Carrie Schwab Pomerantz

Dear Carrie, My wife has a 401(k) from her last job that she left in 1997. It's just sitting in cash. What can we do with it now? Can we roll it over into a Roth IRA or a ROTH 401(k)? My wife doesn't work anymore. --A Reader

Dear Reader, hile leaving a 401(k) with a former employer often seems like the easiest route, it's not always the best idea in terms of making the most of your retirement savings. That's because some employer-sponsored plans have limited investment choices, limited payout options or substantial fees. With a 401(k) sitting in cash, you have even more reason to move that money to another retirement account -- and get it working for you.

A Roth 401(k) isn't possible because that would only be available through another employer. However, your wife could consider a Roth IRA -- as well as a traditional IRA. The choice mostly comes down to taxes. I'll talk about that first and then get into some other ideas for maximizing your retirement savings.


Decide between a Roth and a traditional IRA

You can roll over a 401(k) directly into either a Roth IRA or a traditional IRA. There are no income limitations on a rollover, so the main consideration is whether you want to pay income taxes on the money now -- or later.

--Roth IRA -- taxes now: Contributions to a 401(k) are made with before-tax dollars, meaning you didn't pay income taxes on the money. The taxes are deferred until you take withdrawals, at which time you pay ordinary income taxes on whatever you withdraw. When you roll over a 401(k) to a Roth IRA, you have to pay those income taxes (SET ITAL) upfront(END ITAL). That's because withdrawals from a Roth are income tax free -- and Uncle Sam is not about to let you get away without paying taxes indefinitely. A rollover to a Roth can mean a big tax bite now.

--Traditional IRA -- taxes later: A traditional IRA works just like your 401(k) -- taxes are deferred until you make a withdrawal. So if you roll over to a traditional IRA, it won't cost you anything now, but you'll pay ordinary income taxes on your money later when you withdraw it.

Either way, you end up paying taxes at some point. The question is, will you be in a higher or lower tax bracket come retirement time? If you think you'll be in the same or a higher tax bracket, rolling over to a Roth could make sense as long as you have the cash available to pay the income taxes now.

However, if you think you'll be in a lower tax bracket when you retire, a traditional IRA would be a better choice. You'll pay nothing now and possibly less in taxes later.

Carrie Schwab Pomerantz

Carrie Schwab Pomerantz is a Motley Fool contributor.

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