Should I roll a 403b over to a Roth IRA?

[ER Eddie]

Now that I've crossed the 59 1/2 mark, I've been puzzling over whether I should roll the 403b from my job over to my Vanguard Roth IRA. Help me out here a little, if you would. I am not a financial wonk and get befuddled by taxes sometimes.

As I understand it, and correct me if I'm wrong, it would be advantageous for me to roll it over, because the gains in a Roth are not taxed on withdrawal, whereas gains in a 401k (I believe a 403b is equivalent) are taxed as ordinary income upon withdrawal. Although the 401k/403b money would be taxed as income when I roll it over into the Roth, its subsequent gains would not be taxed in the Roth, whereas they would be, if I left them in the 403b.

So to take a simple example, if I had a $100 in the 403b, and it grew to $120, and I withdrew it, that $120 would be taxed as ordinary income. If instead I rolled that $100 over to a Roth, the $100 would be taxed as ordinary income at the point of the rollover, but if it later grew to $120 in the Roth, the additional $20 gain would not be taxed at withdrawal.

So rolling it over to a Roth seems like a good choice. Do I have that right?

Oh, I should also mention that I'm retired, so my income isn't going to change in the next couple of decades.

I understand that there may need to be some intermediary step with a 403b, where you first have to roll it over to a 401k, then to a Roth. I'm not sure about that, haven't investigated yet. I also understand there are other potential advantages of rolling over to a Roth, such as wider choice of funds or lower fees. However, I don't think those are much of an issue in my case. Fees for the 403b administration are very low, and choice of stock options are pretty good.


So, my main questions are:

1. Do I understand the tax implications correctly?

2. Is it smart to rollover a 403b to a Roth IRA?


Thanks.

[RunningBum]

Quote:

Originally Posted by ER Eddie So to take a simple example, if I had a $100 in the 403b, and it grew to $120, and I withdrew it, that $120 would be taxed as ordinary income. If instead I rolled that $100 over to a Roth, the $100 would be taxed as ordinary income at the point of the rollover, but if it later grew to $120 in the Roth, the additional $20 gain would not be taxed at withdrawal.

You have to take into account the taxes you paid at rollover time, but if you can pay them out of your taxable account you still come out a little ahead with the conversion, if tax rates are the same now and later.

Quote:

Oh, I should also mention that I'm retired, so my income isn't going to change in the next couple of decades.

Are you not going to be collecting social security? And having to take RMDs? These two things favor doing Roth conversions now, while your income is lower. How about spreading Roth conversions over the years until you start taking SS?

ETA: I know very little about 403b's but assume for this purpose it is like a 401K or tIRA.

[bloom2708]

If you did convert the entire 403b to Roth in one year, the full amount would be income and taxed in that year.

Roth conversions (smartly done) may be part of your plan, but it is unlikely a good plan to do the full thing.

I would roll it to a Traditional Rollover IRA. Then consider Roth Conversions based on your current marginal tax bracket vs future brackets with SS and/or pension income.

Your income will change when you start Social Security.

Do a lot of studying on the subject.

[ER Eddie]

Quote:

Originally Posted by RunningBum Are you not going to be collecting social security? And having to take RMDs? These two things favor doing Roth conversions now, while your income is lower. How about spreading Roth conversions over the years until you start taking SS?

I'd forgotten about SS. Good point, that will raise my income. As for RMDs, I'm not sure. I don't think that kicks in until 70, and it only pertains to 401k/403b, iirc. So yes, both of those factors would suggest rolling it over sooner rather than later.

Quote:

Originally Posted by bloom2708 If you did convert the entire 403b to Roth in one year, the full amount would be income and taxed in that year. Roth conversions (smartly done) may be part of your plan, but it is unlikely a good plan to do the full thing.

Yes, thank you, good point. I'll have to think about how to partial it out, so as not to push me into a higher tax bracket.

[erkevin]

Be aware that the Roth conversion will count as income and may impact any ACA subsidies that you receive.

