Join Early Retirement Today
Reply
 
Thread Tools Search this Thread Display Modes
401(k): To convert, or not to convert, that is the question
Old 04-07-2012, 09:52 AM   #1
Recycles dryer sheets
jnojr's Avatar
 
Join Date: Jul 2007
Location: San Diego
Posts: 56
Send a message via AIM to jnojr Send a message via Yahoo to jnojr
401(k): To convert, or not to convert, that is the question

I'm 40 and in the highest tax bracket. Not rich (it's more likely that I'll wind up in the $250K area). I have a 401(k) from my last employer, and in the past I pretty reflexively dumped old 401(k)s into my Roth IRA and took the up-front tax hit. This one's a little bigger (about 50% of my IRA), and I'm just looking for some more input before I decide what to do with it.

The 401(k) is with Principal, and I'm actually fairly happy with the funds I'm in, given what's available. I could leave it as-is. I could convert to a traditional IRA with them, and maybe switch up the funds a little. I could convert to a Roth with them. Or I could convert to either IRA with my primary institution USAA.

I'm aware of at least some of the issues with Roth vs. traditional... if I convert now, I'm taxed at the highest rate, when theoretically I'd be in a lower bracket in retirement. But getting the gains tax-free is great, unless they decide to tax Roth gains, which isn't impossible. Nor is it impossible that they'll just try to raise taxes on everyone. I'm more in the Roth school myself, but who knows? That's why I'm looking for more perspective :-)
__________________

__________________
jnojr is offline   Reply With Quote
Join the #1 Early Retirement and Financial Independence Forum Today - It's Totally Free!

Are you planning to be financially independent as early as possible so you can live life on your own terms? Discuss successful investing strategies, asset allocation models, tax strategies and other related topics in our online forum community. Our members range from young folks just starting their journey to financial independence, military retirees and even multimillionaires. No matter where you fit in you'll find that Early-Retirement.org is a great community to join. Best of all it's totally FREE!

You are currently viewing our boards as a guest so you have limited access to our community. Please take the time to register and you will gain a lot of great new features including; the ability to participate in discussions, network with our members, see fewer ads, upload photographs, create a retirement blog, send private messages and so much, much more!

Old 04-07-2012, 10:05 AM   #2
Thinks s/he gets paid by the post
 
Join Date: Jan 2006
Posts: 2,930
Quote:
Originally Posted by jnojr View Post
I'm ................. in the highest tax bracket.

I'm aware of at least some of the issues with Roth vs. traditional... if I convert now, I'm taxed at the highest rate, when theoretically I'd be in a lower bracket in retirement. But getting the gains tax-free is great,..........................
The real world situation of what might/might not happen is quite complex and not predictable w/ certainty as you point out. Perhaps you should first unravel this simple problem. Have you done any real mathematical calculations of the problem above? Convert at the highest tax bracket and withdraw at a lower bracket later vs. convert at a lower tax bracket later? Yes, getting gains tax-free is great but at what price. In the end, this is a math issue not a conceptual one.
__________________

__________________
kaneohe is offline   Reply With Quote
Old 04-07-2012, 10:26 AM   #3
Recycles dryer sheets
 
Join Date: Jan 2010
Posts: 226
We decided to wait to convert until after retirement. Although we have taxable accounts, we have no Roth; so we will do an annual 401k rollover to a TIRA and then convert that to a Roth based on income (mostly pension), deductions/exemptions, and ceiling on tax brackets. We will delay SS as long as possible to keep our taxable income at a minimum, probably until age 70. We will have 14 years to do the conversions. The question for us will be whether to try to stay in the 15% tax bracket, which will reduce the amount that is converted or to go for it and jump into the 25% tax bracket assuming that taxes will be increased in the future.

