Advice needed: Switch to Roth 401(k)?

[bUU]

We've been getting out financial house in order the last couple of years, and the problem with learning something new every week is that you often learn things that prompt you to take quick action, but before you really know the right direction (and of course, for many things, there really is no way to know the right direction, for sure, before the fact - so we need to rely on long-standing experience that we simply don't have). Our inclination would be to not make decisions based on inadequate knowledge, but that's belied by the fact that not making changes is, itself, a decision.

I'm trying to decide whether to continue to contribute to traditional 401(k), or to switch to contributing to Roth 401(k)s. We plan to max-out whatever contributions we're eligible to make (i.e., $23k in to 401(k)s, either traditional or Roth, for each of us, and $6k each into Roth IRA if we're eligible). I believe that the switch will "cost" us about $13k in extra federal income tax in a year ($46k more in taxable income, 28% tax bracket). That is a bit on the high-side of affordability for us, vis a vis recent spending, but that's only if we don't discount the fact that we purchased two cars for cash this year, and had similar costs refinancing our mortgage last year - expenses we won't likely encounter in the next few years.

Because we're not sure what the future may bring (job loss, job change, etc.), we aren't sure whether we'll qualify for a Roth IRA contribution next year. However, our eligibility will unequivocally be governed by whether we do 401(k) contributions (lowering AGI) or Roth 401(k) contributions (not lowering AGI). So consequently we need to decide "now" what approach we're going to take, so we can have our 401(k) deductions properly characterized in 2013. I'm hoping that it isn't too late to make the change for our first paychecks in 2013, but even it is, I suspect that one paycheck won't make a difference, in the grand scheme of things.

One assumption that we're willing to make, right now, is that we won't have job losses or job changes, and therefore our AGI, even with $46k in traditional 401(k) contributions in 2013, will still be > $178k - almost surely closer to $188k, and probably over $188k, though not by much.

The thing that is stickiest for me is that I really cannot say that we'll be paying as high of a tax rate in retirement. Based on today's brackets, it is possible that we'll drop from 28% to 25% (or 31% to 28%, depending on what Congress does). That seems to argue against the Roth. But of course, marginal rates could increase between now and then, and the benefits the Roth affords us (no tax on the gains) may overwhelm even a 3% decrease in tax rates, right?

You probably need some more information about us... We're 58 and 49, so one will retire midyear 2020, and the other will follow probably five years later (five years of what we expect will be markedly lower salary, for various reasons, including an anticipated job change in that time frame). We have very little in Roth accounts now - $6k for the 58 year old, $5k for the 49 year old. We have more than two years of expenses in cash right now (a problem soon to be rectified) and another three years worth of expenses in taxable investments (which are aimed for keeping us above water while we're waiting for the optimal time to start drawing down from various retirement-oriented sources).

My premise for making the change to Roth 401(k) is to ensure we have enough money to live on prior to 2029 when the younger of us reaches retirement age. We recognize that that five and a half year period between when the younger person stops working and the younger person reaches retirement age is probably going to be the most challenging time, financially - no salary coming in, no company-subsidized health care for one of us, not yet the best time to start drawing from retirement sources for one of us, etc.

Your best insights would be greatly appreciated.

[House Blend]

When in doubt, defer taxes.

the benefits the Roth affords us (no tax on the gains) may overwhelm even a 3% decrease in tax rates, right?

In retirement, what income will be filling all of the lower tax brackets? It is unlikely that every dollar you withdraw from your tax-deferred accounts will be taxed at your marginal rate.

Whereas, every dollar you put into a Roth now is being taxed at your current marginal rate.

[ShowMeTheER]

Pre-Tax 401(k)

I look at your situation this way - how much might you gain in the Roth situation? Doesn't sound like much, if anything.

You have a lot of accessible money available. You'll be able to draw from the pre-tax dollars without penalty soon. You very well might end up withdrawing some of these pre-tax contributions at a significantly lower rate (15%) someday.

I can't imagine paying the taxes now on this money in your case since there is no significant expected benefit.

[stan1]

If you do not have sizeable pensions I'd take the tax deduction now since you are in the 28% marginal tax bracket (especially if you also have state taxes which, for example in California would be an additional 9.3%). Without a pension you'd be withdrawing much of the money to live on at lower tax rates after you retire. If you had pensions that income would "fill up" the lower tax brackets and the decision becomes more of a coin toss.

You know what tax rates are now; you have no idea what they will be in the future. Deduct the contributions now, and save the amount you would pay in additional state and federal taxes ($13K by your calculations) in IRAs. Read up on doing back door Roth IRA conversions for both spouses.

[bUU]

When in doubt, defer taxes.

A maxim that has stayed my hand from making the change without a real strong signal from folks here in the forum.

In retirement, what income will be filling all of the lower tax brackets?