[Alan]

What I did which was a rollover to a regular IRA first as that is a non-taxable event.

Then do partial Roth conversions from the IRA each year to minimize taxes. Partial conversions within the same brokerage are also extremely easy to do.

[Out-to-Lunch]

Good advice so far. However, let me explicitly say that your thinking on the "tax-free increase" is not a good way (IMHO) to conceive of the implications.

To 1st order, Roth conversions are a tax-rate arbitrage play. If your marginal tax rate is lower when making the conversions than they would be when later taking the money out of the traditional account, you come out ahead. Many here find themselves in a high bracket later when on SS and taking RMDs. Also, there can be a lot "hiding" in the term "marginal tax rate," including: ACA subsidies (as erkevin mentioned), but also IRMAA tiers, filing single vs. MFJ if a spouse passes, even NIIT in extreme cases. As many have said upthread, doing Roth conversions over time can be a good way to levelize your income, generally resulting in the lowest tax burden. (And don't forget that under current US law, which of course may change, tax rates are set to go up in 2026.)

But if the marginal tax rate is the same, and you pay for taxes out of the conversion, the timing of the conversion does not matter. But, as RB said, if you use funds from a taxable account, you effectively move that money from a taxable account to a Roth, which is preferable.


Let me just quote myself from an earlier thread:

Quote:

Originally Posted by Out-to-Lunch I think this question is ill-posed. Most of the time that I have seen the matter posed as a "break-even" decision, it is framed as "I need XX years of tax-free growth to make up for the taxes." But this is the wrong way to look at it. It really is about the tax rate when the money is withdrawn (either now, by conversion, or later, for spending). To simplify, consider $1,000 in a tIRA. Further, let's assume that you will be in the same tax bracket (say, 22%) both now and later, and that you will pay for taxes out of the tIRA funds. (More on that last assumption later.) In scenario A, you convert it now, and have $780 in your Roth. Let's say over the next 10 years, the money doubles, there are no further taxes, and you therefore have $1560 in spendable funds. In scenario B, you wait 10 years, and your tIRA money doubles to $2,000. You then decide to spend that, and you take it out and pay your $440 in taxes, which leaves you with (drum roll...) $1560 to spend. Mathemeticians call this "the commutative law of multiplication." There is no break-even time period. Obviously, if the tax rate is higher later, you are better off if you convert now; and, contrariwise, if your tax rate is lower later, you would be better off waiting. Things can get a little more complicated if you are paying for taxes from other funds, like a taxable account. This favors converting now, because you effectively move some of your money in a non-tax-preferred savings vehicle into a tax-preferred account. You can read more about that here: https://personal.vanguard.com/pdf/ISGBETR.pdf

[ER Eddie]

Quote:

Originally Posted by Alan What I did which was a rollover to a regular IRA first as that is a non-taxable event. Then do partial Roth conversions from the IRA each year to minimize taxes. Partial conversions within the same brokerage are also extremely easy to do.

Sounds like a plan. Thanks.

Quote:

Originally Posted by Out-to-Lunch Good advice so far. However, let me explicitly say that your thinking on the "tax-free increase" is not a good way (IMHO) to conceive of the implications. To 1st order, Roth conversions are a tax-rate arbitrage play. If your marginal tax rate is lower when making the conversions than they would be when later taking the money out of the traditional account, you come out ahead.

It may be, but I haven't specifically looked yet at whether my SS would bump my income into another tax bracket. Not even sure when I'll be taking SS.

Quote:

doing Roth conversions over time can be a good way to levelize your income, generally resulting in the lowest tax burden.

Yes, I plan to do that.

Quote:

But if the marginal tax rate is the same, and you pay for taxes out of the conversion, the timing of the conversion does not matter.

Right.

Although I assume it's still better to have it in Roth, since any subsequent gains over the years will not be taxed as they would be in a 401k/403b.

