Roth IRA Conversion question from young physician

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uvadk
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Roth IRA Conversion question from young physician

Post by uvadk »

All, I am physician just starting out in practice and have a question for the group about whether or not to do a Roth IRA conversion this year.

Here is my porfolio:

Emergency funds: 6 mos

Debt: 220k mortgage only at 4%

Tax filing status: Single (currently) - will be married in 2012

Tax rate: 28% fed (2011), will be 33% in 2012. 6% state

Age: 33

AA: 90/10

Intl: 25%

Current Portfolio:

Taxable: 32% Vanguard TSM Index Admiral

Roth IRA: 13% Vanguard Total Int'l Stock Index Admiral
7% Vanguard TSM Index Admiral
7% Vanguard REIT Index Admiral

Rollover IRA: 23% Vanguard Small-Cap Value Index Admiral
10% Vanguard Total Bond Market Index Admiral
8% Vanguard Total Int'l Stock Index Admiral

For the first half of 2011, I was able to contribute to a Roth 403b plan through my fellowship employer. This has been rolled in the Roth IRA.
Currently I do not have access to a tax deferred plan through my group for my first year. I will have access starting next September.

My Rollover IRA is approx $85k which will push my income into the 33% tax bracket this year (from approx $140k --> $225k).

Questions:
1) Does it makes sense to convert my rollover IRA to a Roth IRA this year? My income will be increasing significantly next year.
2) Am I able to/should I contribute to an IRA this year? I believe that my income is too high to deduct the IRA - please correct me if I am wrong. Also, if I am able to deduct, does my previous Roth 403b from earlier in the year negate my ability to contribute to a deductible IRA? If I am only able to contribute to a nondeductible IRA, should I then do a backdoor Roth?

Thank you very much!
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White Coat Investor
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Re: Roth IRA Conversion question from young physician

Post by White Coat Investor »

What will your retirement plan be next year?
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course
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White Coat Investor
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Re: Roth IRA Conversion question from young physician

Post by White Coat Investor »

You realize you need to get rid of the rollover IRA to do a backdoor roth, right? Only rolling over the portion you wanted to convert would have been smarter. Perhaps you can convert part of it now and roll the rest into a 401K next year allowing you to do backdoor roths in the future.

http://whitecoatinvestor.com/retirement ... -roth-ira/
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course
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uvadk
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Re: Roth IRA Conversion question from young physician

Post by uvadk »

Thanks for the advice.

Need to find out the specifics on retirement plan for the group. Will post.

The rollover IRA came from a 403b from residency.
RabbMD
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Re: Roth IRA Conversion question from young physician

Post by RabbMD »

Too late now, but unless expenses were horrible you could have left the money in the old 403b. Often you can roll it straight into other 403bs. To roll into 401ks often though you have to roll into an irs first.
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uvadk
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Re: Roth IRA Conversion question from young physician

Post by uvadk »

RabbMD, thanks for the reply. I am still finding out the details of my group's plan, but it appears to be a 401k.

At this point, would it make sense to convert to a Roth IRA? All/part/or none of the rollover IRA?

Thanks.
Wannaretireearly
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Re: Roth IRA Conversion question from young physician

Post by Wannaretireearly »

EmergDoc wrote:You realize you need to get rid of the rollover IRA to do a backdoor roth, right? Only rolling over the portion you wanted to convert would have been smarter. Perhaps you can convert part of it now and roll the rest into a 401K next year allowing you to do backdoor roths in the future.

http://whitecoatinvestor.com/retirement ... -roth-ira/
Great advice & well written article. I didnt understand this until retiredjg helped me out. Reminds me of the reason why I have 2 old 401ks not converted yet...
“At some point you are trading time you will never get back for money you will never spend.“ | “How do you want to spend the best remaining year of your life?“
RabbMD
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Re: Roth IRA Conversion question from young physician

Post by RabbMD »