We have between $1-2M in our 401k and do not want to get creamed by RMDs.
__________________
misty57 is offline   Reply With Quote
Old 04-07-2012, 10:33 AM   #4
Moderator
Alan's Avatar
 
Join Date: Jul 2005
Location: Eee Bah Gum
Posts: 21,109
I would roll it over to a tIRA. No point in paying high taxes now. The tIRA will give you all the fund choices you need and no taxes payable while you are in a high tax bracket.
__________________
Retired in Jan, 2010 at 55, moved to England in May 2016
Now it's adventure before dementia
Alan is offline   Reply With Quote
Old 04-07-2012, 10:58 AM   #5
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
pb4uski's Avatar
 
Join Date: Nov 2010
Location: Vermont & Sarasota, FL
Posts: 16,446
Quote:
Originally Posted by Alan View Post
I would roll it over to a tIRA. No point in paying high taxes now. The tIRA will give you all the fund choices you need and no taxes payable while you are in a high tax bracket.
+1

I don't think it would be wise to convert while you are in a high tax bracket even though future gains would be not taxable. This assumes that you would be in a lower tax bracket in retirement.

I was in the 28% bracket my last year of work and expect to do a significant tIRA>RothIRA conversion later this year and pay less than 10%.
__________________
pb4uski is offline   Reply With Quote
Old 04-07-2012, 11:55 AM   #6
Thinks s/he gets paid by the post
growing_older's Avatar
 
Join Date: Jun 2007
Posts: 2,608
You might want to consider the backdoor Roth. As a high income earner, you do not qualify for a direct Roth contribution each year, but you can contribute to a non-deductible traditional IRA. Then later convert that to a Roth. The tax due calculation is based on how much pre-tax and how much post-tax money you have in all T-IRA combined. So if this 401k money would infuse a lot of pre-tax money into your T-IRA it could affect your ability to backdoor to a Roth in the future.

If you already have a lot of pre-tax money in T-IRA, then I would move out of the 401k to get away from expensive Principal funds.
__________________
growing_older is offline   Reply With Quote
Old 04-07-2012, 12:25 PM   #7
Thinks s/he gets paid by the post
 
Join Date: Nov 2011
Posts: 2,366
To my knowledge, in some states a 401k is better protected from creditors than is an IRA. Some employers offer a Roth 401k, which is a way to get the funds into Roth format without having to use an IRA.

For most in a high tax bracket, it is better to postpone conversion from traditional to Roth. Situations in which you should convert anyhow include: 1) if you won't be in a lower bracket in future years, 2) if you expect your investments to significantly increase in value, and 3) if special tax breaks exist on conversions, such as happened in 2010.

For example, though it put me in a high bracket, I converted to Roth in bulk about 2 years ago. Since then the IRA has gained more than the tax due, and per the 2010 conversion rules I've not yet paid any conversion tax at all. Those payments deferred into 2012 and 2013, by which time nontaxable dividends will have compounded even further.
__________________
GrayHare is offline   Reply With Quote
Old 04-07-2012, 01:14 PM   #8
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
TromboneAl's Avatar
 
Join Date: Jun 2006
Posts: 11,199
1. Is this an all or none thing?

2. Have used an online Roth conversion calculator?
__________________
Al
TromboneAl is online now   Reply With Quote
Old 04-07-2012, 01:32 PM   #9
Thinks s/he gets paid by the post
 
Join Date: Jan 2006
Posts: 2,930
Quote:
Originally Posted by GrayHare View Post

For most in a high tax bracket, it is better to postpone conversion from traditional to Roth. Situations in which you should convert anyhow include: 1) if you won't be in a lower bracket in future years, 2) if you expect your investments to significantly increase in value, and 3) if special tax breaks exist on conversions, such as happened in 2010.

.
GrayHare.......it's not clear to me if you are saying:
A) you should convert anyhow if conditions 1) AND 2) AND 3) exist

OR

B) you should convert anyhow if
condition 1) exists
OR
condition 2) exists
OR
condition 3) exists

In other words, an AND gate or an OR gate?
__________________
kaneohe is offline   Reply With Quote
Old 04-07-2012, 01:38 PM   #10
Dryer sheet aficionado
 
Join Date: Jul 2009
Posts: 45
Here's a little algebra to demonstrate that it doesn't matter whether you contribute to a Traditional IRA or a ROTH IRA. (If the tax rate is the same before and after retirement and the investments give the same returns). The left side assumes you put the money in pre-tax then earn a return on the investment over "n" number of years and pay tax when it is withdrawn. The right side assumes the money is taxed and then invested and earns a return over "n" number of years. If you love algebra as I do you can see that the left and right sides of the equation are equal if the tax rate is the same before and after retirement. For most people the tax rate is lower in retirement so it's actually better to invest in a traditional IRA and convert to ROTH after retirement when tax rates are presumably less.

