Taxes when you rollover 401k into a Roth IRA

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Taxes when you rollover 401k into a Roth IRA

Post by FrancisK »

Hi there,

I am trying to help my spouse who currently has a 401k and a Traditional IRA. Her income is too high to contribute to a Roth IRA but on the other hand, she cannot deduct the Traditional IRA contribution for her tax (due to her high income).

We are contemplating the possibility to do a backdoor IRA, converting her Traditional IRA into a Roth. The tax should be okay since her contributions to the Traditional IRA were post-tax anyway (there will still be taxes on potential capital gains if I get it correctly?). We would also convert 100% of the traditional IRA so there wouldn't be pro-rata tax.

Now, the real question is about the 401k. Once she leaves her employer, we wanted to roll over this into the new Roth IRA but if I understand correctly, she would have to pay the tax on this rollover contribution because the 401k contributions were pre-tax and the contributions to a Roth IRA are post-tax. If I am correct, the tax bill could be huge since she is in the 35% bracket. This makes us reconsider the benefit of a backdoor IRA.

Unless I got it wrong and we could roll the 401k into a Traditional IRA and then do a backdoor IRA again? Would this operation avoid the tax bill on the post/pre-tax contribution?

Thanks a lot for your help. I am just trying to understand the benefit of a backdoor IRA (converting Traditional to Roth) if one has a huge amount of pre-tax in a 401k and plans to leave the employer in the short term.

Thanks for reading!
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Re: Taxes when you rollover 401k into a Roth IRA

Post by jebmke »

if the 401 is pre-tax, it will be taxed when rolled over to a Roth IRA
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Re: Taxes when you rollover 401k into a Roth IRA

Post by KlangFool »


You should

A) Rollover the 401K into an Trad IRA.

B) Then do a Roth conversion from the Trad IRA to Roth IRA.

You do not owe taxes on (A). You pay taxes on (B).

Do this in two steps. They do not need to happen at the same time. And, (B) can happen at any time that is advantageous to you.

This is not a backdoor IRA.

Backdoor IRA is something else.

It is

A) You contribute after-tax to non-deductible IRA.

B) You rollover the non-deductible IRA to Roth IRA.

You can only do this if you do not have any before-tax Trad IRA.

Last edited by KlangFool on Tue Jan 24, 2023 9:56 am, edited 1 time in total.
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Re: Taxes when you rollover 401k into a Roth IRA

Post by terran »

You're right, rolling the 401(k) to Roth IRA will add the total value of the 401(k) to your taxable income. Unless you expect to be in the 35% bracket for your whole life, including in retirement, this is probably not a good idea.

You're also right that rolling the 401(k) over into a traditional IRA will mean her backdoor Roth will be taxed in an proportion equal to the pre-tax amount (the 401(k) rollover) vs the post tax amount (the non-deductible contribution), so a large 401(k) rolled over to an IRA will effectively block the backdoor Roth.

The better option would be to either leave the 401(k) where it is or roll it over into a new employer 401(k) as long as one of those has decent investment options.

If you decide to roll the 401(k) over into an IRA anyway, then what matters is the IRA balance on December 31 of the tax year in which the IRA to Roth IRA conversion is made, so she can do the backdoor Roth until the year she rolls the 401(k) over into the IRA.
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Re: Taxes when you rollover 401k into a Roth IRA

Post by toddthebod »

There is no way to convert pre-tax amounts to post-tax without the income showing up on your tax return. The only way to avoid a huge tax bill would be to convert in years when you have little or no other income. Going through an intermediate Traditional IRA account doesn't change anything.

Your best option at this point is to keep the 401(k) where it is until she has a new 401(k available to do a rollover. You don't want to move this money into a Traditional IRA if you want to have the option of backdoor Roth in the future due to the pro rata rule. (I.e., any Roth conversion will be considered to have come proportionally from her large pre-tax money and her small annual post-tax money.)
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Re: Taxes when you rollover 401k into a Roth IRA

Post by FrancisK »

Thank you all! I appreciate the responses and bits of advice!
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Re: Taxes when you rollover 401k into a Roth IRA

Post by PaunchyPirate »

Rollover the 401k into a Traditional (Rollover) IRA after she leaves employment. Let it sit there as long as you want. At some point, generally in years with lower income, she may wish to CONVERT part or all of that Traditional IRA to her Roth IRA. She will owe taxes on the amount converted each time she converts some.

I retired in 2019. My Traditional IRA (which contains multiple former 401k's) sat for 4 years before I did my first conversion to Roth in 2022. And I only converted $7500. That is the amount that I decided would be acceptable to me for taxation last year (given my other taxable income sources). Each year, going forward, I will evaluate how much (if any) of my remaining Traditional IRA it makes sense to convert. Roths are great, but it is not always financially prudent to convert a traditional IRA to a Roth. I certainly wouldn't do it all in one year because the amount lost to taxes would be huge. Do it in chunks during your lower income years.
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Re: Taxes when you rollover 401k into a Roth IRA

Post by FiveK »

The backdoor Roth IRA process and Roth IRA conversions aren't exactly the same thing, so it's good to be sure which is being considered.

Is her current 401k so bad that leaving the money there is undesirable?
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