Any wisdom in rolling pre-tax 401k funds into a Roth?

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Miguelito
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Any wisdom in rolling pre-tax 401k funds into a Roth?

Post by Miguelito » Fri Feb 23, 2018 10:59 am

To be clear, I am well aware of the "megabackdoor Roth." My employer does allow in-service distributions and also tracks neatly and separately where the piles of money are (i.e. pre-tax employee contributions, post-tax employee contributions, previous employer rollover, company match, etc.). I did a one time rollover of post-tax contributions to a Roth. I no longer fund my 401k with after-tax dollars.

My question has to do with rolling over pre-tax funds from the 401k to a (new) Roth IRA account. It would appear I am allowed to rollover the funds (and gains) I rolled over from a previous employer. If so, and assuming it works no differently than the standard "megabackdoor Roth" conversion, I would just have to pay taxes on the conversion, no?

That's not trivial, of course. But if I were in a reasonably favorable tax bracket, like say 24%, would it not make sense to convert as much as I can without exceeding the 24% bracket?

I'm around 40 years old and suspect my 401k will be rather "large" upon retirement, so to me this would be a way to better hedge against taxes in the future. I fear while I may not need that much in retirement, I may have no choice but to pull out a bunch of money from the 401k that may trigger a larger tax than I would want.

Thoughts?

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Earl Lemongrab
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Re: Any wisdom in rolling pre-tax 401k funds into a Roth?

Post by Earl Lemongrab » Fri Feb 23, 2018 1:32 pm

It doesn't sound like a great idea. Do you think your tax rate in retirement will be higher than 24%? I'm retired with a pension but I'm in the 12% bracket starting this year.

I don't understand the point about having to take a large distribution. Do you mean an RMD? Or something else? Even if your plan required taking a complete distribution, you could roll the pretax part to an IRA.
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Miguelito
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Re: Any wisdom in rolling pre-tax 401k funds into a Roth?

Post by Miguelito » Fri Feb 23, 2018 3:06 pm

Yes, I meant RMD's. Hypothetically (in today's dollars), if a 401k balance grew to 5M, at ~5%, that would be $250k for a RMD. That's a bit extreme, but the point remains.

In addition, there is the element of decades of tax free growth that will never get taxed.

We used to be in the 33% tax bracket, and at that level it never made sense to me. But at 24%, I do start to wonder. Especially with the prospect of distributions pushing you into the 22% bracket. Of course who knows what brackets will look like in 20+ years, but that may also be a good reason to do it now. Maybe in 5 years for whatever reason we are in the 32% tax bracket or some new even high bracket.

decapod10
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Re: Any wisdom in rolling pre-tax 401k funds into a Roth?

Post by decapod10 » Fri Feb 23, 2018 3:36 pm

Miguelito wrote:
Fri Feb 23, 2018 3:06 pm
Yes, I meant RMD's. Hypothetically (in today's dollars), if a 401k balance grew to 5M, at ~5%, that would be $250k for a RMD. That's a bit extreme, but the point remains.

In addition, there is the element of decades of tax free growth that will never get taxed.

We used to be in the 33% tax bracket, and at that level it never made sense to me. But at 24%, I do start to wonder. Especially with the prospect of distributions pushing you into the 22% bracket. Of course who knows what brackets will look like in 20+ years, but that may also be a good reason to do it now. Maybe in 5 years for whatever reason we are in the 32% tax bracket or some new even high bracket.
Are you assuming the entire $250k RMD is going to be taxed at your marginal rate on retirement (meaning you have a pension or you will still be working)? If the RMD represents your entire retirement income, your effective tax rate will be roughly 17% based on 2018 tax rates filing Married jointly, so even then you’re not really gaining anything by converting everything to Roth right now.

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Tamarind
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Re: Any wisdom in rolling pre-tax 401k funds into a Roth?

Post by Tamarind » Fri Feb 23, 2018 4:33 pm

I did this once (into an existing Roth IRA, not a new one). However, I was very young and underemployed and had a much lower tax rate.

I wouldn't do this just to avoid or reduce RMD if your future tax rate might well be lower.

You could split the difference by doing partial rollover of just the extra space in your bracket?

Olemiss540
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Re: Any wisdom in rolling pre-tax 401k funds into a Roth?

Post by Olemiss540 » Fri Feb 23, 2018 5:07 pm

I have considered this as well as a way of expanding my tax advantaged space instead of taxable investing.

Also considering due to the new 22% bracket and the fact that my state does not tax conversions (5% savings).
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Re: Any wisdom in rolling pre-tax 401k funds into a Roth?

Post by grabiner » Fri Feb 23, 2018 10:08 pm

There are two reasons to do this.

One is the usual reason for converting traditional to Roth money: you expect to retire in a a higher tax bracket, or in about the same tax bracket and you can max out retirement contributions.

The other reason is to open the backdoor. If you don't want to leave the money in the 401(k) (say, because it is expensive), and your new 401(k) doesn't accept transfers, rolling it into an IRA will prevent you from using backdoor Roth IRAs in the future.
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FiveK
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Re: Any wisdom in rolling pre-tax 401k funds into a Roth?

Post by FiveK » Fri Feb 23, 2018 11:06 pm

decapod10 wrote:
Fri Feb 23, 2018 3:36 pm
Miguelito wrote:
Fri Feb 23, 2018 3:06 pm
Hypothetically (in today's dollars), if a 401k balance grew to 5M, at ~5%, that would be $250k for a RMD. That's a bit extreme, but the point remains.
Are you assuming the entire $250k RMD is going to be taxed at your marginal rate on retirement (meaning you have a pension or you will still be working)? If the RMD represents your entire retirement income, your effective tax rate will be roughly 17% based on 2018 tax rates filing Married jointly, so even then you’re not really gaining anything by converting everything to Roth right now.
If in fact, absent any further traditional 401k contributions, the existing balance will grow to that $5M amount, then any further traditional contributions will be taxed at 24% at withdrawal.

Related discussion: Portfolio size needed to reach each tax bracket in retirement.

How confident one should be in that growth is another question....

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