Right now I would find out if my 401k accepts incoming rollovers, a lot do. Then i would rollover the ira into my 401k and then start backdoor roth conversions.
Alan S.
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Re: Roth IRA Conversion question from young physician

Post by Alan S. »

If you cannot pull off the transfer of your rollover IRA to the qualified plan, you may still want to consider making the non deductible contribution and filing Form 8606. The contribution gives you another 5k of tax deferred contributions. You can convert it and pay taxes on the taxable portion now if you think you are headed for the top bracket about the time that the top bracket gets a bump up. You may never have a better chance to convert at lower rates. OR - you can wait to see if there will be another later opportunity to roll your pre tax IRA balance to a qualified plan. The 5k after tax contribution will still be there to be converted tax free. But if you never make the non deductible contribution, you forfeit that opportunity as well as the opportunity to add 5k to your tax deferred balance.

As a high paid professional, converting only what you can convert tax free based on 5k per year will probably not be enough Roth accumulation. You will probably have to siphon in some taxable conversions along the way as well so you do not reach retirement with a huge pot of pre tax retirement funds, where the RMDs can be large enough with your other income to generate still high marginal tax rates.

While incomes for MDs may fluctuate in the future and some disciplines obviously generate more income than others, my comments are more geared to someone who will generate at least the median income for physicians.
letsgobobby
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Re: Roth IRA Conversion question from young physician

Post by letsgobobby »

I wouldn't convert at 28% and definitely not at 33%. If you can't get the TIRA into your group's 401k, you'll have to give up on the backdoor Roth for now, but as Alan S describes you can still make non-deductible contributions of $5000 per spouse per year and file 8806 and eventually that will add up to a little something something.
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Re: Roth IRA Conversion question from young physician

Post by White Coat Investor »

Wannaretireearly wrote:
EmergDoc wrote:You realize you need to get rid of the rollover IRA to do a backdoor roth, right? Only rolling over the portion you wanted to convert would have been smarter. Perhaps you can convert part of it now and roll the rest into a 401K next year allowing you to do backdoor roths in the future.

http://whitecoatinvestor.com/retirement ... -roth-ira/
Great advice & well written article. I didnt understand this until retiredjg helped me out. Reminds me of the reason why I have 2 old 401ks not converted yet...
Yup, that's one of the reasons I kept the TSP when I got out of the service.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course
Topic Author
uvadk
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Re: Roth IRA Conversion question from young physician

Post by uvadk »

EmergDoc, letsgobobby, Alan S, RabbMD, and Wannaretireearly,

Thank you all for the helpful advice. What I have found so far:

-our 401k is with ING. Yes, I can roll an IRA into the 401k.

-not sure yet about fees, funds offered (though I am told they are only ING funds), etc.

This would not start until next year, when my income will increase to the 33% bracket.
EmergDoc wrote:You realize you need to get rid of the rollover IRA to do a backdoor roth, right? Only rolling over the portion you wanted to convert would have been smarter. Perhaps you can convert part of it now and roll the rest into a 401K next year allowing you to do backdoor roths in the future.
Questions:
Is it possible to convert some of the rollover IRA to a Roth this year, and roll the rest into a 401k next year?

Would the group still do the $5k nondeductible IRA?

Thanks!
letsgobobby
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Re: Roth IRA Conversion question from young physician

Post by letsgobobby »

yes to your first question, but why would you want to? Why not make 2 x $5000 non-deductible contributions to 2 TIRAs (call them IRAs 1 and 2) now, wait until next year, roll your original IRA (call it IRA 3) into your 401k, make 2 x $5000 non-deductible contributions to IRAs 1 and 2, then convert IRAs 1 and 2 to Roth IRAs?

At 28% I see no compelling reason to convert an IRA to a Roth IRA.
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uvadk
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Re: Roth IRA Conversion question from young physician

Post by uvadk »

letsgobobby wrote:yes to your first question, but why would you want to? Why not make 2 x $5000 non-deductible contributions to 2 TIRAs (call them IRAs 1 and 2) now, wait until next year, roll your original IRA (call it IRA 3) into your 401k, make 2 x $5000 non-deductible contributions to IRAs 1 and 2, then convert IRAs 1 and 2 to Roth IRAs?

