401k rollover option

[benchmark]

I have a sizable 401k that I'd like to rollover. I was thinking about rollover to Roth IRA, but the tax bill is huge (I live in CA); Anyone has done research on this vs rolling over to traditional IRA?

 

thanks.

[mysticdrew]

It's usually a matter of preference and timing.  If you think you'll have low taxes this year either due to favorable laws or low income vs lower taxes when you're retired, then go for it.  If it is a large tax bill then you're not really gaining anything to doing it now and also consider if you have have the extra cash on the side to pay the tax.  Personally, I would roll it to a regular IRA and deal with the tax consequences when I retire.  Yes tax rates most likely would be higher in the future, but my income will likely be a lot lower and you can manage it with lower distributions that get taxed instead of a lump sum tax.

[Guest]

you should be able to do a partial rollover (if your plan allows it).

[A_Hamilton]

you should be able to do a partial rollover (if your plan allows it).

 

You can also roll your traditional 401k into a traditional IRA and then do partial transfers (or full) into a Roth IRA. I planned mine out so that I dumped a lot of money into a regular 401k right out of college, and then in the year I went back to school I converted everything to a Roth so the tax bill would be substantially lower. I fully intend for my Roth account to create truly dynastic wealth for my family.

[benchmark]

you should be able to do a partial rollover (if your plan allows it).

 

You can also roll your traditional 401k into a traditional IRA and then do partial transfers (or full) into a Roth IRA. I planned mine out so that I dumped a lot of money into a regular 401k right out of college, and then in the year I went back to school I converted everything to a Roth so the tax bill would be substantially lower. I fully intend for my Roth account to create truly dynastic wealth for my family.

 

That's a good idea, I do intend to take some time off travelling in a year or two. So I can rollover now, and do the conversion then.

[tng]

I rolled over to a traditional IRA and then slowly transferred money from the traditional IRA into a Roth IRA. That is probably the best way to do it because you have more investment options outside of your 401k, and you can figure out how much you want to get taxed each time. Just remember to pay your taxes, I screwd up a little bit and got penalized (thankfully, since interest rates are extraordinary low, the penalty was pretty small).

[ERICOPOLY]

I rolled over to a traditional IRA and then slowly transferred money from the traditional IRA into a Roth IRA. That is probably the best way to do it because you have more investment options outside of your 401k, and you can figure out how much you want to get taxed each time.

 

I rolled my 401k to a Rollover IRA at the beginning of 2008.  I waited until the end 2008 to convert the first 1/2.  That was my first mistake as it appreciated a lot in 2008 while I sucked my thumb.

 

My second mistake was waiting until 2009 to convert the second 1/2 of it.  I was planning to not book any gains until 2010 (to keep my income below the allowable conversion limit) but then Fairfax bought out Odyssey Re and blew my income sky high.  Then I had to reverse the conversion and do it again in 2010 (with no income limits).

 

I wound up paying tax on 5x as much conversion principle this way, compared to if I'd just converted the entire thing on day 1 in 2008.

 

Don't wait is my advice -- you never know how much gains you'll make.

[benchmark]

I rolled over to a traditional IRA and then slowly transferred money from the traditional IRA into a Roth IRA. That is probably the best way to do it because you have more investment options outside of your 401k, and you can figure out how much you want to get taxed each time.

 

I rolled my 401k to a Rollover IRA at the beginning of 2008.  I waited until the end 2008 to convert the first 1/2.  That was my first mistake as it appreciated a lot in 2008 while I sucked my thumb.

 

My second mistake was waiting until 2009 to convert the second 1/2 of it.  I was planning to not book any gains until 2010 (to keep my income below the allowable conversion limit) but then Fairfax bought out Odyssey Re and blew my income sky high.  Then I had to reverse the conversion and do it again in 2010 (with no income limits).

 

I wound up paying tax on 5x as much conversion principle this way, compared to if I'd just converted the entire thing on day 1 in 2008.

 

Don't wait is my advice -- you never know how much gains you'll make.

 

After paying taxes, do you think that you are still ahead comparing to invest that amount in traditional IRA?

[ERICOPOLY]

I rolled over to a traditional IRA and then slowly transferred money from the traditional IRA into a Roth IRA. That is probably the best way to do it because you have more investment options outside of your 401k, and you can figure out how much you want to get taxed each time.

 

I rolled my 401k to a Rollover IRA at the beginning of 2008.  I waited until the end 2008 to convert the first 1/2.  That was my first mistake as it appreciated a lot in 2008 while I sucked my thumb.

 

My second mistake was waiting until 2009 to convert the second 1/2 of it.  I was planning to not book any gains until 2010 (to keep my income below the allowable conversion limit) but then Fairfax bought out Odyssey Re and blew my income sky high.  Then I had to reverse the conversion and do it again in 2010 (with no income limits).

