Personal Finance

What to Do With Your 'Old' 401(k)

If you've recently left a job or been laid off, you may be wondering if it makes sense to convert your old 401(k) into a Roth IRA.

It probably does, if you think you're going to be in a higher tax bracket later andyou have the money to pay the taxes you'll incur with the conversion.

A Roth IRA can be a great investment vehicle, allowing you to contribute after-tax money for retirement now, invest those funds and take the money out tax-free at retirement (after age 59 1/2).

Rather than leave a 401(k) with your old employer, you can convert the balance into a Roth IRA at nearly any financial institution.

The cheapest alternative is probably a low-cost mutual fund company, like Vanguard, Fidelityor T. Rowe Price , where there are no commissions and, in most cases, no account fees if you meet some basic requirements. You'll only need a $1,000 to $3,000 minimum balance to get started.

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Talk to a representative at the fund company first to see what forms are required. Also, check with your old employer to make sure you fill out the appropriate paperwork to do the rollover 401(k).

Make sure you request a "direct rollover" from your former employer, which ensures that the funds are made payable to the fund company and go directly into your new account. If the check is made out to you, your old employer will have to withhold 20 percent of the pretax balance for taxes and you'll have to pay a 10 percent early-distribution penalty on the amount withheld for taxes .

If you're not sure what to invest in and don't want to hire a financial advisor to help you, you can create a diversified portfolio by target-dating funds that allocate between stocks and bonds based on how long you have until you reach retirement age and how much risk you want to take.

Though income limits have gone away in 2010 for Roth IRA conversions, the potential tax bite may present a deal breaker for those with large 401(k) balances and too little money to pay the tax.

Remember, if you roll over your 401(k) into a Roth, you'll likely have to pay taxes on that money. A Roth IRA invests after-taxmoney and your 401(k) balance consists of before-taxcontributions. If you convert to a Roth IRA in 2010, you can include the income from the conversion on your 2010 federal income tax return or divide it 50-50 between your 2011 and 2012 returns.

Talk to an accountant to see which is better for you, because your tax rate will likely increase in coming years and may result in an overall, bigger tax hit than if you paid the tax now.

If you decide later that you do not want to invest in a Roth and want to change to a regular IRA, you have until Oct. 15, 2011, to reconvert into a traditional IRA. (Click here to see my story Lowering Your Tax Hit From A Roth IRA)