Advice for retiring parents: converting 401k to Roth IRA

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dorazzle
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Advice for retiring parents: converting 401k to Roth IRA

Post by dorazzle » Wed Jan 09, 2019 9:41 pm

Hello,

I am writing on behalf of my parents who are both in retirement as of Jan 1st. My father recently approached me because he recently read an article about how transferring a little bit money from my mother's 401k to a roth IRA every year could save them in less taxes overall than if waited until age 70.5 and paid taxes on the RMD. My mother is currently 64 if that matters.

They currently do not have any IRA accounts. He is interested in setting up a roth IRA since there is no RMDs and can be passed on to heirs.

My question how to do the conversion? I believe all the money in the 401k is pretax money (I don't believe there are any after-tax contributions in there).

Can the money in the 401k be directly transfered to a Roth IRA after paying taxes on it. Or does it have to go into a traditional IRA first and then converted to a Roth IRA? If so does that mean he can only convert 6k ( + catchup amount) a year?

I have heard of mega backdoor Roth conversions, but my impression was that you could only do that with after tax contributions to 401ks.

Thank you for your help. I am new to personal finance and just learning myself. I have been focused on learning about the things I should be doing as young person and not so much about what to do at the end of retirement

Globalviewer58
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Re: Advice for retiring parents: converting 401k to Roth IRA

Post by Globalviewer58 » Wed Jan 09, 2019 9:52 pm

Your question is a good one and fortunately the Wiki has a page devoted to the topic. You can search the Boglehead Wiki by clicking on the Wiki at the top of the page. In the search bar enter the term Roth IRA Conversion.

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dorazzle
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Re: Advice for retiring parents: converting 401k to Roth IRA

Post by dorazzle » Wed Jan 09, 2019 10:31 pm

Globalviewer58 wrote:
Wed Jan 09, 2019 9:52 pm
Your question is a good one and fortunately the Wiki has a page devoted to the topic. You can search the Boglehead Wiki by clicking on the Wiki at the top of the page. In the search bar enter the term Roth IRA Conversion.
Thank You! I read the page but still have a few questions.

The wiki page talked about converting from traditional IRA to Roth IRA. My mother doesn't have a traditional IRA. So I assume that she would have to open a traditional IRA and move her 401k money to the traditional IRA. And then convert from the traditional IRA to a Roth IRA (at this step she would have to pay taxes). Is there a limit on how much money per year can be transfered from the 401k to the traditional IRA? And is there a limit to how much money can be converted from the traditional IRA to the roth IRA per year?

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Watty
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Re: Advice for retiring parents: converting 401k to Roth IRA

Post by Watty » Thu Jan 10, 2019 12:12 am

I don't know the statistics but my impression is that most people will move their 401k to an IRA when they retire. This is not a taxable event and it usually gives you more better investment options.

Some companies 401k rules can have pitfills when it comes to limitations on inheriting it. There is also a chance that the company will merge with another company or change 401k administrators and they might have to deal with that when they are in their 80's and that could be difficult to manage then. Unless there is a real compelling reason to leave the money in the 401k it would be a good idea for them to roll the money out to an IRA since that would make things simpler.

To do this they should contact the new company(Vanguard, Fidelity, etc) and they will walk them through the process.

Once the money is in an IRA it will be a lot simpler to roll into a Roth and they should be able to do that online pretty much like any other transfer.
dorazzle wrote:
Wed Jan 09, 2019 9:41 pm
I have heard of mega backdoor Roth conversions, but my impression was that you could only do that with after tax contributions to 401ks.
That only applies to people that are still working so you do not need to worry about that.

dorazzle wrote:
Wed Jan 09, 2019 9:41 pm
Or does it have to go into a traditional IRA first and then converted to a Roth IRA? If so does that mean he can only convert 6k ( + catchup amount) a year?
You are thinking of contributions of new money, a Roth conversion is totally different.
dorazzle wrote:
Wed Jan 09, 2019 9:41 pm
My father recently approached me because he recently read an article about how transferring a little bit money from my mother's 401k to a roth IRA every year could save them in less taxes overall than if waited until age 70.5 and paid taxes on the RMD.
In addition to doing Roth conversions before they have the RMD they also need to consider doing them before they start Social Security or a Roth conversion could cause more of their Social Security to be taxed. If they are getting their health insurance with and Affordable Care Act subsidy before they start Medicare they also need to be careful since they could lose the subsidy if they have too much income in 2019.

