Tax Implications

• Converting from a traditional IRA to a Roth IRA or from a traditional 401(k) to a Roth 401(k) has the same tax implications. The amount of tax you will have to pay depends on how much you originally contributed and your current tax bracket. When you convert, you will need to pay taxes at your current rate on all previous contributions. If the market value of your account has increased since you opened it, you will not have to pay taxes on the amount your account increased.
  
  

Traditional IRAs and 401(k) Plans

• Money you contribute to either your traditional IRA or 401(k) plan is not taxed at the time you contribute to the plan. The money you have inside either plan can be invested in stocks, bonds and other types of financial securities. As long as your money is held inside the account, your investments are tax free. You will only be taxed when you begin to withdraw the money after reaching retirement age.
  
  

Roth IRAs and 401(k) Plans

• Like a traditional IRA or 401(k), money held inside a Roth IRA or 401(k) is tax free while in the account. The difference between Roth plans and traditional plans is when you pay taxes. You can only contribute money to a Roth plan that has already been taxed, so, unlike the traditional plans, you will not be taxed when you begin to take distributions from your plan after you retire.
  
  

Considerations

• Depending on how much you have originally contributed to your retirement plan, converting a traditional IRA or 401(k) plan to a Roth can potentially create a large tax burden that you will have to pay during the year of conversion. You cannot use money in the plan to pay the taxes because this would trigger an early withdrawal penalty. Whether or not conversion is right for you may depend on your tax outlook. If you expect your tax bracket to be lower when you retire than it is now, it may be better for you to stay with your original plan. If you expect your tax bracket to be the same or higher when you retire, paying taxes now may make more sense.