At 28% I see no compelling reason to convert an IRA to a Roth IRA.
So, correct me if I'm wrong, but I could only do the back door Roth conversion from non-deductible IRAs (in your example IRAs 1 and 2) if I rolled over my original IRA (IRA 3) into my 401k? In other words, I cannot do the back door Roth conversion with the non-deductible IRAs with money still in a traditional IRA?

Would you recommend doing this $5k (x2 means for me and my spouse, correct?) back door Roth conversion every year?

If that is the case, would you still recommend doing it if it means leaving a Vanguard IRA (with admiral shares) and going into an ING 401k? In fairness, I do not have the details on the funds/expense ratios of the ING funds.
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Re: Roth IRA Conversion question from young physician

Post by Alan S. »

Correct. If your 85k TIRA remains in place, and you make the non deductible contributions, the Roth conversion uses PRO RATE rules to determine the tax bill. To keep the math simple, if you add 3 years of non deductible contributions to the pot, you have a balance of 100k of which 15% (15,000) is post tax. Any conversion you then do is 85% taxable regardless of the amount. If you convert 10k, then you would have 8,500 of taxable income and 1,500 would be tax free due to your non deductible contributions.

BUT, if you roll that pre tax balance of 85,000 into the 401k, your IRA of 15,000 would all be after tax becuase the contributions were not deducted. You then convert tax free. Once you eliminate the pre tax balance of your TIRA, then all contributions you make that are non deductible can immediately be converted to a Roth IRA. The net effect here is the same as if you were eligible to make a regular Roth contribution, it just takes two steps to get there (not counting the rollover to the 401k as a step because you only have to do that one time.

You could do this indefinitely. However, you need to be sure the ING funds used in the 401k plan have reasonable expenses and performance. If the 85,000 is subjected to high costs for several years, the back door benefit is severely watered down or eliminated. Therefore, you need to find out more about the ING investment options.

Also, if your spouse does not have a pre tax TIRA balance, she can just make the contribution and convert. Her IRAs and your IRAs are totally separatei. Only the spouse that has the pre tax balance need to have access to an employer plan that will accept an IRA rollover.
Topic Author
uvadk
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Re: Roth IRA Conversion question from young physician

Post by uvadk »

Thank you for helping me to understand this issue.

Will look into the ING 401k plan details before I consider rolling by TIRA into the new 401k next year.

Will hold off on rolling the TIRA into a Roth this year at 28% marginal rate.

Sounds like the general consensus is:
-Go ahead with the $5k non-deductible IRA contribution this year (getting married next year)
-Then 2x $5k non-deductible IRA contributions in 2012
-As long as 401k has reasonable fees, roll the TIRA into 401k next year
-Then convert the $15k in non-deductible IRAs into back door Roth
-Continue with 2x $5k non-deductible IRA contributions/back door Roths in future

Sounds reasonable?

Thank you ALL very much.
letsgobobby
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Re: Roth IRA Conversion question from young physician

Post by letsgobobby »

that sounds right. and of course your future spouse can make his/her $5000 IRA contribution this year, too, if she/he has earned income in that amount.

It may not seem like much, but we've been making non-deductible contributions since 2006... in 2006, 07, 08, 09, and 10, and then we converted it all to a Roth IRA in 2010. Then we made contributions in 2011, and converted immediately. It adds up.I think we've made $28k in contributions each since 2006, and it grew a little, and it's tax free forever, so I think those $3000-$5000 chunks now add up to around $80,000.
RabbMD
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Re: Roth IRA Conversion question from young physician

Post by RabbMD »