Traditional IRA = RothIRA
------------------------------------------------------------
(Money(1+i)^n)*(1-taxrate) = (Money)*(1-taxrate)*(1+i)^n
You can swap the last two terms because it doesn't matter the order because of the commutative property. So, then the left side of the equation is exactly the same as the right side of the equation.
(Money(1+i)^n)*(1-taxrate) = (Money)*(1+i)^n)*(1-taxrate)
__________________
Bogie is offline   Reply With Quote
Old 04-07-2012, 01:41 PM   #11
Thinks s/he gets paid by the post
 
Join Date: Nov 2011
Posts: 2,366
Quote:
Originally Posted by kaneohe View Post
In other words, an AND gate or an OR gate?
Language vs. Logic is a reason courts exist. You are correct, it was not clear. I meant OR, so if any of those conditions are met, the Roth conversion should pop up on one's radar. Usual disclaimers apply.
__________________
GrayHare is offline   Reply With Quote
Old 04-07-2012, 01:53 PM   #12
Thinks s/he gets paid by the post
 
Join Date: Nov 2011
Posts: 2,366
Bogie - if only the equation were that simple for all. Your example does not take into account the tax deductibility of a tIRA contrib. This came up a few months back: if the tIRA contrib is not deductible, and one pays the same tax rate before and after retirement, the Roth comes out far ahead due to its tax-free compounding.
__________________
GrayHare is offline   Reply With Quote
Old 04-07-2012, 01:56 PM   #13
Thinks s/he gets paid by the post
 
Join Date: Jan 2006
Posts: 2,930
Quote:
Originally Posted by GrayHare View Post
Language vs. Logic is a reason courts exist. You are correct, it was not clear. I meant OR, so if any of those conditions are met, the Roth conversion should pop up on one's radar. Usual disclaimers apply.
ok, I'll bite....leaving aside the question of how you know what your investment will do in the future (your crystal may work better than mine )
Suppose you expect a 100X increase in your investment but you convert at
a higher rate now than in retirement. Can you give an example of how the
Roth works out better?
__________________
kaneohe is offline   Reply With Quote
Old 04-07-2012, 02:00 PM   #14
Thinks s/he gets paid by the post
 
Join Date: Nov 2011
Posts: 2,366
Quote:
Originally Posted by kaneohe View Post
ok, I'll bite....leaving aside the question of how you know what your investment will do in the future (your crystal may work better than mine )
Suppose you expect a 100X increase in your investment but you convert at
a higher rate now than in retirement. Can you give an example of how the
Roth works out better?
If my tIRA value jumped by 100x, so would its taxable RMDs, which would by themselves put me in a higher tax bracket during retirement.
__________________
GrayHare is offline   Reply With Quote
Old 04-07-2012, 02:23 PM   #15
Thinks s/he gets paid by the post
 
Join Date: Jan 2006
Posts: 2,930
OK, I got carried away by my 100X increase.....revise to some large increase but not enough to make later bracket higher than conversion rate.
I guess I am thinking that the relative tax rates: conversion vs. withdrawal are still the largest factor in the conversion decision.
__________________
kaneohe is offline   Reply With Quote
Old 04-07-2012, 02:29 PM   #16
Thinks s/he gets paid by the post
 
Join Date: Jan 2006
Posts: 2,930
Quote:
Originally Posted by GrayHare View Post
Bogie - if only the equation were that simple for all. Your example does not take into account the tax deductibility of a tIRA contrib. This came up a few months back: if the tIRA contrib is not deductible, and one pays the same tax rate before and after retirement, the Roth comes out far ahead due to its tax-free compounding.
It also assumes that due to limited funds, the full allowable Roth contribution is not made. If the full Roth contribution is made because the tax is paid by available other funds, the Roth is ahead , even at equal rates.
("The Roth is bigger" effect).
__________________
kaneohe is offline   Reply With Quote
Old 04-07-2012, 02:29 PM   #17
Moderator
Alan's Avatar
 
