Ask an Advisor: 'I'm So Lost.' Should I Roll My Old 401(k) into My Current Plan or Convert it to a Roth IRA?

I’m so lost: I have a 401(k) that’s sitting doing nothing. I have not transferred the funds to my new employer‘s 401(k) because I’m not sure it’s the best decision. I’m thinking of transferring funds into a Roth IRA but I’m afraid it will affect our tax bracket because I’m sure we will have to pay the IRS.

– Liliana

You are correct that you’ll owe income tax on the money if you move it into a Roth IRA, but that doesn’t necessarily mean it’s a bad idea. Leaving it where it is or moving it into your new employer’s plan could also be good moves. Let’s take a look at your options to see which might be best for you.

Not sure whether tax-deferred or Roth savings make more sense? A financial advisor can help you compare your options and build a retirement strategy around your goals.

Leaving It Where It Is

This is the simplest approach in the short run, but there are some downsides. The main one is that it’s another account to keep track of. That could be an extra hassle going forward and it’s not likely to give you any additional benefit.

You mention that it’s “doing nothing.” In my experience, this usually means you haven’t invested your money or you’re holding very conservative investments that provide little growth potential. If you decide to keep it where it is, make sure you review your investment choices and select investments that align with your goals and risk tolerance.

Another thing to keep in mind is that some employer plans charge higher fees than others. It’s worth reviewing the fees and investment options available to make sure the plan is still a good fit. You can typically find this information in your plan’s fee disclosure documents, online account portal or fund fact sheets, which may show administrative fees, expense ratios and other plan costs.

Rolling It Into Your New Employer’s Plan

This should be fairly straightforward. You may need to fill out some paperwork or simply contact the financial institution that manages your old employer’s plan and tell them where to transfer the money.

The biggest advantage to a rollover is simplicity. Having your retirement savings in one workplace plan makes it easier to manage and monitor your progress. In some cases, your new plan may also offer lower costs or better investment options than your old one.

There can be another benefit as well. If you retire after age 55 but before age 59 ½, money in your current employer’s 401(k) may be eligible for penalty-free withdrawals under a special IRS exception. That rule generally doesn’t apply to money held in an IRA, so it can be worth considering if early retirement is a possibility.

(Work with a financial advisor to create a retirement plan that converts your 401(k)s, IRAs and other assets into a sustainable income stream.)

Click Your State to Get Matched With Financial Advisors That Serve Your Area

Choose your state and answer some questions to get matched with up to three fiduciary advisors that serve your area.

Converting It to a Roth IRA

This option may make sense depending on your current tax rate and the balance in the account.

When you convert pre-tax 401(k) money to a Roth IRA, the amount converted is added to your taxable income for the year. That means a large conversion could increase your tax bill significantly.

A Roth conversion can increase your taxable income enough to move part of it into a higher tax bracket. However, the higher rate only applies to the income within that bracket, not your entire income. Even with that distinction, it’s worth estimating the tax bill before converting so you know what to expect.

A Roth IRA can offer tax-free income in retirement, as long as withdrawals meet the qualified distribution rules. It also gives account owners more control over timing, since Roth IRAs do not require lifetime RMDs. For someone who expects higher tax rates later, converting now and paying the tax bill upfront may reduce taxes over time.

You don’t necessarily have to convert the entire balance at once, either. Some people choose to convert smaller amounts over several years to spread out the tax cost and avoid pushing too much income into higher tax brackets. (And if you want help planning a Roth conversion, speak with a financial advisor about your unique situation.)

Another Option: A Traditional IRA

One option you didn’t mention is rolling the old 401(k) into a traditional IRA. This allows you to keep the tax-deferred status of the account without creating a current tax bill.

A traditional IRA may also provide a much wider range of investment choices than most employer-sponsored retirement plans. For some investors, that flexibility is a major advantage.

If you expect to do Roth conversions in the future, moving money into a traditional IRA can make that easier. That’s because you don’t have to navigate employer plan rules to do it.

Bottom Line

Roth ira conversion memo near retro briefcase and glasses.

There isn’t a single right answer. The best choice depends on factors such as your current tax bracket, expected future tax rates, investment preferences and how important simplicity is to you.

If paying a large tax bill today would be difficult, a full Roth conversion may not make sense right now. On the other hand, if your income is temporarily lower than usual, converting some or all of the account could be worth considering.

Before making a decision, compare the fees and investment options in your old plan to your new employer’s plan and any IRA you’re considering. Taking time to evaluate those differences can help you choose the option that best supports your retirement strategy.

Retirement Planning Tips

Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Review whether your portfolio is built for withdrawals, not just growth. A portfolio that worked while you were saving may not be ideal once you begin taking income from it. Before retirement, consider whether your investments can support regular withdrawals, manage market declines and provide enough liquidity so you are not forced to sell long-term assets at the wrong time.

Brandon Renfro, CFP®, is a SmartAsset financial planning columnist and answers reader questions on personal finance and tax topics. Got a question you’d like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.

Please note that Brandon is not an employee of SmartAsset and is not a participant in SmartAsset AMP. He has been compensated for this article. Some reader-submitted questions are edited for clarity or brevity.