[RunningBum]

Quote:

Originally Posted by ER Eddie It may be, but I haven't specifically looked yet at whether my SS would bump my income into another tax bracket. Not even sure when I'll be taking SS.

You should also look at how much taxable withdrawals from your tax deferred account would push additional SS into being taxed. The tax rate for the SS hump can be as high as 49.95%. That can be a good incentive for getting your tax deferred savings converted to a Roth before you start getting SS.

[ER Eddie]

Quote:

Originally Posted by RunningBum You should also look at how much taxable withdrawals from your tax deferred account would push additional SS into being taxed. The tax rate for the SS hump can be as high as 49.95%. That can be a good incentive for getting your tax deferred savings converted to a Roth before you start getting SS.

Hmm. I didn't realize it would also affect SS tax rates. Okay, thanks. More incentive to do it sooner rather than later, as you say. Cheers.

[Out-to-Lunch]

Quote:

Originally Posted by ER Eddie Although I assume it's still better to have it in Roth, since any subsequent gains over the years will not be taxed as they would be in a 401k/403b.

With respect, I think you have not yet comprehended the points explicated in the numerical example that I provided you.

[Out of Steam]

Quote:

Originally Posted by RunningBum You should also look at how much taxable withdrawals from your tax deferred account would push additional SS into being taxed. The tax rate for the SS hump can be as high as 49.95%. That can be a good incentive for getting your tax deferred savings converted to a Roth before you start getting SS.

The threshold for taxation of 85% of Social Security benefits is fairly low. Other than by pre-age 65 income management for ACA subsidies (living off after-tax savings instead), its hard to see how a married couple with even $60K in other taxable income would (or could) avoid it.

[TheWizard]

I've been doing partial conversions from my 403(b) to my Roth IRA since 2013.
I expect to be in the 24% Federal tax bracket both during the past few years of conversions and in the future, so no advantage in doing large conversions.

SS taxability is a non issue for me but Medicare IRMAA is. If I converted $5000 more last year, I'd be in the next higher IRMAA tier next year.

I will stop doing these Roth conversions in 2023, the same year I start RMDs. Due to proper planning, I expect my AGI to be roughly the same across that transition...

[RunningBum]

Quote:

Originally Posted by Out of Steam The threshold for taxation of 85% of Social Security benefits is fairly low. Other than by pre-age 65 income management for ACA subsidies (living off after-tax savings instead), its hard to see how a married couple with even $60K in other taxable income would (or could) avoid it.

I should have qualified it to say that SS taxation may already be maxed. As a single, I made a rough estimate that I would be a few thousand$ under having the full 85% taxed. I might have been too conservative on my portfolio growth estimate over the next 10 years. I just figured if I was close, a couple that was mostly living off of a Roth IRA could easily be under that threshold. I'll bet there are more than a few couples with less than $60K of other income.

[Out of Steam]

Quote:

Originally Posted by RunningBum I should have qualified it to say that SS taxation may already be maxed. As a single, I made a rough estimate that I would be a few thousand$ under having the full 85% taxed. I might have been too conservative on my portfolio growth estimate over the next 10 years. I just figured if I was close, a couple that was mostly living off of a Roth IRA could easily be under that threshold. I'll bet there are more than a few couples with less than $60K of other income.

True, though estimation is difficult even for a single year. I expected that our income would not be above the top of the 12% Federal tax bracket for 2020 and 2021, and withheld accordingly for 2020. Being our first full year of retirement, I didn't do any midyear recalculations.

Because of part-time work before the pandemic, and back pension payments for 2019 that arrived in early 2020, I missed by a lot. The IRS will be putting a large divot in our checking account today.

[copyright1997reloaded]

Quote:

Originally Posted by RunningBum You have to take into account the taxes you paid at rollover time, but if you can pay them out of your taxable account you still come out a little ahead with the conversion, if tax rates are the same now and later. Are you not going to be collecting social security? And having to take RMDs? These two things favor doing Roth conversions now, while your income is lower. How about spreading Roth conversions over the years until you start taking SS? ETA: I know very little about 403b's but assume for this purpose it is like a 401K or tIRA.

