Changing Jobs? Consider a Roth Conversion

“What should I do with my 401k plan when I leave my job?”

The answer to that single question will lead you to an almost unhealthy number of resources offering the right solution for you. If you’ve asked this question before – as have Get Rich Slowly, Money Ning, Joe Taxpayer, Oblivious Investor, or Cash Money Life – then you probably are already familiar with the standard template.

Generally, you have four main options when deciding what to do with your plan.

• Cash Payout
• Leave in old plan
• Bring to new plan
• Convert to IRA*

*It’s worth noting that before 2006, this process was somewhat cumbersome as you first had to roll over the 401k into a Traditional IRA and then convert from there to a Roth IRA. The Pension Protection Act changed this and allowed direct conversions between 401ks and Roth IRAs.

From there, the pros and cons of each option are weighed. Obviously, the cash payout is never the right answer – what with all the spending you’d be doing and the gnarly penalty taxes. Don’t stay in the old plan, with the mediocre investment choices and administrative fees. Don’t go with the new plan because it’s probably fraught with the same problems as the old.

And the answer – IRA conversion!

Now, this was simplified dramatically and isn’t necessarily the only option. There have been cases made for leaving it at your old plan too or bringing into the new one (the arguments are essentially the same since this is two sides of the same coin). The point of this article is to highlight the little caveat that no one ever seems to mention, but is a huge draw towards the conversion.

Your converted funds do not count against your annual contribution.

Depending on how much you have socked away, it’s getting free years of missed (or ineligible) contributions added to your account. Of course, this is a taxable event going between tax-deferred and tax-free accounts so you will owe income tax on the 401k amount.

With all the changes that occurred in 2010, it doesn’t seem worthwhile to bring this up. Anyone can convert a traditional IRA to a Roth IRA so what’s the big deal?

Because if you are a younger individual, with many working years ahead of you, and the intent of eventually being priced out of this retirement vehicle – this can be a powerful consideration when deciding what to do with your retirement account and working towards squeezing more out of your retirement account.