Tax liability question re: transferring 401k to Roth IRA

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shm7454
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Joined: Thu Jul 11, 2019 11:58 am

Tax liability question re: transferring 401k to Roth IRA

Post by shm7454 » Thu Jul 11, 2019 12:18 pm

I've been reading this board off and on for about a year, but new to posting so apologies for the stupid question.

I have a traditional 401k from an old employer that's currently just sitting with no additional contributions since I left the firm - only about $70k. My current firm doesn't offer 401k admin or matching yet (small firm) so I'm contemplating transferring the 401k to a personal Roth IRA with Etrade so I can max out contributions on my own.

However, I'm unsure if (a) this is the best strategy and (b) if I do roll over the 401k to a personal Roth IRA, I'm not 100% about what I'll be facing with regard to the tax liability/penalty. I understand I'll be dinged heavily for switching from traditional to Roth, but I'm not sure what the penalty percentage is, when that liability will be due (i.e. next tax season or upon withdrawals at retirement, etc.), and if I invest the lump sum amount into VG funds, will I need to sell some of the invested amount to pay for the tax liability.

Again, apologies for the dumb question and I appreciate the help.

bloom2708
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Re: Tax liability question re: transferring 401k to Roth IRA

Post by bloom2708 » Thu Jul 11, 2019 1:18 pm

You would be doing a Roth Conversion. You will pay tax as if the conversion is ordinary income.

If you are in the 22% top tax bracket now, add $70k on. Does that push you up to 24% Fed? State tax also applies.

Most would move this money into their current 401k if possible.

If you are at a place where you do Back Door Roth IRA, you would not want to transfer this to a Traditional/Rollover IRA. No tax is due going from old 401k to Rollover IRA, but it does interfere with your ability to do Back Door Roth IRA each year. Pro Rata Rule comes into play.

I would do this order

1. Merge with current 401k (if you get one in the future)
2. Leave where it is
3. Transfer to Rollover IRA at Vanguard/Fidelity, etc. (no tax)

You could do a Roth Conversion down the road. Best when you are done working and before Social Security. Your income is low by design. You "create" income by doing a Roth Conversion to keep you in the 12% or 22% bracket. Assuming when pensions or SS kicks in and RMDs hit that you will be in a higher bracket.

Lots going on in these. Don't pay tax if you don't have to at a high rate.
Last edited by bloom2708 on Thu Jul 11, 2019 1:45 pm, edited 1 time in total.
"We are not here to agree with you; we are here to provoke thoughtfulness." Unknown Boglehead

retiredjg
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Re: Tax liability question re: transferring 401k to Roth IRA

Post by retiredjg » Thu Jul 11, 2019 1:36 pm

shm7454 wrote:
Thu Jul 11, 2019 12:18 pm
I have a traditional 401k from an old employer that's currently just sitting with no additional contributions since I left the firm - only about $70k. My current firm doesn't offer 401k admin or matching yet (small firm) so I'm contemplating transferring the 401k to a personal Roth IRA with Etrade so I can max out contributions on my own.
Two things.

If you roll the old 401k to Roth IRA, you will owe tax on $70k for tax year 2019. You probably want to avoid that. You can leave the old 401k where it is (if costs are low) or roll it to a Rollover IRA in which case no taxes would be due.

But what do you mean "so I can max out contributions on my own?" If your current firm does not offer a 401k, you cannot contribute to one.

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grabiner
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Re: Tax liability question re: transferring 401k to Roth IRA

Post by grabiner » Thu Jul 11, 2019 2:57 pm

bloom2708 wrote:
Thu Jul 11, 2019 1:18 pm
You would be doing a Roth Conversion. You will pay tax as if the conversion is ordinary income.