How much to convert really depends on their tax situation. If they convert a lot they will get into a higher tax bracket and at some point the taxes will be too high to make it a good choice. If they are financially secure and have ample funds then doing Roth conversions up to top of the 12% federal tax bracket usually makes sense unless they will be leaving the funds to a charity when they die.

Above the federal 12% tax bracket it is more complicated and harder to justify. For example for a Roth conversion in the 22% federal tax bracket to make sense then they, or their heirs, would need to be in a tax bracket above 22% someday. It takes a lot of income to get above the 22% tax bracket so if you are dealing with that amount of money it is likely worth getting professional tax advice on how much to convert.

They also need to be careful because it they convert a lot then they may have a lot higher Medicare payments called IRMAA and that could be expensive.

https://www.medicare.gov/your-medicare- ... rt-b-costs

The way that Social Security is taxed is complicated too so they need to consider that.

https://www.bogleheads.org/wiki/Taxatio ... y_benefits

People that do Roth conversion often do them in December since they can do a dummy tax return to figure out how much to convert. They may want to get everything organized and wait until early December to do the actual Roth conversion.

lgerla
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Re: Advice for retiring parents: converting 401k to Roth IRA

Post by lgerla » Thu Jan 10, 2019 3:09 am

Watty's advise is correct. The only way to get money from a 401k to a Roth IRA, is to first do a rollover to the IRA. You can't roll over pre-tax 401k contributions directly to a Roth; they have to be converted from a rollover IRA. Conversions have no annual limit other than what you can/want to pay in additional income tax.

The rollover from the 401k to the rollover IRA is not a taxable event. The conversion to the Roth IRA is. But it is better to only roll over what you can convert in one calendar year, because of the pro rata rule (see the Wiki article).

For that reason, it would also depend on the withdrawal rules of the 401k plan(s). For example, once I retire, my plan (currently) will allow any amount to be withdrawn as often as I like. My husband's plan requires an all-or-nothing withdrawal. We have the same plan provider, but since we work at different companies, the plans and rules are different. You can usually find a summary of the plan document on the 401k website. If it's not clear, call to find out.

For all the complexity, it can be very worthwhile to do. When my husband retired last year, we moved his 401k into a solo 401k (we have a side business), and now it's time to figure out whether/how much to roll to his IRA and convert to Roth in 2019. :beer

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Tamarind
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Re: Advice for retiring parents: converting 401k to Roth IRA

Post by Tamarind » Thu Jan 10, 2019 8:08 am

You don't mention your parents' ages. If they are not eligible for Medicare yet, how are they going to handle medical insurance until 65? If they are planning to go on ACA plans, they may need some very careful math regarding Roth conversions. Conversions count as income when figuring the ACA subsidy. Just helped my mom work through this.

rkhusky
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Re: Advice for retiring parents: converting 401k to Roth IRA

Post by rkhusky » Thu Jan 10, 2019 8:31 am

lgerla wrote:
Thu Jan 10, 2019 3:09 am
The only way to get money from a 401k to a Roth IRA, is to first do a rollover to the IRA. You can't roll over pre-tax 401k contributions directly to a Roth; they have to be converted from a rollover IRA.
This isn't true, you can convert directly from a Traditional 401k to a Roth IRA (you will owe taxes due on tax day of the following year). You may not want to make multiple transfers though, because it is generally more cumbersome to move money from a 401k to an IRA. Moving money from a Traditional IRA to a Roth IRA with the same provider can be as simple as a couple of mouse clicks and will only take a day or two to process. In a worst case, moving money from a 401k to an IRA can take multiple paper forms, notarized signatures, and a month to process.

Unless you have an investment option in your 401k that is really special (like the TSP G Fund for example) or you live in a state that offers better protection for 401k's than for IRA's, I would not think twice about moving the entire Traditional 401k to a Traditional IRA.

As has been mentioned, there are a number of tax pitfalls that one should be aware of, if you convert too much in one year. Taxation of SS can bump the marginal rate on RMD's from 12% to 20%, if you expect to be in that tax bracket.

retiredjg
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Re: Advice for retiring parents: converting 401k to Roth IRA

Post by retiredjg » Thu Jan 10, 2019 8:34 am

dorazzle wrote:
Wed Jan 09, 2019 9:41 pm
Can the money in the 401k be directly transfered to a Roth IRA after paying taxes on it.
Yes. This has been allowed for quite awhile. It was not allowed at some time in the past.

If so does that mean he can only convert 6k ( + catchup amount) a year?
The limit you are thinking of has to do with contributions. It does not apply to conversions. There is no limit for conversions.

I have heard of mega backdoor Roth conversions, but my impression was that you could only do that with after tax contributions to 401ks.
Does not apply to someone who is no longer working.