 

I wound up paying tax on 5x as much conversion principle this way, compared to if I'd just converted the entire thing on day 1 in 2008.

 

Don't wait is my advice -- you never know how much gains you'll make.

 

After paying taxes, do you think that you are still ahead comparing to invest that amount in traditional IRA?

 

Oh, yes, no doubt.  For one thing, Washington state didn't have an income tax.  Now I live in California.  Big difference right there.

 

1/2 of my BAC warrants are in my Roth IRA.  Now, suppose that account is worth $25 million in 2019 at age 45.  What's it going to be worth when I'm 70 and I start getting hit with forced withdrawals?  At 10% per annum, I'd say north of $250 million.

 

No doubt in my mind getting it all into Roth IRA is the best move as early as possible. 

 

Here is the short reason why:

Let's assume the rate of compounding (I invest in the same things) is the same in the taxable account as well as in the Traditional IRA account.  I would be trying to grow a present tax bill (to do a Roth IRA conversion today) in a taxable account at the same rate as the Traditional IRA (which compounds tax free).

 

So a Roth conversion today is a no brainer unless you can make after-tax returns in your taxable account grow at least as fast as your tax-deferred compounding rate in your Traditional IRA.  And if you can do that,  then do it in your IRA too!

[Evolveus]

An advantage to a Roth is that there are no required minimum distributions for the account owner unlike a traditional Ira at age 70.5.  Below i pasted text from an article on Boston.com that explai a that in a little more depth.

 

 

Required Minimum Distributions for Roth IRAs

 

"Roth IRA owners are not required to take Required Minimum Distributions (RMDs) but the beneficiaries of their Roth IRA may. Unlike traditional IRAs, owners of Roth IRAs are not required to take RMDs during their lifetime. However, after a Roth IRA account owner dies, non-spouse beneficiaries of the owner's Roth IRA do need to take RMDs. Spousal beneficiaries have the option to take RMDs or have the Roth IRA treated as their own, thus avoiding the need to take RMDs on the Roth IRA.

 

In other words, for a Roth IRA, RMD rules do not apply before the owner's death. However, when the Roth IRA owner dies, RMDs must begin unless the beneficiary of the Roth IRA is the owner's surviving spouse.

 

Generally, non-spouse beneficiaries of a Roth IRA must begin taking RMDs after the account owner dies and must be fully distribute the IRA within five years. In cases where all of the non-spouse beneficiaries are 'designated beneficiaries', the Roth IRA can be distributed over the life expectancy of the oldest beneficiary if the distributions begin by December 31 of the year after the account owner dies."

 

[benchmark]

 

Here is the short reason why:

Let's assume the rate of compounding (I invest in the same things) is the same in the taxable account as well as in the Traditional IRA account.  I would be trying to grow a present tax bill (to do a Roth IRA conversion today) in a taxable account at the same rate as the Traditional IRA (which compounds tax free).

 

In the last statement, I assume that by "Traditional IRA", you actually meant "Roth IRA"?

[ERICOPOLY]

 

Here is the short reason why:

Let's assume the rate of compounding (I invest in the same things) is the same in the taxable account as well as in the Traditional IRA account.  I would be trying to grow a present tax bill (to do a Roth IRA conversion today) in a taxable account at the same rate as the Traditional IRA (which compounds tax free).

 

In the last statement, I assume that by "Traditional IRA", you actually meant "Roth IRA"?

 

I meant Traditional IRA.  I don't think my paragraph was very clear.

 

I'm trying to point out that I expect my IRA to be huge, meaning if I hadn't converted it already then one day when withdrawn it would effectively be taxed at the top rate.  Today's top rate at 35% isn't that bad.  Who knows, we could get some Republican presidents to jack up the rates again, like Eisenhower did (to 92%) and like Hoover did (from 25% to 63%!).

 

But even if today's top rate of 35% is still the same down the road, it's still better to convert now rather than later.  In that last sentence of my prior post I was trying to convey that it's better to pay 35% of the account value now rather than later because I'm using funds from my taxable account to pay the tax.  There is no way that my taxable account is growing at the same pace as a Traditional IRA can grow (with it's tax deferral).  So if you don't pay the tax today, then you wind up using an ever larger % slice of your taxable funds to pay that tax down the road (this is because your taxable funds grow at a slower pace than your Traditional IRA).

 

 

[ERICOPOLY]

Oh yeah, and there's more to my thinking that I left out.

 

Traditional thinking is that you don't convert 100% of your Traditional IRA because you want some money to withdraw a little bit each year at low tax rates after you reach retiremenet age.  My approach would seem wasteful to them.