Even that (bolded) has a secondary effect. First, it assumes cash (otherwise assets would need to be sold with possible tax ramifications). Secondly, x $ spent on taxes (to fund the conversion) is $x not invested.

[RunningBum]

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Originally Posted by copyright1997reloaded Even that (bolded) has a secondary effect. First, it assumes cash (otherwise assets would need to be sold with possible tax ramifications).

A fair point, but I'd have to do the math to see if this really tips it the other way. It seems like if your gains in the Roth after conversion ever exceed the capital gains on the sold investment, you come out ahead selling taxable shares to cover the conversion tax. Presumably you choose shares with a higher % of basis to sell, to lighten the tax load. Of course that has to be factored in to your ACA subsidy cliff calculation, if the cliff returns.

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Secondly, x $ spent on taxes (to fund the conversion) is $x not invested.

Run the numbers. It's been done already in many threads, so I'm not going to repeat it. As long as you make money on your investments, paying taxes out of your taxable account puts you ahead on Roth conversions with equal regular income tax rates now and later. It's the difference of investments growing tax deferred in a Roth vs. eventually being taxed in a taxable account.

There are ways to avoid paying taxes in the taxable account:

1. Low enough income for LTCGs to be in the 0% tax range
2. Donating shares to charity, assuming you itemize taxes already.
3. Dying with the shares untouched, which gives heirs a stepped up basis. You'd be taking your chances that tax law doesn't change, and that you won't need them in an emergency after all.

[ER Eddie]

Quote:

Originally Posted by Out-to-Lunch With respect, I think you have not yet comprehended the points explicated in the numerical example that I provided you.

Probably so. I got lost in some of what you were saying. As I said in my OP, I'm not a financial wonk and get confused about tax jargon. You lost me with your first sentence (I have no idea what a "tax-rate arbitrage play" means), then you piled on the details, jargon, and acronyms pretty fast and dense. I followed maybe half of it. I honestly didn't even look at the quoted bit, because my head was spinning already (I'll go back and read it now, though.)


edit: Ok, I've read that numerical example. Let me make sure I'm following. I'll repost it:

Quote:

To simplify, consider $1,000 in a tIRA. Further, let's assume that you will be in the same tax bracket (say, 22%) both now and later, and that you will pay for taxes out of the tIRA funds. (More on that last assumption later.) In scenario A, you convert it now, and have $780 in your Roth. Let's say over the next 10 years, the money doubles, there are no further taxes, and you therefore have $1560 in spendable funds. In scenario B, you wait 10 years, and your tIRA money doubles to $2,000. You then decide to spend that, and you take it out and pay your $440 in taxes, which leaves you with (drum roll...) $1560 to spend.

So in that example, there is zero benefit to rolling over a 401k to a Roth IRA. No benefit at all.

Thank you. It always helps me to see an actual example worked, rather than just words. Sorry I didn't look at it earlier.

So I guess now I'm wondering why I would bother to do it in the first place. Seems like a lot of trouble for no real benefit (assuming those assumptions hold).

[Scuba]

I would definitely roll it over to a traditional IRA because fees are quite high for many 403b plans compared to a self-directed IRA. I would consult a CPA for advice on whether it then makes sense for you to do any Roth conversions. This depends on your individual tax situation.

[ER Eddie]

Quote:

Originally Posted by Scuba I would definitely roll it over to a traditional IRA because fees are quite high for many 403b plans compared to a self-directed IRA. I would consult a CPA for advice on whether it then makes sense for you to do any Roth conversions. This depends on your individual tax situation.

Thanks, Scuba. I checked the fee structure, and I was surprised at how low it was -- $7 per quarter. You still have the normal fees associated with individual funds, but I've got most of the money in low-fee index funds, and that would be true wherever the money sat. So I'm not so concerned about the fee angle.

I may run it by the guy who does my taxes, next time we talk.