Mine. We're ten years apart in age, and my spouse be retiring at least five if not a full ten years prior to me.

It is unlikely that every dollar you withdraw from your tax-deferred accounts will be taxed at your marginal rate. Whereas, every dollar you put into a Roth now is being taxed at your current marginal rate.

A lot of this comes down to what money are we going to use in that ten year period between our respective retirement ages, and more specifically in the second five year period within that ten year period, when we're both retired but only can rely on retirement sources for one of us. However, what you've written here is a strong case to leave things traditional.

And thanks to all of you for the great advice. It's making me feel a lot more comfortable with what we're going to do.

[stan1]

In retirement, what income will be filling all of the lower tax brackets?

Mine. We're ten years apart in age, and my spouse be retiring at least five if not a full ten years prior to me.

I'd plan to live off the single income for the 5-10 years and make no withdrawals from the retirement accounts, if that's at all possible.

[bUU]

In retirement, what income will be filling all of the lower tax brackets?

Mine. We're ten years apart in age, and my spouse be retiring at least five if not a full ten years prior to me.

I'd plan to live off the single income for the 5-10 years and make no withdrawals from the retirement accounts, if that's at all possible.

That would be our preference, but I expect that that might be exceedingly difficult. That period will coincide with career events that I'm anticipating will result in a significant step down in salary. (My industry is not kind to older folks.) I'd be prompted to simply work full-time the full ten years, just to keep us from needing to dip into savings so soon, except that would mean we would start "enjoying our golden years together" when my spouse is 77.

[vveat]

By the way, why are you concerned about the Roth IRA eligibility? You can always use the backdoor - contribute (after tax) to traditional IRA and next day have the funds converted to Roth. No income restrictions.
http://thefinancebuff.com/the-backdoor- ... ow-to.html

[bUU]

We have existing traditional IRAs, so trying to accomplish what we accomplish with a Roth IRA contribution with a new traditional IRA contribution and converting it to a Backdoor Roth would make my head explode. If you could explain how that would work that would be great.

Also, I don't see anywhere where it says that you can contribute to a traditional IRA, even after-tax, in the same year you fully fund a traditional 401(k).

[linguini]

We have existing traditional IRAs, so trying to accomplish what we accomplish with a Roth IRA contribution with a new traditional IRA contribution and converting it to a Backdoor Roth would make my head explode. If you could explain how that would work that would be great.

If your company's plan allows this, you can do this by transferring all assets from your traditional IRA's into your 401k. See the wiki: http://www.bogleheads.org/wiki/Backdoor ... RA#Caution

Also, I don't see anywhere where it says that you can contribute to a traditional IRA, even after-tax, in the same year you fully fund a traditional 401(k).

401k max and IRA max do not interact. Many bogleheads max out their 401k with the $17k contribution and then contribute $5k to a traditional IRA and do a backdoor Roth conversion. It is perfectly legal.

[ruralavalon]

When in doubt, defer taxes.

the benefits the Roth affords us (no tax on the gains) may overwhelm even a 3% decrease in tax rates, right?

In retirement, what income will be filling all of the lower tax brackets? It is unlikely that every dollar you withdraw from your tax-deferred accounts will be taxed at your marginal rate.

Whereas, every dollar you put into a Roth now is being taxed at your current marginal rate.

+1. Defer the taxes.

[bUU]

We have existing traditional IRAs, so trying to accomplish what we accomplish with a Roth IRA contribution with a new traditional IRA contribution and converting it to a Backdoor Roth would make my head explode. If you could explain how that would work that would be great.

If your company's plan allows this, you can do this by transferring all assets from your traditional IRA's into your 401k. See the wiki: http://www.bogleheads.org/wiki/Backdoor ... RA#Caution

I confirmed that both of our current-employer 401(k)s will accept tIRA rollovers. However, Fidelity will charge $50 for each; that's their charge for emptying out an IRA account. I just paid that fee to set up both of those IRAs at Fidelity (Fidelity refunded one of the fees, charged by the previous brokerage), so I'm not inclined to incur that $50 fee again (especially since there's no way anyone's going to refund it this time).

I think I'm going to pass on the rollover to 401(k) idea. I'm either going to bite the bullet and pay the taxes now (on the Roth conversion), or skip the idea of the Roth conversion for now.

Actually I think I'm going to do a split decision: Convert my spouse's $3k IRA, pay the tax now (actually, next year), and then my spouse will contribute $6k to a tIRA each year and convert that to Roth. I'll sit out.

[bUU]

I found a webpage that answered a question I had (which I have now edited out of the post, above) about my inherited IRA and how it would affect the Roth conversion:

... when it comes to converting your own traditional IRA to Roth, an inherited IRA that isn’t yours is not included in the calculation for the percentage converted (the "pro-rata rule").

http://thefinancebuff.com/inherited-ira ... -rule.html

[bdpb]

Check your 401k for after-tax contributions and in-service withdrawal/rollover to Roth IRA/401k options. You can defer over 50k in 401k this way. Contribute 17k tax deductible and the rest to after-tax contributions in each 401k. Then roll over your after-tax contributions and presumably small earnings to Roth.