Additionally, for 2011 both you and your finance can contribute up until april 15th, 2012 to either a roth or a nondeductible ira. Thus you do not have to figure this out now. If your agi is under the roth limit for both yourself and finance (and you both have earned income sufficient), you can just contribute directly to a roth ira this year (again up until april 15th, 2012). If your income is too high then the backdoor comes into play. Also, the rollover of the ira into the new ing 401k just has to be completed by dec 31st of the year of the conversion of the nondeductible to roth event. Thus you could contribute to a nondeductible in jan 2012, immediately convert in jan 2012, and in case you werent eligable to roll over the ira until sept into the 401k, youd still avoid prorata issues as long as the rollover was completed by dec 31, 2012. Look at irs form 8086 (pretty sure this is the right number).
Topic Author
uvadk
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Re: Roth IRA Conversion question from young physician

Post by uvadk »

letsgobobby and RabbMD,

Thank you very much for the info.

Just found out the details on the ING 401k and they are not good. Mostly actively managed funds with expense ratios in the 0.9-1.4% range. I am certainly going to work on changing these funds/fees.

However, assuming worst case scenario and I am unable to change things...would it make sense to roll my TIRA into the 401k just to be able to do the back door Roth? Does not seem so to me.
letsgobobby wrote:that sounds right. and of course your future spouse can make his/her $5000 IRA contribution this year, too, if she/he has earned income in that amount.

It may not seem like much, but we've been making non-deductible contributions since 2006... in 2006, 07, 08, 09, and 10, and then we converted it all to a Roth IRA in 2010. Then we made contributions in 2011, and converted immediately. It adds up.I think we've made $28k in contributions each since 2006, and it grew a little, and it's tax free forever, so I think those $3000-$5000 chunks now add up to around $80,000.
From the above, it sounds like I could start to make the non-deductible contributions now, work on improving the 401k, and roll over the TIRA once the funds/fees improve in the future?
letsgobobby
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Re: Roth IRA Conversion question from young physician

Post by letsgobobby »

yes, that would be a good strategy. Make the non-deduct contribs now, but wait on the rollover.

How long do you plan to work at this job?
Topic Author
uvadk
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Re: Roth IRA Conversion question from young physician

Post by uvadk »

letsgobobby wrote:yes, that would be a good strategy. Make the non-deduct contribs now, but wait on the rollover.

How long do you plan to work at this job?
Thanks. Hopefully plan to be at this practice for a career (30 years?).

Finding out more details about the plan....even higher fees than originally realized. Upwards of 2% for some funds with all fees added.

Reading up in the forum/wiki about changing 401k plans.
letsgobobby
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Re: Roth IRA Conversion question from young physician

Post by letsgobobby »

if you are planning to stay a long, long time, it would argue against rolling over into your 401k, unless your 401k also allows in-service withdrawals... see the game? You could roll in your TIRA, make your non-deductible contributions, convert to a Roth IRA. Then you could in-service withdrawal your 401k contents to a low cost IRA. Then, conceivably, repeat each year.

I'm being somewhat facetious. I'm sure there are reasons why this wouldn't work, like looking at the value of your TIRA for pro-rata purposes only at a single date, like Dec 31, of each year.
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Re: Roth IRA Conversion question from young physician

Post by Default User BR »

letsgobobby wrote:if you are planning to stay a long, long time, it would argue against rolling over into your 401k, unless your 401k also allows in-service withdrawals... see the game? You could roll in your TIRA, make your non-deductible contributions, convert to a Roth IRA. Then you could in-service withdrawal your 401k contents to a low cost IRA. Then, conceivably, repeat each year.

I'm being somewhat facetious. I'm sure there are reasons why this wouldn't work, like looking at the value of your TIRA for pro-rata purposes only at a single date, like Dec 31, of each year.
It would work. You would just have to time the rollovers so that the IRA went in near the end of one year, and back out the beginning of the next. That might be a significant amount of hassle for some people.


Brian
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uvadk
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Re: Roth IRA Conversion question from young physician

Post by uvadk »

Thanks.

