Rollover 401K into Traditional, Then Convert To Roth IRA?

Email  Print Print  

I have a 401k from my former employment. My CPA says to turn into a traditional IRA and then over to a Roth IRA for tax benefits eventually. He suggest investing in a very low risk A bonds and 25% low risk stock.

His reasoning is we are only taxed now on the lower end of balance, but later as it grows will be beneficial to us then.

I am 52. I plan on using the funds after 59.5 yrs.

1. Is there always a fee connected with rolling over into an IRA — bank, cpa, etc.

2. Does this sound like a wise?

I am very conservative in my finances.

Your question has three parts actually:
Should you roll over a 401k to a Traditional IRA?
If you think that the Traditional IRA gives you access to better investment options, then yes you should roll it over. The tax rules are the same for a Traditional IRA (in this case it’s called a Rollover IRA) and a 401k. There is generally no fee associated with rolling over an account.

Should you convert a Traditional IRA into a Roth IRA?
When you convert, you pay taxes on the entire Traditional IRA balance because you didn’t pay income taxes on that amount before you contributed it. If you remember, your 401K contributions were deducted from your paycheck, thus making it tax-free; and since Roth IRA funds are post-tax, they extract the tax when you make the conversion. Will this be beneficial to you? Only if you think that your income tax rate will be higher that it is now when you’ll be withdrawing the funds in seven years. Only you know that so I can’t tell you what I’d do in your situation.

A subquestion to the “whether you should convert question” is how you’d pay for it. You can pay for the tax with funds outside of your IRA’s or you can pay using the principal within the IRA. If you need to tap into the principal to pay for the tax, I probably wouldn’t do the conversion because you’re sacrificing earning potential when you decrease that principal. If you can pay for the tax outside of the IRA, then you have a decision on your hands.

Does this sound wise?
It only sounds wise if you want to go through the trouble (or are willing to pay this CPA to do it for you, which has a lot to do with why he or she suggested it for you) and if you think your income tax rate will be higher in seven years. Luckily your conservative investment style has nothing to do with this, if you think you’ll be taxed more in 7 years and you can pay the tax with funds outside of the IRA, then you probably want to convert. If you don’t think you’ll be taxed more in 7 years, don’t do it. If you don’t think you can pay for the conversion (which will cost you your tax rate times whatever you convert), don’t do it.

Good luck!

{ 9 comments, please add your thoughts now! }

Related Posts

RSS Subscribe Like this article? Get all the latest articles sent to your email for free every day. Enter your email address and click "Subscribe." Your email will only be used for this daily subscription and you can unsubscribe anytime.

9 Responses to “Rollover 401K into Traditional, Then Convert To Roth IRA?”

  1. More questions that should be answered…

    Is your CPA an investment expert? It sounds as if his/her advice primarily considers tax issues…

    Have you done any financial planning? If you are “conservative,” you must especially be aware of the greatest risk to an investor: Outliving your money. Market risk is only one factor to consider…

    Is your CPA a fiduciary? Probably not. A fiduciary must meet a higher standard of conduct by showing a process underlying their recommendations. The “process” will likely involve the assessment of risk tolerance, risk capacity, investment objective, and investment time horizon. A fiduciary will also likely have an “investment policy statement” that demonstrates in writing the process of the fiduciary’s investment selection and monitoring. Finally, a fiduciary is personally liable for their actions. Can you sue your CPA for giving you “bad advice?” You could try but you probably wouldn’t win…

    I can not make any assumptions as to your financial status or preparation but I can sum up what I do know with a quote from Shakespeare:

    “A fool doth think he is wise but the wise man knows himself to be a fool.”

    Good luck…

  2. kkgbear says:

    I’ve also been considering such a conversion from a 401k to Trad IRA and then to a Roth. A key factor is the tax that must be paid at the time of conversion. You are giving up not only the tax but all future earnings of those tax dollars. Assuming constant tax rates, I ran the numbers and it takes many years to re-coup, but ultimately (20+ years) the conversion to a Roth wins out. If I had a CPA, I would request that he/she run the numbers and present the results with all assumptions declared.

    Obviously, if tax rates increase, conversion becomes more attractive. However, since no one can predict future tax rates, I have decided to convert only a portion of my 401k. Thus mitigating the tax rate question by putting my “nest egg” in two baskets. Currently the value of my 401k is 4 times my existing Roth, so I will convert enough to balance that more evenly in the coming years.

  3. dong says:

    The rollover and conversion issues are predominantly tax issues, and flexibility issues. What you do with the money in the account is the investment issue. The CPA doesn’t sound like he’s givind investment advice as much as tax advice (obviously there’s some overlap).

