Should You Convert Your Traditional 401(k) Into a Roth 401(k)?

A few years back, the Roth 401(k) was the new kid on the block when it came to company-sponsored retirement accounts.

But now, 86% of employers offer a Roth 401(k) option to their employees.¹ If the Roth 401(k) is on the table at your workplace, that’s great news for you!

But if your company is offering a Roth 401(k) option, you’re probably wondering what to do with your existing traditional 401(k). Is converting a traditional 401(k) to a Roth the way to go? Or should you just leave it alone?

There are some things to keep in mind before you make this decision, so let’s dive in.

What Is a Roth 401(k)?

The Roth 401(k) is a workplace retirement savings account that combines the convenience of a traditional 401(k) with all the benefits of a Roth IRA—plus a few more. It’s the best of both worlds!

A traditional 401(k) and a Roth 401(k) are similar. You can get your company match by contributing to either type of account, and both have a $23,000 contribution limit for 2024.² But that’s where the similarities end.

The biggest difference between a traditional 401(k) and a Roth 401(k) is how your contributions are taxed. When you put money into a traditional 401(k), you’re using pretax dollars. That means the money goes into your 401(k) before you pay taxes on it. Those taxes are then deferred until you make withdrawals from your 401(k) in retirement.

On the other hand, your contributions to a Roth 401(k) are made with after-tax dollars, meaning you invest that money in your Roth 401(k) after you pay taxes on it. It’s a little more expensive on the front end, but it’s worth it. Why? Because you get the benefit of tax-free growth on your contributions. So when you start withdrawing money in retirement, you won’t have to pay a single penny in taxes.

Whenever you can make tax-free growth part of your investment strategy, do it!

Roth 401(k) vs. Roth IRA

A Roth 401(k) also has some advantages over a Roth IRA. The big one is the contribution limit. While a Roth 401(k) has a $23,000 contribution limit, a Roth IRA’s limit is $7,000—or $8,000 if you’re 50 or older.³

Plus, a Roth IRA has an income limit on contributions ($146,000 for single filers and $230,000 for married couples).⁴ A Roth 401(k) has no income limit.

Roth 401(k) With a Match

There’s one important thing to remember about the Roth 401(k): Only your contributions grow tax-free. If your company offers a match, you’ll have to pay taxes on retirement income from the match side of the account.

Still, the Roth 401(k) is an amazing deal. It could literally save you hundreds of thousands of dollars in retirement. And yet, only 26% of workers are making contributions to their company plan’s Roth option.⁵

If you’re just starting out with a company and they give you this option, take the ball and run with it!

But if you still have debt to pay off (except for your house) and don’t have a fully funded emergency fund, pump the brakes. You need to get your financial house in order before you start saving for retirement.

If you’d like a specific, step-by-step plan to becoming a millionaire by the time you retire, we’ve got one. There’s a whole group of millionaires called Baby Steps Millionaires who’ve followed Ramsey’s 7 Baby Steps to hit the million-dollar mark. By following the Baby Steps, they were able to pay off all their debt and reach a million-dollar net worth in about 20 years.

Should I Convert My Current 401(k) Into a Roth 401(k)?

If you already have a traditional 401(k) at your current job and the company just introduced a Roth 401(k) option, converting that 401(k) into a Roth might sound like a good idea. But is a conversion your best option? It depends on your situation.

How much will you need for retirement? Find out with this free tool!

The main drawback of converting a traditional 401(k) into a Roth 401(k) is the tax bill that comes with making the switch. You’re going to have to pay taxes on that money because it hasn’t been taxed yet.

Let’s say you have $100,000 in your traditional, pretax 401(k) and you want to do a Roth conversion. If you’re in the 22% tax bracket, that means you’d be paying $22,000 in taxes on those funds you rolled over. That’s a lot of cash!

