What Happens If I Convert My 401(k) to a Roth IRA in 2022?

If you're ready to make some moves with your old 401(k), a Roth IRA conversion may be an option for you. This will give you a chance to turn your employer-sponsored retirement plan into a tax-free income machine. But as attractive as this may sound, you need to know what you're signing up for so you won't be caught off-guard during tax time.  

Here are some factors you should consider to ensure a Roth IRA conversion is the best move for you right now. 

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Going from 401(k) to a Roth IRA 

A 401(k) is one of the most popular vehicles used to feed retirement savings at work. It's also a great way to slash your tax bill in the current year.

But if you leave your employer, you have to think about what you're going to do with your 401(k). One option is to roll over your 401(k) to an IRA (individual retirement account). You won't have to worry about taxes yet if you choose a traditional IRA since it's also a pre-tax account.

If you're looking to get your tax tab out the way now, you may want to consider a Roth IRA. This is ideal if you expect your tax rate to be higher later. However, you'll have to do some calculations to think about how going from a pre-tax account to an after-tax account will impact your current year tax bill. 

Taxes may derail your Roth IRA plans 

When going from a traditional 401(k) to a Roth IRA, you need a tax plan. The amount you roll over into a Roth IRA will be counted as income.

Let's say you convert $20,000 from your former employer's 401(k) to a Roth IRA. The $20,000 will boost your gross income for the tax year, and will be taxed at your ordinary income rate. Your tax bill would be up to $4,400 on the conversion if your marginal tax rate were 22%. But if the conversion bumps you into a higher tax bracket, you could end up owing more money.  

Here are the ordinary income tax rates for each filing status that you need to consider if you convert your 401(k) to a Roth IRA in 2022: 

Data source: IRS. Calculations by author.

Plan ahead for your tax bill 

Although it may be tempting to use money from your conversion to pay your tax bill, this may not be the best move. Putting money aside to cover taxes will save you from a potential headache later. 

If you haven't turned 59 1/2 yet, you may be subject to a 10% penalty if you try to use converted funds to pay your tax bill. This is on top of the income taxes you already have to pay. 

The Roth IRA conversion can work in your favor 

This may be a great time to pursue a Roth IRA conversion if any of these situations apply:

• You are in a lower tax bracket in 2022.
• Your Roth IRA conversion won't boost your income into a higher tax bracket. 
• You expect your taxes to go up in the future. 
• You don't want to worry about required minimum distributions later. 
• You want more freedom and flexibility to invest in your favorite assets. 
• You want to diversify your retirement income with some tax-free savings. 

Is this the right time to convert your 401(k) to a Roth IRA? 

Since no one knows where tax rates will land in the future, many people try to get as much money as they can into accounts that will eliminate all future tax concerns. But you want to think about how much money you have in your 401(k) and your projected income for 2022 so you won't be hit with an unexpected tax bill. 

Getting your money in a Roth IRA may be ideal if you don't want to worry about required minimum distributions. You can keep the money in your account for as long as you want and allow the assets in your portfolio to accelerate your path to wealth. However, before you make a move, make sure this is the best year for you to take action.