401K to Roth Conversion Questions
Are there tax benefits to converting a 401K to a Traditional IRA prior to converting to a Roth? Contemplating Roth conversions of Traditional IRA’s and a 401K in 2010. We’ve seen Ed Slott’s presentation on PBS recently and are retiring at the end of the year. I’ve read several of the posts…unfortunately, I don’t understand many of the tax terms used.
Would appreciate any advice.
Thanks!
Permalink Submitted by Alan Spross on Wed, 2009-09-09 22:00
Assuming that a conversion is indeed in your best interest, and you have assets in both TIRA and 401k accounts, the account with the highest % of after tax assets is the one that should be converted first. This will move the after tax assets to a Roth more quickly and reduce the tax bill per dollar you choose to convert.
If you first combine the accounts in a TIRA, higher of the two after tax percentages will be diluted by the lower percentage. If you have no after tax amounts in either plan, or if the % are very close, then you should probably proceed with a direct rollover of the 401k plan to the TIRA, and then execute your conversions.
Just this week, the IRS has clarified how 401k plans holding after tax amounts will allocate those amounts between an IRA rollover and a Roth conversion directly from the plan. This gets complex, but if you have pre 1987 after tax amounts, you can convert them alone to a Roth IRA tax free. But all other after tax amounts come out of the plan using a pro rate precentage if you do direct rollovers. This would cause some of your after tax amount to go to the TIRA and some of the pre tax amount to go to the Roth IRA. But you can get around that if you do an indirect rollover and have the funds to make up the 20% withholding. You can then roll the pre tax amount to the TIRA yourself, and AFTER that you can roll the after tax amount to a Roth IRA.
But the most important issue is whether you should be converting at all, and if so how much. If you convert too much in a single year, you will probably inflate your tax cost of the conversion into a higher bracket than your expected rate in retirement, and that would be harmful.
You should also consider whether you should take advantage of NUA potential if you have highly appreciated employer stock in your 401k. If so, these shares would not go to an IRA of any type, but to a taxable account where you would get the lower LT cap gain rate upon sale.
The options for someone in your situation have become staggering, and then includes when to claim SS benefits, especially if you are going to convert to a Roth. This forum can address specific issues and help you become familiar with the issues, but it is not geared to develop a specific plan for someone. For that, you should gather up as much detail as possible about your situation and schedule an appointment with a local financial professional.
Permalink Submitted by Joanne Lamora on Thu, 2009-09-10 13:15
Thank you Alan for your response. I should have described the situation more clearly in my question. All our accounts are pre tax. I just wondered if there were any tax benefits to rolling over a 401K to a TIRA before converting to a Roth…is it necessary to do so, etc.
Yes, I am quickly learning that the options are staggering and to the average person quite confusing….and that the “Government Plan” for retirement savings in these types of accounts is not in the general publics best interest….which is why I’ve never been a fan.
We are planning to seek the advice of a financial professional in the near future.
Permalink Submitted by mk foss on Thu, 2009-09-10 18:02
It is no longer necessary to convert the 401k to a traditional IRA before converting to Roth.