Join Date: Jul 2005
Location: Eee Bah Gum
Posts: 21,109
Quote:
Originally Posted by GrayHare View Post
Bogie - if only the equation were that simple for all. Your example does not take into account the tax deductibility of a tIRA contrib. This came up a few months back: if the tIRA contrib is not deductible, and one pays the same tax rate before and after retirement, the Roth comes out far ahead due to its tax-free compounding.
I fully agree.
__________________
Retired in Jan, 2010 at 55, moved to England in May 2016
Now it's adventure before dementia
Alan is offline   Reply With Quote
Old 04-07-2012, 02:32 PM   #18
Thinks s/he gets paid by the post
 
Join Date: Nov 2011
Posts: 2,366
Quote:
Originally Posted by kaneohe View Post
I guess I am thinking that the relative tax rates: conversion vs. withdrawal are still the largest factor in the conversion decision.
Agreed, kaneohe, it takes special/uncommon situations to outweigh the tax factor. You and I have posted about IRAs before, and I believe our conclusions are usually very similar.
__________________
GrayHare is offline   Reply With Quote
Old 04-07-2012, 02:44 PM   #19
Dryer sheet aficionado
 
Join Date: Jul 2009
Posts: 45
GrayHare,
My example assumes the tIRA was deductible.

And Alan, I was assuming the tIRA was deductible and I agree that the ROTH would be far an away better if it's not since the tIRA growth would be taxed. I was just trying to point out that for a deductible IRA vs ROTH it doesn't matter whether the tax is paid now or later if you assume the tIRA and ROTH get the same tax rate and earn the same return, you will have the same balance at the end after taxes are paid. Many people seem to think the tIRA is better because the pre-tax growth is compounded when actually it's tax is compounded as well. I didn't intend for tangential issues to be covered as those are individual experiences, YMMV.
__________________
Bogie is offline   Reply With Quote
Old 04-07-2012, 02:53 PM   #20
Moderator
Alan's Avatar
 
Join Date: Jul 2005
Location: Eee Bah Gum
Posts: 21,109
Quote:
Originally Posted by Bogie View Post
GrayHare,
My example assumes the tIRA was deductible.

And Alan, I was assuming the tIRA was deductible and I agree that the ROTH would be far an away better if it's not since the tIRA growth would be taxed. I was just trying to point out that for a deductible IRA vs ROTH it doesn't matter whether the tax is paid now or later if you assume the tIRA and ROTH get the same tax rate and earn the same return, you will have the same balance at the end after taxes are paid. Many people seem to think the tIRA is better because the pre-tax growth is compounded when actually it's tax is compounded as well. I didn't intend for tangential issues to be covered as those are individual experiences, YMMV.
I agree.

When I ER'ed I had only a non-deductible IRA, as well as a large 401k. I held off rolling over the 401k until the following tax year to allow me to convert my IRA to a ROTH, paying taxes only on the gains of that IRA.

Now that the 401k is in an IRA with a zero cost basis, the arithmetic is quite different on doing conversions.
__________________

__________________
Retired in Jan, 2010 at 55, moved to England in May 2016
Now it's adventure before dementia
Alan is offline   Reply With Quote
Reply


Currently Active Users Viewing This Thread: 1 (0 members and 1 guests)
 
Thread Tools Search this Thread
Search this Thread:

Advanced Search
Display Modes

Posting Rules
You may not post new threads
You may not post replies
You may not post attachments
You may not edit your posts

BB code is On
Smilies are On
[IMG] code is On
HTML code is Off
Trackbacks are Off
Pingbacks are Off
Refbacks are Off


Similar Threads
Thread Thread Starter Forum Replies Last Post
How to Look Rich MasterBlaster FIRE and Money 56 04-11-2012 10:53 AM
Cancer screening.. what turned out to be important Brat Health and Early Retirement 30 04-08-2012 08:51 AM
What to do with cash during the present 'yield famine' Midpack FIRE and Money 15 04-07-2012 02:25 PM
The Best Intentions of Mice... jdmorton FIRE and Money 1 04-07-2012 09:08 AM
Pension / grandfather clause question almost there FIRE and Money 18 04-07-2012 08:39 AM

 

 
All times are GMT -6. The time now is 11:46 PM.
 
Powered by vBulletin® Version 3.8.8 Beta 1
Copyright ©2000 - 2017, vBulletin Solutions, Inc.