Can I Rollover a 401(k) to a Roth IRA While Still Employed?

A 401(k) plan serves as a tax-advantaged retirement savings vehicle offered by many employers, allowing pre-tax contributions to grow tax-deferred. A Roth IRA, conversely, is funded with after-tax dollars, meaning qualified withdrawals in retirement are entirely tax-free. Many individuals contemplate converting their pre-tax 401(k) savings to a Roth IRA to benefit from tax-free income during their retirement years. This process, however, involves specific conditions and steps, especially when undertaken while still employed.

Eligibility for In-Service 401(k) Distributions

Accessing 401(k) funds while still employed is known as an “in-service distribution.” Not all 401(k) plans permit these distributions, and rules vary significantly. Consult your plan documents or speak with your human resources department or plan administrator to determine if this option is available.

A common eligibility criterion for non-hardship in-service distributions is reaching age 59½. Many plans allow participants to withdraw or roll over vested funds at this age without incurring the 10% early withdrawal penalty. Some plans may permit in-service distributions of specific contribution types, such as after-tax contributions, even before age 59½. Pre-tax elective deferrals, which are regular salary contributions, generally remain inaccessible until age 59½ for in-service distributions.

Beyond age and contribution type, some plans may impose additional requirements. These can include a minimum number of years of participation, often five years, or a condition that funds have been held for a specific duration, sometimes two years. Only the vested portion of your account balance is typically available for distribution. Understanding these rules is fundamental before initiating any rollover.

Completing a 401(k) to Roth IRA Rollover

Once eligibility for an in-service distribution is confirmed, initiate the rollover. Contact your 401(k) plan administrator or human resources department to request the distribution and subsequent rollover. If you do not already have a Roth IRA, establish one with a financial institution.

The most straightforward and recommended method is a direct rollover, also known as a trustee-to-trustee transfer. Funds are electronically or via check transferred directly from your 401(k) plan provider to your Roth IRA custodian. This method is advantageous because no taxes are withheld at the time of transfer, simplifying the process and ensuring the full amount is moved.

An alternative is an indirect rollover. Your 401(k) plan administrator issues a check payable to you, with a mandatory 20% federal income tax withholding applied. You have 60 days from receipt to deposit the entire distribution, including the 20% that was withheld, into your Roth IRA. This avoids it being considered a taxable withdrawal and potentially subject to additional penalties. If you fail to deposit the full amount within this 60-day window, the unrolled portion becomes a taxable distribution.

Tax Implications of a Roth Conversion

Converting pre-tax funds from a 401(k) to a Roth IRA is a taxable event. The entire amount converted, including pre-tax contributions and accumulated earnings, is treated as ordinary income in the year of conversion. This can elevate you into a higher income tax bracket, increasing your tax liability. It is advisable to pay the taxes owed on the conversion using funds from outside your retirement accounts to maximize the amount that continues to grow tax-free within the Roth IRA.

Any after-tax contributions made to your 401(k) are not taxed upon conversion to a Roth IRA, as taxes were already paid. Distinguish between pre-tax and after-tax portions for correct tax reporting. The 401(k) administrator will issue IRS Form 1099-R to report the distribution, indicating the gross distribution and taxable amount. For direct rollovers to a Roth IRA, the form has a specific distribution code, such as ‘G’, and the taxable amount box reflects the conversion.

A separate 5-year rule applies specifically to Roth conversions. Each conversion has its own five-year holding period, which commences on January 1st of the calendar year in which the conversion was made. To withdraw the converted funds tax-free and penalty-free, you must satisfy this five-year waiting period, in addition to meeting a qualified distribution condition, such as reaching age 59½. Failing to meet this 5-year rule for converted amounts, if under age 59½, can result in a 10% early withdrawal penalty on the converted principal. State income taxes may also apply to the converted amount, depending on your state of residence, further impacting the total tax burden. Consulting a qualified tax advisor or financial planner is recommended to understand the specific implications for your individual financial situation.