[grabiner]

My premise for making the change to Roth 401(k) is to ensure we have enough money to live on prior to 2029 when the younger of us reaches retirement age. We recognize that that five and a half year period between when the younger person stops working and the younger person reaches retirement age is probably going to be the most challenging time, financially - no salary coming in, no company-subsidized health care for one of us, not yet the best time to start drawing from retirement sources for one of us, etc.

The alternative to using a Roth 401(k) is using a Traditional 401(k) and investing the tax savings in a taxable account; this will serve the same purpose of ensuring more money for retirement, but it may cost more in taxes because the taxable investment will have a tax cost. (You'll want to draw from your existing Traditional 401(k) in those years because you will be in a low tax bracket).

If you expect to retire in a 25% bracket and have a good 401(k), then the Roth 401(k) may be better even in a 28% bracket now; see the last example in the Wiki article Traditional versus Roth.

[BillyG]

I think I'm going to pass on the rollover to 401(k) idea. I'm either going to bite the bullet and pay the taxes now (on the Roth conversion), or skip the idea of the Roth conversion for now.

Bicker,

You should give this more thought and see if you are comfortable with it. I just did this during the last couple of weeks. The rollover of pre-tax money from multiple IRAs into my 401(k) was not that difficult and the Roth conversion of after-tax contributions was a breeze. It is much easier than it looks, and it is a whole lot cheaper than paying taxes that frankly you don't have to pay.

Billy

[bUU]

I'm not worried about how complex the transfer would be... I'm worried about telling my spouse to pay a second $50 fee to move the same $3300 for a second time in a 90 day period.

[bUU]

I just had another thought, that could take my spouse's concern about excessive fees out of the picture.

When you roll a tIRA into a 401(k), need it be complete? I'm think the answer is 'no'. I have the form for one of the 401(k)'s here, and it says clearly:

Code: Select all

Amount to be rolled over from present provider:
[__] 100% of account
[__] Partial rollover of $_______________

Fidelity only charges to close an IRA (and the CSR made very clear that emptying it automatically closes it). So maybe I should just leave $10 behind when I rollover the tIRA assets into the 401(k)s.

Fidelity does have low-balance fees. However: (1) Apparently they're assessed only once a year, perhaps in November (details are sketchy). But... (2) I think the low-balance fee is only assessed on low mutual fund balances. If, instead, what's sitting in your IRA is (for example) $10 in the core position, then there might not be any fees. This'll all be good to ask Fido on Wednesday, perhaps. (Maybe we need to leave $25 in each account?)

I just realized one additional wrinkle: We cannot touch my spouse's tIRAs until March, without incurring a short-term trading fee of $75. So that affects timing of this as well.

So if my assumptions are correct, we should be able to wait until March, and then:
1) Liquidate the holdings in the tIRAs;
2) Initiate the rollover from tIRA into the 401(k)s for all but $10 of the proceeds;
3) Once the rollover is complete, put another $6000 into each tIRA;
4) Convert each tIRA into a Roth.
5) Tax-time, pay taxes on only the $10 we left in each account.

And that's only the first year - after that, we wouldn't have any more taxable tIRA money to worry about.

Sound right?

[Buckeye]

Defer the taxes.

One thing to keep in mind is that often you can withdraw from your 401k penalty free if you retire at 55. Double check with employer and keep in mind it needs to stay in the plan, you can't roll it over to IRA till 59 1/2.

[BillyG]

So if my assumptions are correct, we should be able to wait until March, and then:
1) Liquidate the holdings in the tIRAs;
2) Initiate the rollover from tIRA into the 401(k)s for all but $10 of the proceeds;
3) Once the rollover is complete, put another $6000 into each tIRA;
4) Convert each tIRA into a Roth.
5) Tax-time, pay taxes on only the $10 we left in each account.

And that's only the first year - after that, we wouldn't have any more taxable tIRA money to worry about.

Sound right?

I think that's pretty much right except you can contribute $6500 (with the catch-up) in 2013. Each of you can contribute this much to a Roth assuming both of you will be 50 or older during 2013.

Also, you can swap steps 3 and 4 so the money doesn't sit in the account too long and accumulate taxable gains before you do the conversion.

Billy

[Default User BR]

I'm not worried about how complex the transfer would be... I'm worried about telling my spouse to pay a second $50 fee to move the same $3300 for a second time in a 90 day period.

Check on the fee. When I rolled from TD Ameritrade into the qualified plan, they waived the transfer fee.