My plan for now is to start with making the non-deductible IRA contributions, keep my TIRA, and work on improving the 401k. Assuming I am able to decrease the fees of the 401k and include low cost index funds, I will plan on rolling over the TIRA in the future and make the back door Roth conversions of the non-deductible IRAs.

Is it easy to do the non-deductible IRAs? Form 8086?
letsgobobby
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Re: Roth IRA Conversion question from young physician

Post by letsgobobby »

yes, very easy... especially with a program like Taxact or TurboTax
Topic Author
uvadk
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Re: Roth IRA Conversion question from young physician

Post by uvadk »

All,

Over the past year, my practice has successfully changed from Wells Fargo/ING to Vanguard for our 401k. The change is set to come in the next 2 weeks.

As a reminder, here is my current portfolio:

Emergency Funds: 6 mos expenses
Future House Downpayment: $28k (adding approx $5k/mo for next 6-8mos)
Debt: $100k her student loans ($57k @ 6.55%, $47k @ 2.14%) - started paying $6k/mo since wedding x 2 mos ago
Tax Filing Status: Married filing jointly
Tax Rate: 33% federal, 6% state (GA)

Desired Asset Allocation: 90/10 (current: 94/6)
Desired Int'l Allocation: 20-25%

Current Portfolio (mid 6 figures):
Taxable:
Vanguard TSM Index Admiral : $190k (54%)

Tax Deferred:
Traditional IRA (non-deductible, Dec '11 contribution) : Vanguard TSM Index: $5600 (2%)

Rollover IRA: (from prev employer)
Vanguard Total Bond Index Admiral: $22k (7%)
Vanguard SCV Index Admiral: $52k (15%)

Roth IRA:
Vanguard Total Int'l Index Admiral: $63k (18%)
Vanguard REIT Index Admiral: $16k (5%)

403b (Her):
Vanguard Target Retirement 2050: $8k

401k (Him):
Vanguard Target Retirement 2045: $8k

QUESTIONS:
1) What should I do with the non-deductible IRA funds at this point? I initially made the $5k non-deductible IRA contribution in Dec 2011 thinking that I was going to roll my rollover IRA into our group's 401k (as we just moved to Vanguard Funds); however, I want to be sure this makes sense as I would be giving up the admiral shares I currently hold (401k does not have admiral shares avail) and have to pay the 401k fees (though small since this is with Vanguard small business). Can I still convert these funds even though the contribution was in Dec 2011 and the conversion will be in 2012? Do I have to convert by Dec '12? Or do I have until April '13? How about the 2012 contribution? Do I have until April '13 to make it?

2) Should we do a backdoor Roth for my wife (and I?) for 2012? Her current income level for this year will be around $50k. Next year it will rise, but she does not have any other IRA in her name. If so, any suggestions what we should put this in?

3) Just to be clear on the actual conversion...I would make the $5k contribution to a non-deductible IRA on day 1, and then convert to Roth on day 2? Should I simply put in a money market fund on day 1?

Thank you!
DK
Alan S.
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Re: Roth IRA Conversion question from young physician

Post by Alan S. »

You need to find out the total ER for your new 401k chosen investment options. Eg, if the ER is 40 basis points, you would be paying a little over $200 per year in added fees vrs the Admiral shares on 74k for the benefit of doing multi year backdoor Roth tax free conversions. For this difference the rollover is probably worth it but if the ERs are considerly higher it may not be. If you do the rollover, you could leave the non rollover IRA alone and just pay taxes on the $600 of gains I assume were earned on the 5k contribution.

You shouldn't convert until the rollover is completed, just in case it does not get done before year end for some reason. The conversion is nearly tax free so you could do the conversion this year after the rollover or next year. The fact you made the contribution for 2011 is immaterial. You can also make your 2012 contribution (up to 4/15/2013) before converting or just do an additional conversions for your 2012 contribution if you need to wait to make that contribution. You could also do your 2013 contribution anytime after 1/1 and convert that one right away as well. No problem doing multiple conversions in a single year, they just get added together for reporting purposes.

