and don't qualify for one of the exceptions, the 10% penalty will apply.

[John G]

You have to get the funds done by year end if you expect to utilize the lower tax rate of this year. Not every 401K plan is going to act on this request fast enough for your plan to work. You should call your 401k plan adminstrator and talk about timing.

You don't have to convert 100%. You could do a partial conversion to better control the tax problem.