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

By: Chris Lyding

Chris Lyding — Sun, 06 Dec 2009 04:15:14 +0000

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

By: EMF (I converted 401(k) to Roth)

EMF (I converted 401(k) to Roth) — Mon, 10 Sep 2007 02:43:34 +0000

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.

By: Art Dinkin

Art Dinkin — Sat, 08 Sep 2007 22:30:38 +0000

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.

By: Lord

Lord — Sat, 08 Sep 2007 05:00:18 +0000

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

By: JLP

JLP — Fri, 07 Sep 2007 16:56:07 +0000

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.

By: dong

dong — Fri, 07 Sep 2007 16:29:25 +0000

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)

By: kkgbear

kkgbear — Fri, 07 Sep 2007 14:58:50 +0000

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.

By: The Financial Philosopher

The Financial Philosopher — Fri, 07 Sep 2007 13:20:37 +0000

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…