How to Convert a 401(k) to a Roth 401(k)

If you’ve been diligently saving for retirement through your employer’s 401(k) plan, you may be able to convert those savings into a Roth 401(k) and gain some added tax advantages.

How to Convert to a Roth 401(k)

Here’s a general overview of the process of converting your traditional 401(k) to a Roth 401(k):

1. Check with your employer or plan administrator to see if converting is even an option.
2. Calculate the tax of converting.
3. Set aside enough money from outside your retirement account to cover what you’ll owe when you file your taxes.
4. Tell your employer or plan administrator that you’re ready to make the conversion.
5. The process from here may differ from company to company, but the plan administrator should be able to provide you with the necessary forms.

Not every company allows employees to convert an existing 401(k) balance to a Roth 401(k). If you can’t convert, consider making your future 401(k) contributions to a Roth account rather than a traditional one. You are allowed to have both types.

As mentioned, you’ll owe income tax on the amount you convert. So after you calculate the tax cost of converting, figure out how you can set aside enough cash— from outside your retirement account—to cover it. Remember that you have until the date you file your taxes to pay the bill. For example, if you convert in January, you’ll have until April of the following year to save up the money.

Should You Convert to a Roth 401(k)?

If your company allows conversions to a Roth 401(k), you’ll want to consider two factors before making a decision:

1. Do you think you’ll be in a higher tax bracket during retirement than you are now? If so, that can be a good reason to switch to the Roth. You’ll pay taxes now at a lower tax rate and enjoy tax-free income later when your tax rate is higher.
2. Do you have the cash to pay taxes on the conversion? You’ll owe income tax on any money you convert. For example, if you move $100,000 into a Roth 401(k) and you’re in the 22% tax bracket, you’ll owe $22,000 in taxes. Make sure you have the cash elsewhere to cover the tax bill, rather than using money from your 401(k) to pay it. Otherwise, you’ll miss out on years of compounding. And that could end up costing you a lot more than $22,000.

Traditional 401(k)s vs. Roth 401(k)s

Employer-sponsored 401(k) plans are an easy, automatic tool for building toward a secure retirement. Many employers now offer two types of 401(k)s: the traditional, tax-deferred version and the newer Roth 401(k).

Of all the retirement accounts available to most investors, such as 401(k) and 403(b) plans, traditional IRAs, and Roth IRAs, the traditional 401(k) allows you to contribute the most money and get the biggest tax break right away. For 2021, the contribution limits are $19,500 if you’re under age 50. If you’re 50 or older, you can add an extra $6,500 catch-up contribution for a total of $26,000. In 2022, the amount is $20,500.

Plus, many employers will match some or all of the money you contribute. A Roth 401(k) offers the same convenience as a traditional 401(k), along with many of the benefits of a Roth IRA. And unlike a Roth IRA, there are no income limits for participating in a Roth 401(k). So if your income is too high for a Roth IRA, you may still be able to have the 401(k) version. The contribution limits on a Roth 401(k) are the same as those for a traditional 401(k): $19,500 or $26,000 (in 2021), or $20,500 in 2022, with the $6,500 catch-up amount, depending on your age.

The biggest difference between a traditional 401(k) and a Roth 401(k) involves getting a tax break. With a traditional 401(k), you can deduct your contributions, which lowers your taxable income for that year. With a Roth 401(k), you don’t get an upfront tax break, but your withdrawals will be tax-free. Once you put money into a Roth, you’re done paying taxes on it.