Strategy for Roth 401k to Roth IRA conversion and withdrawals

[sweng85]

I was hoping someone could provide some insight into the following strategy I was considering regarding a Roth 401k conversion to a Roth IRA and future withdrawals.

A little about myself first:
1. I started my Roth IRA in 2008 and made a contribution for the 2007 year, so I'm assuming my Roth IRA's 5-year clock started in 2007.

2. In 2008 I also started contributing to my company's Roth 401k.

So, now the strategy and possible "loophole" I've read about:

Whenever I terminate employment with my company I will be allowed to rollover my Roth 401k into my Roth IRA without any issues. The rolled over funds also assume the 5-year clock of my IRA. After the 5-year clock ends (2012 in my case) I will be able to withdraw the contributions (not the earnings though) that I rolled over from my Roth 401k into my Roth IRA.

Is this too good to be true or am I missing something? It sounds like the Roth 401k is an awesome vehicle for funding my Roth IRA (especially if I ever get to the point where I can contribute the 16.5k yearly max), which allows me to withdraw contributions I made penalty free from my Roth 401k conversion. In fact, I don't see any reasons why I should even be contributing to a regular 401k until I'm mid-level or late into my career whenever my income is significant enough to warrant tax savings (I'm only 1.25 years into my career).

 

[Ed_The_Gypsy]

You got it. Roths are awsome.

However, if I recall correctly, the 5 year clock is for each and every contribution, not on the Roth itself. That means you can't withdraw something that was put in less than five years ago.

Why can't you withdraw earnings, too? Roths are tax-free forever, including earnings.

Roths have been touted as a savings account that you can tap whenever you want. I don't like this idea. It is a retirement vehicle.

Don't rely on what I say. Check it out for yourself. But now you know what to look for.

 

[crazy connie]

I think the contributions can be withdrawn at any time. It's the earnings that must meet the 5 years or age 59.5 requirement. Read up at Ed Slotts Forum: Ed Slott and Company IRA Discussion Forum • Index page
They are the GURU's on all aspects of IRA's in my opinion!

 

[Ed_The_Gypsy]

Thanks, Connie. I had it mixed up. Of course, if we use a Roth for retirement, 5 years doesn't mean anything.

 

[crazy connie]

Ed, I agree that retirement is the best use of a Roth, but it is nice to know that it is available if need be without penalty. Later on this year I will be converting my 401K to an IRA and the after tax contributions will come home to momma where I will stuff all of them on into a ROTH. Having spent down most of my after tax savings over the 5 years of early retirement I have been enjoying, it is great to know I can get to a bucket o' bucks should I need to. Like most my plans have taken a whipping and the mental security of another source of funds lets me sleep a bit easier at night.

 

[MasterBlaster]

Well here is something to ponder about Roth versus traditional IRAs...

With a traditional IRA you put money in (deducted) at your (highest) marginal rate and then pay taxes on your withdrawals in retirement. If your income in retirement consists of only IRA withdrawals then your average tax rate in retirement will be based on the entire income and will be (significantly) less than your working marginal rate. If you have other income form pensions and/or taxable SS income then your retirement tax rate will have to include them but will still likely be a lower rate than your working marginal rate.

My point is, is that a ROTH may not be the great deal that it seems to be. For most working people a traditional IRA/401k just may be a better approach to paying less tax.

exceptions, of course, for people who have accumulated very high nest-eggs and will have very high income in retirement. These people would be those (few) whose average retirement tax rate is greater than their working marginal rate.

Also one need look in their crystal ball to predict (perhaps rising) tax rates some decades out.

 

[Amyterrot]

sweng85,

Just like other said, it depends on your situation and where (financially) do you except to be when you're about to retire.

This should help:

Roth IRA Conversion

Roth IRA vs Traditional IRA

Roth IRA Investments

and

Roth IRA Tax

Cheers

I was hoping someone could provide some insight into the following strategy I was considering regarding a Roth 401k conversion to a Roth IRA and future withdrawals.

A little about myself first:
1. I started my Roth IRA in 2008 and made a contribution for the 2007 year, so I'm assuming my Roth IRA's 5-year clock started in 2007.

2. In 2008 I also started contributing to my company's Roth 401k.

So, now the strategy and possible "loophole" I've read about:

Whenever I terminate employment with my company I will be allowed to rollover my Roth 401k into my Roth IRA without any issues. The rolled over funds also assume the 5-year clock of my IRA. After the 5-year clock ends (2012 in my case) I will be able to withdraw the contributions (not the earnings though) that I rolled over from my Roth 401k into my Roth IRA.