Your wife's backdoor is much simpler. Just make the non deductible contributions when she can and convert right afterwards. You would each file your separate 8606 on your joint return to report your respective non deductible contributions FOR that year and any conversions done IN that year.

The contributions can either be invested in MM or the eventual investment before conversion, but for converting immediately, the mm will eliminate dealing with any huge 2 or 3 days swings before you convert.
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uvadk
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Re: Roth IRA Conversion question from young physician

Post by uvadk »

You need to find out the total ER for your new 401k chosen investment options
The options in our 401k would be Vanguard Investor Shares of both the Total Bond Market and the SCV Index (though I may end up moving this to TSM Index) which would be 22 and 35 BP respectively. I am awaiting the recordkeeping fees. By my calculations, it would be approx $100/yr increase (before recordkeeping fees) if I made the move from Admiral in the IRA to Investor in the 401k. Assuming this is the increase in fees, sound worth it?
If you do the rollover, you could leave the non rollover IRA alone and just pay taxes on the $600 of gains I assume were earned on the 5k contribution.
Not sure I understand this? If I do rollover the IRA to the 401k, I would then do the backdoor Roth with the non-dec IRA of $5600 (yes, $600 earned on $5k contribution). What happens with the extra $600? Do I pay taxes on that amount? Since it is already in a TSM Index Fund, I would probably just leave it in same fund in Roth. Maybe this is what you meant....

Thanks!
DK
Alan S.
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Re: Roth IRA Conversion question from young physician

Post by Alan S. »

Your plan fees are low enough to make the rollover worthwhile, as you may be able to make several years of non deductible contributions and convert them.

For the conversion of the current IRA of 5,600, since your basis is 5,000 and the value is 600 more than your basis, the $600 will be taxed. If you really want to avoid that tax, you could transfer the 600 to your rollover IRA before you roll it into the 401k. Then you will avoid taxation since your conversion will not be more than your basis. Remember, for IRA tax purposes, the individual investments do not matter. Taxation occurs only when you take a distribution and a conversion is a two part transaction, first a distribution and then a rollover to a Roth IRA.
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uvadk
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Re: Roth IRA Conversion question from young physician

Post by uvadk »

Thanks for the advice. Much appreciated! Will plan on transferring $600 into my IRA before rolling it into my 401k.
DK
RabbMD
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Re: Roth IRA Conversion question from young physician

Post by RabbMD »

Saw this was reupped. One more thing to consider asking about your new vanguard 401k. We use Employee Fiduciary with vanguard funds because when I changed our S corps 401K from a high few one in 2008ish vanguard was not doing any small 401ks. Vanguard does not allow admiral funds on index funds in 401k plans, but they do allow us access to signal funds, which basically have the same ER as the admiral funds. Not exactly sure why vanguard uses admiral for IRA/taxable index funds and signal for 401k/403b instititutional plans, but they do. Also, in our 401k we can get admiral funds on non index funds if the combined balance is >$50,000. We currently have the tips admiral fund (the tips funds are not index funds for vanguard, just low expense active funds). So you couls see if you can get access to signal funds from vanguard for your core index funds (total stock, international, total bond, ect), and also admiral funds for any of the active funds available in your plan.
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uvadk
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Re: Roth IRA Conversion question from young physician

Post by uvadk »

Great idea. We discussed this with the group. We have initially decided to stay with their institutional/investor shares so that the group will get the benefit of lower recordkeeping fees. However, it may be advantageous to the partners in the group to go to signal shares for some of the funds - despite the increased recordkeeping fees the group (i.e. partners) will be paying out of pocket. Any thoughts on how to make this call? Do the slightly lower ER of signal shares outweigh the slightly increased cost of recordkeeping fees (I believe the recordkeeping costs will be approx $7k/year on $7mil total with our current arrangement of institutional shares - the costs would increase $1k for every $1mil we moved over to signal).
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