 

However, I will also have sizeable funds in my taxable account.  I will probably invest some of those funds in variable annuities (which are effectively mutual funds taxed the same as Traditional IRAs).  There are no limitiations on variable annuity contributions (meaning you can put billions into them if you wish).

 

So I will make slow withdrawals from the variable annuities to shelter the profits at low tax rates each year.

 

Thus, I have no strategic use for a Traditional IRA and it's better for me to convert the entire account to Roth IRA as I have done.

[ERICOPOLY]

 

Here is the short reason why:

Let's assume the rate of compounding (I invest in the same things) is the same in the taxable account as well as in the Traditional IRA account.  I would be trying to grow a present tax bill (to do a Roth IRA conversion today) in a taxable account at the same rate as the Traditional IRA (which compounds tax free).

 

In the last statement, I assume that by "Traditional IRA", you actually meant "Roth IRA"?

 

I meant Traditional IRA.  I don't think my paragraph was very clear.

 

I'm trying to point out that I expect my IRA to be huge, meaning if I hadn't converted it already then one day when withdrawn it would effectively be taxed at the top rate.  Today's top rate at 35% isn't that bad.  Who knows, we could get some Republican presidents to jack up the rates again, like Eisenhower did (to 92%) and like Hoover did (from 25% to 63%!).

 

But even if today's top rate of 35% is still the same down the road, it's still better to convert now rather than later.  In that last sentence of my prior post I was trying to convey that it's better to pay 35% of the account value now rather than later because I'm using funds from my taxable account to pay the tax.  There is no way that my taxable account is growing at the same pace as a Traditional IRA can grow (with it's tax deferral).  So if you don't pay the tax today, then you wind up using an ever larger % slice of your taxable funds to pay that tax down the road (this is because your taxable funds grow at a slower pace than your Traditional IRA).

 

Hypothetical, if future tax rates aren't higher at retirement (i.e. time of withdrawal) than today, and if one can compound at a high rate, then one should be indifferent between Roth and Traditional, in my view.  At a low rate of compounding, one should prefer the Roth.

 

Huh?  I just explained why it's better to do the Roth conversion now rather than later even when the tax rates are identical.

 

Let's say two things first:

1)  your tax rate is 25% on $100k worth of conversion whether you convert today or in 5 years' time. 

2)  Your accounts (taxable and IRA) are all going to double over the next 5 years.

 

Scenario A:

Convert Today:  $25,000 in tax paid on conversion amount.  You pay this in cash from your taxable account

 

Scenario B:

Convert Five years from now:  $50,000 tax paid on conversion amount.

 

There you have it.  So now do you see how you've stuffed it up?  The $25,000 that you could have used to pay your tax was doubled, so now it's $50,000.  You kept that $25,000 invested in your taxable account, it's now worth $50,000 pre-tax. 

 

It's not worth $50,000 after-tax.  You've blown it.  The IRS is thanking your for your mistake.

 

[benchmark]

 

Let's say two things first:

1)  your tax rate is 25% on $100k worth of conversion whether you convert today or in 5 years' time. 

2)  Your accounts (taxable and IRA) are all going to double over the next 5 years.

 

Scenario A:

Convert Today:  $25,000 in tax paid on conversion amount.  You pay this in cash from your taxable account

 

Scenario B:

Convert Five years from now:  $50,000 tax paid on conversion amount.

 

There you have it.  So now do you see how you've stuffed it up?  The $25,000 that you could have used to pay your tax was doubled, so now it's $50,000.  You kept that $25,000 invested in your taxable account, it's now worth $50,000 pre-tax. 

 

It's not worth $50,000 after-tax.  You've blown it.  The IRS is thanking your for your mistake.

 

This makes perfect sense -- if the rate is the same or higher. If the rate when you retire or convert is lower, then it might not (let's say that you stop working and has no income except the conversion amount).

[ERICOPOLY]

 

Let's say two things first:

1)  your tax rate is 25% on $100k worth of conversion whether you convert today or in 5 years' time. 

2)  Your accounts (taxable and IRA) are all going to double over the next 5 years.

 

Scenario A:

Convert Today:  $25,000 in tax paid on conversion amount.  You pay this in cash from your taxable account

 

Scenario B:

Convert Five years from now:  $50,000 tax paid on conversion amount.

 

There you have it.  So now do you see how you've stuffed it up?  The $25,000 that you could have used to pay your tax was doubled, so now it's $50,000.  You kept that $25,000 invested in your taxable account, it's now worth $50,000 pre-tax. 

 

It's not worth $50,000 after-tax.  You've blown it.  The IRS is thanking your for your mistake.

 

This makes perfect sense -- if the rate is the same or higher. If the rate when you retire or convert is lower, then it might not (let's say that you stop working and has no income except the conversion amount).

 

Right, totally depends on your income you expect when retiring.  I flushed my IRA completely into a Roth IRA because I'm expecting to have some taxable income from variable annuities when I'm of retirement age.

