Because of the different tax rules, rolling over money from a traditional to a Roth 401(k) has tax consequences, with converted funds classified as taxable income. This can increase the amount of income taxes you owe the IRS in the year the conversion takes place.
However, while you may get a large IRS tax bill, this can make sense in some situations. You may wish to convert a traditional 401(k) to a Roth 401(k) under the following circumstances:
- You're in a lower tax bracket now than you expect to be in retirement: If this is the case, you'll owe less tax on the converted funds at your current low tax rate than you'd otherwise pay when taking taxable distributions from a traditional 401(k) as a retiree.
- You want to minimize taxes on Social Security: Distributions from a Roth 401(k) aren't considered "countable" income when you're determining if a portion of your Social Security benefits will be taxed.
Converting a traditional 401(k) to a Roth 401(k) is simple -- you'll just need to complete some paperwork to request the transfer of funds.
However, you'll want to make sure you have money available outside of your retirement account to pay the taxes due as a result of the conversion. Otherwise, you could be forced to make an early withdrawal, which may be subject to a 10% penalty.