Converting a 401K to a ROTH
I have a 66 year old client with a $1.3 M 401K… thinking of doing a conversion in 2010 to a ROTH. His income is $200K so he is above the AGI and this income will not change… (Pension and SS). His taxable event will be about $400K. But he has to wait til 2010. He needs to do something with this account before 2010, or just does not want to wait 2 years. My thought is he would be better off spending $35K per year on a $2M life insurance policy to pay taxes on any RMD’s from the Traditional IRA than paying $400K tax now, as this 401K is solely to leave to his 2 children and 2 grandchildren. Anyone have an opinion? Or another thought on this? Also my thought obviously as he wants protection and safety as well as Multi-gen is to move this to an Annuity (FIA) 10% deposit bonus! That is a nice jolt to his already $1.3M.
Thanks in advance!
Permalink Submitted by Alan Spross on Thu, 2008-08-28 00:58
Well, January 2010 is only 16 months away, and a 2010 conversion provides an option to defer the taxes (technically the taxable income) on the conversion 50% to 2011 and 50% to 2012. This provides considerable tax deferral and also averages the amount of additional income into two years. Still, it is not wise to do a total conversion since the value of conversions decreases along with the reducing amount of RMD taxable income left. Perhaps converting 40% to 60% over a period of years including 2010 would further reduce the tax cost of the conversions in total. His marginal bracket would have to be determined based on his total tax picture, to see if increasing that bracket due to conversions can be avoided. Obviously, his SS will always be 85% included in AGI.
Most annuities have various fees that add up to a drain on total return, so if one is elected it should be a very low cost variety. The life insurance idea may also be viable depending on the premium and his expected mortality. Usually, he should be primarly concerned with properly providing for a 25 to 30 year retirement for himself, than trying to overplan for multiple generations of beneficiaries. There are just too many variables that can change over a period that long.
Finally, do not forget to check for NUA potential if he has highly appreciated employer stock in the 401k. In that case a qualified LSD should be considered to lock in the lower LT cap gain rate on the NUA, although we also cannot predict how much lower that rate will remain over time.