How Do Taxes Work With Rollover Roth IRA?

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WhataM
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How Do Taxes Work With Rollover Roth IRA?

Post by WhataM »

I'm kinda confused with how the taxes are calculated when it comes to a 401(k) rollover to Roth IRA. Does the money from the 401(k) get added into your income you made from your job that year then taxed. Or, is the money from the 401(k) taxed separately from income. Examples:

A. You make $10,000 at your job and your 401(k) has $20,000. The income combined is $30,000 and the taxes are deducted from the $30,000.

OR

B. You make $10,000 and your 401(k) has $20,000. The two amounts are taxed separately.
Silk McCue
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Re: How Do Taxes Work With Rollover Roth IRA?

Post by Silk McCue »

The answer is A.
user5027
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Re: How Do Taxes Work With Rollover Roth IRA?

Post by user5027 »

WhataM wrote:I'm kinda confused with how the taxes are calculated when it comes to a 401(k) rollover to Roth IRA. Does the money from the 401(k) get added into your income you made from your job that year then taxed. Or, is the money from the 401(k) taxed separately from income. Examples:

A. You make $10,000 at your job and your 401(k) has $20,000. The income combined is $30,000 and the taxes are deducted from the $30,000.

OR

B. You make $10,000 and your 401(k) has $20,000. The two amounts are taxed separately.
A is correct but your terminology is confusing. Taxes are not deducted. The rollover will be a distribution on 1099-R and entered on Form 1040, line 15 16.

edit: Corrected my mistake on the line number.
Last edited by user5027 on Tue Apr 18, 2017 3:20 pm, edited 1 time in total.
clydewolf
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Re: How Do Taxes Work With Rollover Roth IRA?

Post by clydewolf »

The "rollover" is a distribution from your 401k. Distributions from a 401k are reported on your 1040 line 16.

If you are at least age 70-1/2 your RMD amount would have been issued to you from the 401k before the "rollover", as RMD amounts are not eligible for "rollover".

The taxable amount of the distribution is reported on line 16 and added to your other income to arrive at your total income on line 22.
robertalpert
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Re: How Do Taxes Work With Rollover Roth IRA?

Post by robertalpert »

Is the 4012k Traditional or Roth?
Topic Author
WhataM
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Re: How Do Taxes Work With Rollover Roth IRA?

Post by WhataM »

robertalpert wrote:Is the 4012k Traditional or Roth?
The account is traditional
Topic Author
WhataM
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Re: How Do Taxes Work With Rollover Roth IRA?

Post by WhataM »

Ultimately, I'm trying to decide if I benefit from rolling my Traditional 401(k) at the end of the year into a Roth IRA. Or if I should just set up a Traditional IRA and pay the taxes later. When I start my new job I'll be moving from the 15% tax bracket to the 25% tax bracket.
Alan S.
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Re: How Do Taxes Work With Rollover Roth IRA?

Post by Alan S. »

If you are going to convert at all, do it before you end up in the 25% bracket.

If you do a direct rollover from pre tax 401k to your Roth IRA, you will be taxed on the full 20k (assuming all pre tax). But if you rolled it to your TIRA, you could convert a smaller amount if you wanted to. Whether you do the direct rollover to Roth or go through your TIRA, the Roth conversion can still be recharacterized if you want to reverse it due to taxes you do not want to pay or a loss on your conversion.

The reporting is a little different - for direct rollover from 401k to Roth IRA, the 1099R will indicate the taxable amount and the rollover is reported on line 16 of Form 1040.

If you roll to a TIRA first, that rollover will also be reported on line 16a and 16b, with no taxes due. But the later conversion from TIRA to Roth IRA will require a Form 8606 to report the conversion, and the taxable amount ends up on line 15b of Form 1040. Therefore, doing the two step approach gives you more control over the conversion amount and dates, but requires a little more reporting work.

The central guideline for conversions is that you want to convert when your tax rate is lower or no worse than equal to what you expect your rate to be in retirement. Of course, guessing what your rate in retirement will be decades later is a guess, a wild guess in some cases.
Topic Author
WhataM
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Re: How Do Taxes Work With Rollover Roth IRA?

Post by WhataM »

Alan S. wrote:If you are going to convert at all, do it before you end up in the 25% bracket.

If you do a direct rollover from pre tax 401k to your Roth IRA, you will be taxed on the full 20k (assuming all pre tax). But if you rolled it to your TIRA, you could convert a smaller amount if you wanted to. Whether you do the direct rollover to Roth or go through your TIRA, the Roth conversion can still be recharacterized if you want to reverse it due to taxes you do not want to pay or a loss on your conversion.

The reporting is a little different - for direct rollover from 401k to Roth IRA, the 1099R will indicate the taxable amount and the rollover is reported on line 16 of Form 1040.

If you roll to a TIRA first, that rollover will also be reported on line 16a and 16b, with no taxes due. But the later conversion from TIRA to Roth IRA will require a Form 8606 to report the conversion, and the taxable amount ends up on line 15b of Form 1040. Therefore, doing the two step approach gives you more control over the conversion amount and dates, but requires a little more reporting work.

The central guideline for conversions is that you want to convert when your tax rate is lower or no worse than equal to what you expect your rate to be in retirement. Of course, guessing what your rate in retirement will be decades later is a guess, a wild guess in some cases.
I'm 26. So my rate in retirement is a extremely wild guess at the moment. My thinking was, pay the tax on the money now since I'm the lower tax bracket. And then convert to a TIRA and not have to pay the tax on the principal later on at potentially higher rate. Is that thinking correct?
Alan S.
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Re: How Do Taxes Work With Rollover Roth IRA?

Post by Alan S. »

You meant "convert to a Roth IRA". Yes, particularly if you have good future potential for advancement and increasing salary, now is the time to convert incremental amounts each year. Convert the whole 20k but not above the top of the 15% bracket if you can.
robertalpert
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Re: How Do Taxes Work With Rollover Roth IRA?

Post by robertalpert »

Alan S. wrote:You meant "convert to a Roth IRA". Yes, particularly if you have good future potential for advancement and increasing salary, now is the time to convert incremental amounts each year. Convert the whole 20k but not above the top of the 15% bracket if you can.
By converting only to top of 15% bracket, would he avoid paying any conversion-related taxes at all?
Or would he simply be paying 15% rather than 25%?
Alan S.
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Re: How Do Taxes Work With Rollover Roth IRA?

Post by Alan S. »

The latter.

He would pay 15% plus state tax unless some of the conversion was in the 10% bracket. The 10% marginal rate increase above the 15% bracket is significant enough that for many people the top of the 15% bracket is a natural place to cap taxable income if you have the choice, and of course a conversion is optional.

While OP has no idea of his tax rate in retirement, it is very likely to be 15% or more but less likely to be 25% or more.

I always try to make the point that your rate in retirement has MUCH MORE to do with your personal make up and financial decisions than it does with tax law changes.

Characteristics that work against accumulation and therefore result in lower tax rates in retirement:
1) Spender vs Saver
2) Poor health
3) Early retirement
4) Divorce
5) Bad career choices
6) No inheritance

The fewer of the above characteristics or tendencies you have, the more likely conversions will be beneficial. If you are prone to the above items, best not to waste tax money converting unless you can convert for near nothing.
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