 

I'm not sure you saw what I posted earlier, so I'm going to write it again:

 

 

I will probably invest some of those [taxable] funds in variable annuities (which are effectively mutual funds taxed the same as Traditional IRAs).  There are no limitiations on variable annuity contributions (meaning you can put billions into them if you wish).

 

So I will make slow withdrawals from the variable annuities to shelter the profits at low tax rates each year.

[ERICOPOLY]

There is one other little advantage to Roth IRA conversions.

 

5 years after you do a conversion, you can withdraw the amount you converted without incurring the usual early withdrawal penalty.

 

There might be some reason for withdrawing some funds early.

 

In my case, if I run out of taxable funds early on I might need to withdraw a portion of my Roth IRA early.  Actually, since I did my last conversion in 2010 I only have to wait until tax year 2015.  I'll be 42 years old, much younger than the 59.5 that I'd otherwise need to be.

 

 

[CONeal]

Hi Ericoply,

 

I haven't been able to find it but with Roth IRA are the funds required to pay the 5% Obamacare tax?

[ERICOPOLY]

Hi Ericoply,

 

I haven't been able to find it but with Roth IRA are the funds required to pay the 5% Obamacare tax?

 

Well, I'd never thought of that.  But a minute on Bing found me this:

 

One other potential planning opportunity involves Roth conversions. While IRA required minimum distributions are not considered unearned income they are considered part of MAGI. Roth IRA distributions are not considered unearned income or MAGI.

 

http://www.thestreet.com/story/11709964/1/2-obamacare-taxes-hitting-high-income-earners.html

[redwood]

one more thing to be careful about is partial rollover.

"

You cannot isolate your after-tax IRA money and convert it tax-free

while keeping your pre-tax IRA  money in the Traditional IRA.

 

When a partial conversion is done, a pro-rated amount of after-tax money

(or basis) is included with each dollar converted.

 

For example, if you have IRAs worth $40,000 and $20,000 of

that money is after-tax, when you convert $20,000 of the Traditional

IRAs 50% ($10,000) will be tax-free and 50% ($10,000) will go towards

your taxable income.

"

[ERICOPOLY]

one more thing to be careful about is partial rollover.

"

You cannot isolate your after-tax IRA money and convert it tax-free

while keeping your pre-tax IRA  money in the Traditional IRA.

 

When a partial conversion is done, a pro-rated amount of after-tax money

(or basis) is included with each dollar converted.

 

For example, if you have IRAs worth $40,000 and $20,000 of

that money is after-tax, when you convert $20,000 of the Traditional

IRAs 50% ($10,000) will be tax-free and 50% ($10,000) will go towards

your taxable income.

"

 

However, when you leave your employer and rollover a 401k to a Rollover IRA, you can have 100% of the after-tax money go directly to a Roth IRA, and have 100% of the pre-tax money go directly to the Rollover IRA.

 

The after-tax money from the 401k can go straight to the Roth IRA even though you haven't yet decided whether or not to do a Roth Conversion on the pre-tax money.

 

That's what I did  :)

 

EDIT:  Actually, it might have just been the Roth-401k contributions that went straight to the Roth IRA.  I had both Roth-401k and the regular pre-tax kind in that company plan.

[benchmark]

one more thing to be careful about is partial rollover.

"

You cannot isolate your after-tax IRA money and convert it tax-free

while keeping your pre-tax IRA  money in the Traditional IRA.

 

When a partial conversion is done, a pro-rated amount of after-tax money

(or basis) is included with each dollar converted.

 

For example, if you have IRAs worth $40,000 and $20,000 of

that money is after-tax, when you convert $20,000 of the Traditional

IRAs 50% ($10,000) will be tax-free and 50% ($10,000) will go towards

your taxable income.

"

 

However, when you leave your employer and rollover a 401k to a Rollover IRA, you can have 100% of the after-tax money go directly to a Roth IRA, and have 100% of the pre-tax money go directly to the Rollover IRA.

 

The after-tax money from the 401k can go straight to the Roth IRA even though you haven't yet decided whether or not to do a Roth Conversion on the pre-tax money.

 

That's what I did  :)

 

EDIT:  Actually, it might have just been the Roth-401k contributions that went straight to the Roth IRA.  I had both Roth-401k and the regular pre-tax kind in that company plan.

 

One other thing that I realized was that if you convert this year, you'll avoid the obama health care tax on the conversion amount, which is 3.8%, no small percentage.

[benchmark]

One other thing that I realized was that if you convert this year, you'll avoid the obama health care tax on the conversion amount, which is 3.8%, no small percentage.

 

Yet another discovery -- CA's proposition 30 means a potential 2-3% more tax on the conversion -- on top of 10% state tax. :(