If you are in the 22% top tax bracket now, add $70k on. Does that push you up to 24% Fed? State tax also applies.
If this is the case, and you do decide you want the money in a Roth, you can save in taxes by rolling enough to the Roth this year to get to the top of the 22% bracket, and the rest to a Traditional IRA which you convert to a Roth next year at 22%.
Wiki David Grabiner

carmonkie
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Re: Tax liability question re: transferring 401k to Roth IRA

Post by carmonkie » Thu Jul 11, 2019 3:17 pm

What funds are in that old 401(k)? You can build a set it and forget it 3 fund portfolio. $70K is nothing to frown upon.

Depending on your AA, you can do S&P 500 fund + bonds or S&P + Int + Bonds. You can take a look at it once a year and rebalance as needed.
or simply a target fund that matches your AA. If you post the fund selection with Expenses and your desired AA, we can help.

You do not want a tax hit nor handcuff yourself if down the road you can do backdoor conversions. The Pro Rata rule will get you because of the Rollover IRA.

cas
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Re: Tax liability question re: transferring 401k to Roth IRA

Post by cas » Thu Jul 11, 2019 3:20 pm

shm7454 wrote:
Thu Jul 11, 2019 12:18 pm
I understand I'll be dinged heavily for switching from traditional to Roth, but I'm not sure what the penalty percentage is, when that liability will be due (i.e. next tax season or upon withdrawals at retirement, etc.),
Technically, unless you meet something called "safe harbor for estimated taxes" (use the search box at the top of this page for more information), all the taxes on the Roth conversion will be due in the quarter that you do the conversion (i.e. NOT delayed until April 2020 when you file your 2019 taxes). And super-technically (if you don't meet safe harbor), unless you fill out the somewhat labor-intensive Schedule AI (Annualized Income), those taxes had to be paid in equal quarterly estimated payments by 4/15/2019, 6/15/2019, 9/15/2019, and 1/15/2020. (In other words, you would already be late on the first two quarterly payments for paying estimated taxes.) You might end up with a penalty for underpayment of estimated taxes.
and if I invest the lump sum amount into VG funds, will I need to sell some of the invested amount to pay for the tax liability.
If you are less than 59 1/2 and you need to use funds that were in the 401k to pay the taxes for the conversion to Roth IRA, then you will owe an additional 10% early withdrawal penalty (in additional to the normal income taxes that other people have mentioned) on the funds used to pay the taxes.

If (for whatever reason) you think that it isn't possible to leave the funds in the old 401k, Is there a reason that you don't want to roll over the 401k to a Rollover IRA (no taxes would be due), rather than converting the funds in the 401k to a Roth IRA?

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teen persuasion
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Re: Tax liability question re: transferring 401k to Roth IRA

Post by teen persuasion » Fri Jul 12, 2019 7:51 am

shm7454 wrote:
Thu Jul 11, 2019 12:18 pm

I have a traditional 401k from an old employer that's currently just sitting with no additional contributions since I left the firm - only about $70k. My current firm doesn't offer 401k admin or matching yet (small firm) so I'm contemplating transferring the 401k to a personal Roth IRA with Etrade so I can max out contributions on my own.
You can leave the old 401k as is, it remains invested in whatever you invested in while working. You simply cannot add more new contributions to it, but it can grow on its own.

If you don't have access to an employer plan thru your new job, you can contribute to an IRA, either Roth or traditional. Your MAGI determines whether you are eligible for Roth contributions, or deductible tIRA contributions, or non-deductible tIRA contributions. If you are not eligible for either Roth or deductible tIRA contributions, you can make non-deductible tIRA contributions and convert them to Roth IRA (as long as you have no other tIRA balances). This is referred to as the backdoor Roth IRA.

If you need to go the backdoor route to contribute to a Roth IRA, then you should avoid creating other tIRA accounts - that is, don't do a rollover from your 401k to a tIRA, leave it in the 401k.

If/when you get access to a 401k in the future, you can then decide whether to roll the old 401k into the new, or leave it where it is. If there's no option to roll in, no decision to make. If new 401k has better fund choices, lower fees, consider rolling in. If new has worse funds/fees, consider leaving it as is.

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