In spite of the fact that money can go directly from 401k to Roth IRA, that does not mean it is possible in every single case. Her plan must allow for multiple distributions for it to happen. I think most do. Maybe all do. It may even be required by law for all I know. The point is, if she wants to do this, she needs to find out from her plan how many /how often her plan allows a distribution.

Also, just because a person is allowed to leave their money in a 401k after retirement does not mean it is always the best idea. It may be fine to leave money in a very low cost plan. But sometimes, even with a low cost plans, expenses that had been paid by the employer may get passed to the employee after retirement. From a cost perspective, it is frequently better to roll 401k money to a traditional IRA.

Once a person decided to consider Roth conversions, the decision of "how much to convert?" comes up. This is different in each case. This depends on their income, tax bracket, ages, and a lot of other things we don't know.

Even though there are no limits on how much to convert, there are limits one might now want to go over. For example, if they convert enough to push their income over $170k, this will push their Medicare premiums higher. This starts at age 63 (meaning going over the limit at 63 causes higher premiums at 65, and so on each year). There are other limits for the Affordable Care Act (ACA). Another thing to watch is whether conversions will make more of their SS to be taxed.

The bottom line is that Roth conversions early in retirement can be a good idea in many situations. However, we do not know enough about your parent's situation to help much. And since she or they are newly retired, they may not even know what their income and expenses will be.

lgerla
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Re: Advice for retiring parents: converting 401k to Roth IRA

Post by lgerla » Thu Jan 10, 2019 1:10 pm

Retiredjg, thanks for the correction on distributing directly from a 401k to a Roth IRA, and apologies to the OP. :oops:
I believe you still want to check with the specifics of the plan, and would want to replace the mandatory tax withholding to get the full amount into the Roth.

DrGoogle2017
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Re: Advice for retiring parents: converting 401k to Roth IRA

Post by DrGoogle2017 » Thu Jan 10, 2019 5:12 pm

Also I don’t know if anybody mentioned this yet but if you have multiple 401k accounts, you have to take distribution from all of them, it’s not the same as having multiple IRA accounts, it’s treated as one big account. So in short you maybe required to take out more than IRA.

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dorazzle
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Re: Advice for retiring parents: converting 401k to Roth IRA

Post by dorazzle » Thu Jan 10, 2019 6:05 pm

Thank you everyone for all your kind responses.

In regards to healthcare, both my parents were county employees in California and their health insurance premiums are covered by CalPers in retirement. In fact the money that I'm talking about moving into an IRA is from the CalPERS deferred compensation plan (if that makes a difference in regards to any of the points made above).
rkhusky wrote:
Thu Jan 10, 2019 8:31 am
Unless you have an investment option in your 401k that is really special (like the TSP G Fund for example) or you live in a state that offers better protection for 401k's than for IRA's, I would not think twice about moving the entire Traditional 401k to a Traditional IRA
Does the pro-rata rule complicate moving the the entire amount into a traditional IRA and moving a little bit out every year into a roth IRA. Or does the pro-rata rule not apply?

billfromct
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Re: Advice for retiring parents: converting 401k to Roth IRA

Post by billfromct » Thu Jan 10, 2019 6:32 pm

Dr Google said, "if you have multiple 401k accounts, you have to take distribution from all of them, it's not the same as having multiple IRA accounts, it's treated as one big account."

I think Dr Google is talking about taking RMDs at age 70.5 from 401k accounts without specifically mentioning that he is talking about 401k RMDs. The op is talking about converting money from a 401k to a Roth IRA for his 64 year old mother.

I was under the impression that there are no rules concerning taking money out of 401k plans after age 59.5 & before age 70.

If I am incorrect in my interpretation of Dr Google's post, please let me know.

bill

rkhusky
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Re: Advice for retiring parents: converting 401k to Roth IRA

Post by rkhusky » Thu Jan 10, 2019 7:14 pm

dorazzle wrote:
Thu Jan 10, 2019 6:05 pm
rkhusky wrote:
Thu Jan 10, 2019 8:31 am
Unless you have an investment option in your 401k that is really special (like the TSP G Fund for example) or you live in a state that offers better protection for 401k's than for IRA's, I would not think twice about moving the entire Traditional 401k to a Traditional IRA
Does the pro-rata rule complicate moving the the entire amount into a traditional IRA and moving a little bit out every year into a roth IRA. Or does the pro-rata rule not apply?
The pro-rata rule applies if you have deducted and undeducted contributions in your Traditional IRA’s. But even if it applied, since you are doing Roth conversions in retirement, it might cause some extra paperwork, but no real problem. The main issue is when people want to do backdoor Roth contributions while working.