Is this too good to be true or am I missing something? It sounds like the Roth 401k is an awesome vehicle for funding my Roth IRA (especially if I ever get to the point where I can contribute the 16.5k yearly max), which allows me to withdraw contributions I made penalty free from my Roth 401k conversion. In fact, I don't see any reasons why I should even be contributing to a regular 401k until I'm mid-level or late into my career whenever my income is significant enough to warrant tax savings (I'm only 1.25 years into my career).

 

[lhamo]

Well here is something to ponder about Roth versus traditional IRAs...

With a traditional IRA you put money in (deducted) at your (highest) marginal rate and then pay taxes on your withdrawals in retirement. If your income in retirement consists of only IRA withdrawals then your average tax rate in retirement will be based on the entire income and will be (significantly) less than your working marginal rate. If you have other income form pensions and/or taxable SS income then your retirement tax rate will have to include them but will still likely be a lower rate than your working marginal rate.

My point is, is that a ROTH may not be the great deal that it seems to be. For most working people a traditional IRA/401k just may be a better approach to paying less tax.

exceptions, of course, for people who have accumulated very high nest-eggs and will have very high income in retirement. These people would be those (few) whose average retirement tax rate is greater than their working marginal rate.

Also one need look in their crystal ball to predict (perhaps rising) tax rates some decades out.

The other exception is if you have a decent salary to begin with. It doesn't have to be terribly high, either. For those with an employer-sponsored retirement plan, the 2008 phase outs for a married couple filing jointly are 83k-103k. That means many dual-income, middle class families don't get any current tax benefit if the contribute to a traditional IRA. Phase outs for Roth IRAs are much higher -- 159k-169k in 2008.

We haven't been able to take a tax deduction for a traditional IRA since we both started working after grad school. We don't have terribly high salaries given our degrees (2 Ph.Ds.) and specialized experience. But putting two of them together puts us over the limit by quite a bit. We have been contributing to Roths as our work situation allows, though. In our case, we can only contribute our US earned income every year, which doesn't even take us up to the maximum (at most we each work 1-2 weeks a year in the US). But every little bit counts, especially considering that the majority of that income ends up being tax free anyway (total annual US income well below our deductions, and the rest of our income falling under the Foreign Earned Income Exclusion). Sometimes it is good to be an expat!

lhamo

 

[crazy connie]

There are 3 things in particular I really like about a ROTH.
1. No mandatory distributions
2. Being able to access contributions if needed without penalty
3. Tax free distributions on all earnings (and basis) once qualified

I would not choose a Roth as the only plan but for me currently I have about 20% of my retirement in the after-tax Roth bucket. That seems better than a straight up brokerage account. If you have enough to live and save and can put some into a Roth as well, my suggestion is do it. In the future it will hopefully enhance my income or be leftovers for my kids.

 

[sweng85]

Thanks all for the great resources and responses! Actually, it seems the more I read the more I am unsure about whether I want to go pre-tax or post-tax. However, as everyone mentioned, it ultimately comes down to each individual's situation and I finally gave into this fact by sitting down to really think about my future income and retirement savings (I even created a spreadsheet too!).

I'm 23 right now with 1.25 years of work experience, a current salary of 65k, and will be done with my technical master's degree later this year. I expect a promotion when I reach the 2 year mark with my company to around 75k (that's the average that I've noticed inside my company). When I'm 28 I expect to not only have completed a technical master's degree but also an MBA (earned part-time and paid wholly by my company) and my income should be 100k if not for the MBA and technical master's but because I will have 5 years experience within my field. Additionally, I'm also very fortunate (or unfortunate...) that I will be in a position to buy a townhouse later this year with 20% down with help from my parents, which I expect will reduce my income by ~24k yearly for quite some time.

So with that background out of the way, I think the most efficient strategy for my circumstance is to continue to save 10% into my Roth 401k and maximize my Roth IRA until I turn 28+, at which point it may be better to invest pre-tax money.

Also to summarize with a few bullet points as to why I'm choosing to go with 100% Roth 401k contributions over a regular 401k contributions

• Age 22-28 income is relatively low compared to rest of life and I will probably be investing pre-tax afterwards up until I retire
• Aren't taxes likely to go up with all of the recent government spending?
• My company matches 7% in pre-tax money, so I will be semi tax-diversified anyways
• I loovee that I can rollover my Roth 401k into my Roth IRA because of the ability to withdraw contributions as I mentioned earlier (it may even allow me to retire earlier!). Actually, does anyone know if the entire rollover is considered a contribution? EX: If I contributed 4k to my Roth 401k but it grows to 5k and then i rollover the 5k into my Roth IRA, is the 5k considered a contribution or is it just 4k as a contribution and 1k as earnings?

Whew, that was a lot of writing! I mostly wrote it to support my own retirement strategy, but hopefully it also gives somebody else some help too. And if anyone sees any flaws, please point them out!