Good news and bad news about converting your 401(k) to a Roth IRA

I will probably make $200,000 dollars plus this year. I am 51 yrs old and I would like to convert my 401K which totals $80,000 to a Roth. How would that affect me tax wise?

The good news is that beginning in 2008, direct conversions from your 401(k) plan to a Roth IRA are permitted. Prior to 2008, individuals who wanted to convert their 401(k) or parts of their 401(k) accounts to a Roth IRA were required to follow a two step process. They would need to convert their 401(k) to a traditional IRA and then convert the traditional IRA to a Roth IRA. While the Pension Protection Act of 2006 eliminated this two step process, you will still need to meet certain criteria to qualify for a Roth IRA conversion. In addition, you will need to be sure that your employer’s 401(k) plan allows in-service distributions to withdraw funds to convert. Although the law allows the direct conversion, your 401(k) may not allow the withdrawal/distribution of your 401(k) assets (without a penalty) until you reach a certain age or until you discontinue working for that employer.

The bad news is that based on the information you provided in your question, it appears that you are not qualified to convert your 401(k) to a Roth IRA this year even if you employer's 401(k) allows the withdrawal/distribution. Your Modified Adjusted Gross Income (MAGI) for 2008 exceeds the $100,000 dollar limit under the Roth conversion rules. This limit applies to single individuals and married couples for 2008 and 2009. In addition, married couples whose filing status is “married filing separately” are also precluded from doing a Roth conversion until 2010.

Beginning in 2010, the MAGI and filing status limits go away and anyone with and IRA can convert to a Roth IRA. Again, your employer’s 401(k) plan still needs to allow in-service distributions to be able to do a Roth IRA conversion from your 401(k) but at least you will not be subject to the income or filing status limits.

For tax purposes, you are required to pay taxes on the taxable amounts converted. You will not need to pay taxes on any after-tax amounts that are converted. To get the most benefit out of the conversion, you should try to pay the resulting tax with funds other than those in your 401(k) or IRA. Funds withdrawn from these accounts to pay the tax are also subject taxes and will further reduce your retirement savings.