DrGoogle2017
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Re: Advice for retiring parents: converting 401k to Roth IRA

Post by DrGoogle2017 » Thu Jan 10, 2019 8:12 pm

billfromct wrote:
Thu Jan 10, 2019 6:32 pm
Dr Google said, "if you have multiple 401k accounts, you have to take distribution from all of them, it's not the same as having multiple IRA accounts, it's treated as one big account."

I think Dr Google is talking about taking RMDs at age 70.5 from 401k accounts without specifically mentioning that he is talking about 401k RMDs. The op is talking about converting money from a 401k to a Roth IRA for his 64 year old mother.

I was under the impression that there are no rules concerning taking money out of 401k plans after age 59.5 & before age 70.

If I am incorrect in my interpretation of Dr Google's post, please let me know.

bill
Yes that is correct because if OP’s mom doesn’t take it now, she will be forced to take it later in. So it’s best to empty with a good tax saving strategy while you can.

HEDGEFUNDIE
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Re: Advice for retiring parents: converting 401k to Roth IRA

Post by HEDGEFUNDIE » Thu Jan 10, 2019 11:17 pm

The top of the 12% bracket for married filing jointly is $79k. add the standard deduction of $24k, and you can convert up to $103k/yr.

DrGoogle2017
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Re: Advice for retiring parents: converting 401k to Roth IRA

Post by DrGoogle2017 » Thu Jan 10, 2019 11:32 pm

It depends on what else do the parents have for income. Any pension, SS, dividends, etc...

retiredjg
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Re: Advice for retiring parents: converting 401k to Roth IRA

Post by retiredjg » Fri Jan 11, 2019 8:18 am

dorazzle wrote:
Thu Jan 10, 2019 6:05 pm
Does the pro-rata rule complicate moving the the entire amount into a traditional IRA and moving a little bit out every year into a roth IRA. Or does the pro-rata rule not apply?
There is nothing to pro-rate since there are no other IRAs. If there were another IRA and it contained contributions that were not-deductible at the time she made them, that is when pro-rating would occur.

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Strayshot
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Re: Advice for retiring parents: converting 401k to Roth IRA

Post by Strayshot » Fri Jan 11, 2019 9:01 am

If the 401k does not have any particularly good or unique investment options vs what are available in an IRA at a major firm (Fidelity, Vanguard, Schwab) I would just roll the entire 401k into an IRA and start doing partial conversions every year in the $$ amount you desire based on taxability. Makes the process and paperwork a piece of cake (speaking from Fidelity experience).

My 401k has an amazing fixed income option that doesn’t exist anywhere else that I wouldn’t want to lose access to, but other than that every asset category has an equal or better counterpart in a Fidelity IRA.

James Lange and others have written good information about when to utilize Roth conversions in the sweet spot between retirement and taking social security/required minimum distributions to maximize tax benefits etc.

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Peter Foley
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Re: Advice for retiring parents: converting 401k to Roth IRA

Post by Peter Foley » Fri Jan 11, 2019 9:34 am

A couple points have not been mentioned. Leaving some money in a 401k/403b/457 can be a good option if that account has access to low cost funds and possibly a higher interest paying stable value fund. I use a stable value fund as part of my bond allocation.

An IRA can have some advantages when one approaches RMD's. Qualified charitable distributions (gifts to charity) can only be made from IRAs. Doing a QCD as one's first withdrawal each year can lower one's MAGI and one's taxes.

I personally would want to have an IRA because the QCD offers a "charitable deduction" of sorts for individuals who may otherwise take the standard deduction.

lstone19
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Re: Advice for retiring parents: converting 401k to Roth IRA

Post by lstone19 » Fri Jan 11, 2019 9:47 am

Even though she's over 59-1/2, I believe the five year rule for penalty-free withdrawals of earnings from a Roth IRA still applies (the five-year rule for withdrawals from conversions does not apply once over 59-1/2). So it's in your mother's best interests to get a Roth created this year and get the five-year clock ticking (it's by calendar years so anytime in 2019 is considered 1/1/19 for purposes of that rule).

I see little value in leaving money in a 401k after retirement. Get it into a traditional IRA where you have more options. I've seen some references to a Rollover IRA but if you're retired with no plans to work again, there is nothing to be gained by a Rollover IRA as that's just a special form of Traditional IRA which has kept money from a 401k rollover segregated so it can be rolled back into a new employer's 401k.

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