3663 / What should an individual consider when choosing whether to convert retirement funds to a Roth IRA or to a Roth 401(k)?

Prior to 2018, one important characteristic of a Roth IRA conversion was the taxpayer’s ability to undo the transaction through a recharacterization transaction that moves the funds back into the traditional account, eliminating the tax liability that the initial conversion created.¹ This option was unavailable if the individual chooses to convert to a Roth 401(k).

If the taxpayer’s account performed poorly in the months after the conversion took place, or if the taxpayer otherwise found that he or she was unable to pay the tax bill that results from a Roth conversion, the taxpayer had until October 15 of the year following the conversion to recharacterize the funds. The tax reform changes to the recharacterization rules placed Roth IRAs on par with Roth 401(k)s, where once the conversion takes place, the taxpayer is required to pay the associated taxes regardless of any events that occur post-conversion.

A taxpayer who converts to a Roth IRA is able to escape the IRS’s required minimum distribution (RMD) rules so that the funds in the account are permitted to grow tax-free over a longer period of time. Taxpayers who use Roth 401(k)s are often required to comply with the RMD rules when they turn 73 (72 for 2020-2022, 70½ prior to 2020), possibly reducing the account’s growth potential if the taxpayer does not need to access the funds.² A taxpayer who plans to use a Roth account as a wealth transfer vehicle may also prefer the Roth IRA because the entire account value can be passed to heirs upon his or her death.