If you convert your 401(k) into a Roth 401(k), you need to have the cash on hand to cover the tax bill—no exceptions. Do not use money from the investment itself to pay the taxes. If you do, you’ll lose a lot more than $22,000. You could get charged a 10% early withdrawal penalty if you’re under age 59 1/2. And you’ll also miss out on years of compound growth on that $22,000, which is typically about 11% a year.

For example, after 30 years, a $100,000 account could grow to about $2.67 million. An account with a starting point of $78,000 would grow to $2.08 million. That’s a difference of $587,000!

Want to run the math on your retirement account balance? Try our investment calculator that will do the calculations for you.

Alternatives to Roth Conversion

There are also alternatives to a 401(k) conversion to consider. For example, you can leave your traditional 401(k) alone and start putting money from your paycheck into a new Roth 401(k) instead. That way, you don’t have to worry about taking a hit paying taxes now and still take advantage of the Roth’s tax-free growth later.

Here’s the deal: We want you to be careful as you think about transferring your retirement savings into a Roth 401(k). It might make sense for you if you can pay cash for the taxes without taking money out of your 401(k) and if you’re still several years away from retirement. If those scenarios don’t apply to you, you probably want to think about a different option.

But before you do anything, make sure you talk with an investing professional. They can help you understand the tax impact of a 401(k) conversion and weigh the pros and cons of each option.

How Do I Convert My Traditional 401(k) Into a Roth 401(k)?

The process of converting your pretax 401(k) into a Roth 401(k) varies from company to company, but here’s a general overview.

1. Find out if you’ll be able to convert your 401(k).

According to the IRS, in order to be eligible for a 401(k) conversion, the money must be vested (that just means it’s fully owned by you).⁶ All the money you put into your 401(k) is immediately vested, but your employer’s contributions might be vested over time—meaning the money isn’t yours until it’s been in your account for a while. Depending on the vesting schedule set up by the company and how long you’ve been there, your existing 401(k) might not be fully vested yet.

Companies sometimes have their own additional restrictions on who can convert their 401(k), so ask your employer if you’re eligible.

2. Figure out how much you owe in taxes.

You can estimate those taxes by multiplying the amount you plan on converting by your income tax rate based on your tax bracket. When you get your number, set aside the money or come up with a plan to save up the cash you need to pay those taxes when tax season arrives without dipping into the money from your 401(k).

For example, if you’re converting $100,000 and your tax rate is 12%, you’d need to set aside $12,000 for taxes.

3. Check with your company for information about their conversion process.

Your company will be able to give you the forms to fill out. After that, you can enjoy all the benefits of a Roth 401(k)!

What Should I Do With an Old 401(k)?

You might have an old traditional 401(k)—or several—lying around from previous employers. Transferring the money from a 401(k) to your new employer’s Roth 401(k) might seem like an appealing option. But just remember, you’ll get smacked with a tax bill if you go that route.

Rolling your old 401(k) into a traditional IRA is another way to go. You’ll have more control over your investments and will be able to choose from thousands of mutual funds with the help of your financial advisor. Plus, you won’t face any tax consequences since you’re moving from one pretax account to another.

If you aren’t able to transfer your money into your new employer’s plan but think a Roth is for you, you could go with a Roth IRA. But just like with a 401(k) conversion, you’ll pay taxes on the amount you’re putting in. If you have the cash available to cover it, then the Roth IRA might be a good option because of the tax-free growth and retirement withdrawals.

Talk to a Pro Before Converting Your 401(k)

Deciding whether to convert your traditional 401(k) into a Roth 401(k) is a huge decision. There are thousands of dollars at stake! You definitely don’t want to make a decision like this on your own.

An experienced investing professional can help you figure out the best way to handle your investment accounts to keep you on track toward your retirement goals. And if you don’t understand something, ask questions. We don’t ever want you to make a financial move you don’t understand.

If you’re looking for an investing pro in your area, use our SmartVestor program. It’s a way to connect with investing professionals who are ready to help you make the most of your retirement dollars.