Retirement account rollovers can look deceptively simple. Moving a large balance from one account to another sounds like a transfer. The difference in how the two are taxed is where many retirees end up surprised.
Gina, a 56-year-old retiree, wrote to Suze Orman’s Women & Money podcast after her former employer’s benefits department recommended rolling her $1.6 million pretax 401(k) into a Roth 401(k) and then into a Roth IRA. The recommendation came from a benefits professional at her old workplace.
Orman had a response. The personal finance commentator has built a reputation for blunt, direct advice, and her answer to Gina was no exception.
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The tax trap inside a $1.6 million Roth conversion
The problem Orman identified is that moving money from a pretax retirement account into a Roth account is a conversion, not a simple rollover. Pretax 401(k) contributions have not yet been taxed. Roth accounts are funded with after-tax dollars. Converting a large balance makes the full amount taxable as ordinary income in the year it moves.
“With the utmost of respect to your benefits person at the place that you used to work, are you crazy? Really? I don’t know how else to say it,” Orman said. She called the plan “absolutely crazy.”
Converting $1.6 million in a single tax year would generally push a retiree into a significantly higher bracket. Higher reported income in that year could also trigger increased taxes on Social Security benefits and raise Medicare premiums through the income-related monthly adjustment amount, or IRMAA.
The exact impact depends on filing status, other income, deductions and the timing of the conversion. Orman said the caller would “owe income taxes at that point in time for that year’s income tax.” For a retiree no longer drawing a salary, that bill could be difficult to absorb.
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The $100,000 move Orman says makes far more sense
Rather than converting the entire balance at once, Orman suggested moving $100,000 from the pretax 401(k) into a Roth IRA and paying the taxes on that amount alone.
Spreading conversions across multiple years gives the retiree more control over which bracket she lands in each year. It also helps manage taxable income in retirement, particularly before required minimum distributions begin, which currently start at age 73 for most retirement account holders.
The staged approach also preserves options. If tax law changes or income shifts in a given year, converting less that year costs nothing. Converting too much in a single year cannot be undone.
There is also a Roth IRA five-year rule to keep in mind. Tax-free qualified withdrawals generally require that the account has been open for at least five years from the first contribution. A retiree who opens a Roth IRA at 56 would need to wait until at least 61 before those five years are up.
The costly mix-up between a rollover and a conversion
What a benefits administrator calls a rollover may not be one. The two transactions share enough surface-level similarity that the distinction gets lost in casual conversation, and both involve moving retirement money from one account to another. But when a pretax 401(k) balance moves into a traditional IRA, the money stays inside the same tax-deferred system, and no income is recognized in that year. The IRS does not send a bill.
Moving that same money into a Roth IRA or Roth 401(k) is a Roth conversion. The converted amount is generally taxable as income in that year. Moving a Roth 401(k) into a Roth IRA is a rollover between two Roth accounts and generally carries no immediate tax, either, provided it is handled correctly.
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The confusion between the two is common enough that it can cost retirees significantly before anyone realizes the mistake. Benefits departments and plan administrators sometimes use the terms without distinguishing between them, which is part of what Orman was flagging.
Moving money between two tax-deferred accounts carries the least risk of an unintended tax bill. A Roth conversion is a different calculation. Done in pieces across several years, the tax cost stays manageable. Done all at once with a seven-figure balance, the math rarely works in the retiree’s favor.
What to confirm before any retirement money moves
Before any money moves, a retiree needs to know exactly what they agreed to. The paperwork for a rollover and the paperwork for a conversion can look similar at the start. One results in no immediate tax owed; the other adds the full converted amount to that year’s taxable income. Benefits administrators do not always flag that difference clearly, which is part of what Orman was pointing to.
A tax projection showing the estimated bill for the conversion amount should come before any money moves. Converting in stages across several tax years can help retirees stay within a manageable bracket and plan around the income thresholds that affect Medicare premiums and Social Security taxation.
The tax bill on a conversion should come from cash held outside the retirement account, not from the converted amount itself. When money is withheld from the transfer to cover taxes, the balance entering the Roth shrinks. That smaller balance is the one that grows tax-free, and a smaller starting point means less to show for the conversion over time.
Employer benefits departments can be a useful starting point, but they are not always positioned to give personalized tax advice. A seven-figure retirement account deserves input from a qualified tax professional or fee-only financial planner who can look at the full income picture before a large balance moves.
Why a benefits department is not a tax adviser
Orman’s response to Gina is a reminder that not all retirement advice carries the same weight. A benefits administrator can point to plan options. Assessing the tax consequences of those options for a specific retiree’s situation is a different kind of work.
A Roth IRA can be a powerful tool in retirement, particularly for retirees who expect to be in a higher bracket later or who want to leave tax-free assets to heirs. But the benefits of the account depend entirely on when and how the conversion happens, and what it costs in the year it does.
The retirees who come out ahead on a Roth conversion are usually the ones who treated it as a multi-year project. Converting what fits inside a given bracket each year keeps the annual tax cost predictable. A bad year, whether from a property sale, a larger Social Security benefit, or a required distribution that overlaps, can be absorbed without wrecking the whole plan. Moving a seven-figure balance into a Roth in a single year rarely survives contact with the actual tax math.`
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