    There are lot’s of factors in play here. How much money is in the account? I believe if you convert the whole lump sum, you could jump a tax bracket which would make it dumb to do so. In general I think converting to a Roth makes sense if there are no outstanding issues about jumping tax brackets by the conversion or jumping down a tax bracket in retirement. kkgbear also makes an excellent point about recouping earnings from what gets paid in taxes. However aside from different monerary issue, a Roth IRA is much more flexibile because it has not forced withdrawal requirements (this can make money management much easier)

  4. JLP says:

    One thing to consider is if you have to use money inside the 401(k) to pay the taxes on the conversion, you will have to pay a penalty on the money that is withdrawn to pay taxes. Not a good deal.

  5. Lord says:

    Don’t forget that most 401ks are accessible from age 55, although you would probably do this in installments over time.

  6. Art Dinkin says:

    There are plenty of reasons to roll a 401(k) into a traditional IRA in addition to investment flexability. There are issues of control, distribution, expenses (yes, 401(k)’s have expenses and sometimes the former employee is left to pay them, and good luck finding them) and several others.

    I actually applaud the CPA for this advice. Most CPA’s that I know are very good at telling you the consequences for what has already happened. Very few are willing to think forward. Based on what I am reading in between the lines, he is recommended the transfer to an IRA now, and a conversion to a Roth down the road. Perhaps even 2010 when special provisions apply for paying the tax?

    The one thing I do not understand is why you automatically assume that the CPA only recommended this to earn a fee. Are you that skeptical of financial professionals? Especially ones who have earned a significant designation like a CPA through years of study, formal practice, and challenged difficult boards? Yes there are a few rotten apples in ever bunch. That does not mean you shouldn’t eat fruit.

  7. Responding to kkgbears comment: If you’re in the same tax bracket in retirement as you are now, it makes absolutely no difference which route you go. Let’s say that your investment increases 10-fold, and that your marginal tax bracket is 25%. A $1000 contribution to a tax-deferred account grows to $10,000 of which you pay $2,500 in taxes and are left with $7,500. The $750 left over after paying taxes on the $1000 will grow to $7,500 on which you will pay no taxes. You have the same amount either way.

    But it’s rarely that simple, because you may be in a lower bracket in retirement, but you could be in a higher tax bracket as well. In fact being in a higher tax bracket may be more likely than you think.

    I discuss this in further detail in
    link. Since I couldn’t preview my post, I don’t know for sure if I’ve formatted the link properly — if it doesn’t work then I also have a link to the post above under my handle.

  8. Chris Lyding says:

    In view of the economy and the almost certainty (IMHO) of increased taxes within a year or two, I am personally willing to pay at least some of the taxes out of the converted principal. There are Roth Conversion calculators online that will help with the analysis but I think the decision is so important that a trusted CPA as well as your Financial Advisor should be consulted.
    For some people, this is a no-brainer to convert and for others it is a no-brainer to not convert. Generally, the younger set should convert because their time horizon is likely to be long enough to absorb the tax payments. However, because the conversion creates income, those with children nearing college or those near or in retirement should be very careful. Those parents whose children are hoping for Financial Aid will almost surely not benefit from the extra income on their tax return (which is used as the primary financial source for the FAFSA). Likewise, beyond certain income limits (which have been in place unchanged since 1982), up to 85% of Social Security Benefits are taxable so retirees and near-retirees should be aware of the impact of conversion.
    Keep in mind also that your Roth account can’t be tapped for 5 years after conversion. If you do, you’ll pay the 10% early withdrawal penalty.
    There’s so much to say about this subject. I’m very excited about the possibilities but frankly the decision shouldn’t be made in a vacuum but rather as part of a financial plan that addresses every area of a person’s/couple’s life, including their hopes, dreams, concerns, end-of-life and after-life wishes.

    All the best to you,

    Chris Lyding, CPA
    Financial Planner

  9. uclalien says:

    Keep in mind that if you convert a traditional IRA to a Roth IRA, it will be taxed as income in the year the conversion takes place. For tax purposes, you cannot retroactively apply it to the prior calendar year in the same way you can for traditional/Roth IRA contributions (through April 15th).

Please Leave a Reply
Bargaineering Comment Policy

Previous Article: «
Next Article: »
Advertising Disclosure: Bargaineering may be compensated in exchange for featured placement of certain sponsored products and services, or your clicking on links posted on this website.
About | Contact Me | Privacy Policy/Your California Privacy Rights | Terms of Use | Press
Copyright © 2016 by All rights reserved.