Brian

[bUU]

3) Once the rollover is complete, put another $6000 into each tIRA;
4) Convert each tIRA into a Roth.

Also, you can swap steps 3 and 4 so the money doesn't sit in the account too long and accumulate taxable gains before you do the conversion.

Uh that confuses me. You can't convert a tIRA to a Roth until you've put the money into the tIRA. Otherwise, you're just contributing to a Roth, which we cannot do with our AGI. What did I miss?

Check on the fee. When I rolled from TD Ameritrade into the qualified plan, they waived the transfer fee.

I'm pretty sure that's what I asked Fidelity on Friday - I called Fidelity and asked them about whether they'd charge a fee to transfer a tIRA into my employer's 401(k). They said yes, because emptying the tIRA would close it, and they charge a fee on closing of a tIRA.

[BillyG]

BillyG wrote:
bicker wrote:
3) Once the rollover is complete, put another $6000 into each tIRA;
4) Convert each tIRA into a Roth.

Also, you can swap steps 3 and 4 so the money doesn't sit in the account too long and accumulate taxable gains before you do the conversion.

Uh that confuses me. You can't convert a tIRA to a Roth until you've put the money into the tIRA. Otherwise, you're just contributing to a Roth, which we cannot do with our AGI. What did I miss?

Maybe I didn't say it very well. What I meant is to do the Roth conversion on the after-tax IRA as soon as you do the rollover, and then do a second Roth conversion after setting up the $6500 TIRA. You can try to set up the accounts in parallel but there's no need to wait and do a single conversion -- the idea is to perform the conversions as soon as the accounts are ready so the money doesn't accumulate taxable gains waiting for the conversion.

Billy

[bUU]

Okay I think you missed some of the details - we don't have any after-tax tIRAs. Since the existing tIRAs are pre-tax, the consensus is to not convert those assets to Roth. (That's what several posters were referring to by saying, "Defer the taxes.") So the first action is to roll those (pre-tax) tIRA assets into my current-employer 401(k), so they don't get snagged up in the Roth conversion by the pro-rata rule. (I'm going to aim to leave $10 behind, to save a $50 fee Fido would assess if I transferred the entire balance of the tIRA to the 401(k).) Then, I'll add $6500 (after-tax) to the $10 (pre-tax) in each tIRA (that shouldn't cause a problem right?), and convert them to Roth.

I think.

[BillyG]

Bicker,

It sounds like you're on the right path. Sorry I missed that about no after-tax IRA money, so your situation is much simpler than mine.

I don't think the $10 left behind will cause any problems but others may chime in. If there is extra reporting for that, it may be worth paying the $50 fee...

Billy

[bUU]

Update: Fidelity confirms that it will not allow the balance to dip below $50 without closing the IRA account (and therefore triggering the fee), so I need to leave at least that much in the account. That's (what?) $20 worth of tax? Better to pay $20 worth of tax than a $50 fee.

I'm not sure what the cost BillyG was referring to with regard to "extra reporting". Does anyone know if there are such hidden costs?

[bUU]

Me again... I reading through Pub 590 and I think there is a problem with doing what folks have suggested.

The two tIRAs we have were rolled into Fidelity in October and December of this year (2012). Does that mean I cannot roll them into employer 401(k)s for until October and December of next year (2013)?

I know the 1-year rule doesn't apply to Roth conversions, but I have to roll the pre-tax tIRA money into 401(k)s before we can consider the Roth conversion.

[Default User BR]

Me again... I reading through Pub 590 and I think there is a problem with doing what folks have suggested.

The two tIRAs we have were rolled into Fidelity in October and December of this year (2012). Does that mean I cannot roll them into employer 401(k)s for until October and December of next year (2013)?

I know the 1-year rule doesn't apply to Roth conversions, but I have to roll the pre-tax tIRA money into 401(k)s before we can consider the Roth conversion.

What did you find in 590 that has you concerned?

Brian

[bUU]

This appears several paragraphs below the chart on which the rollover from tIRA to 401(k) is listed as valid ("yes"):

Waiting period between rollovers. Generally, if you make a tax-free rollover of any part of a distribution from a traditional IRA, you cannot, within a 1-year period, make a tax-free rollover of any later distribution from that same IRA. You also cannot make a tax-free rollover of any amount distributed, within the same 1-year period, from the IRA into which you made the tax-free rollover.

Okay, an update thanks to another thread in the forum. This is the part that matters:

A transfer of funds in your traditional IRA from one trustee directly to another, either at your request or at the trustee’s request, is not a rollover... Because it is not a rollover, it is not affected by the 1-year waiting period required between rollovers.

So that covers one tIRA. The other tIRA was a rollover but not a rollover from one IRA to another either... the source was a pension plan, not an IRA.

So I should be good for doing the rollovers into the 401(k)s, after the short-term trading deadline is up.