Strategies for converting 401k/traditional IRA to Roth IRA

[Tenacious E_rivals41982]

I am 52 and to this point, I have taken a pretty hands off approach where I contribute the max and I get contributions from where I work on top of that. I have been reading about the backdoor Roth conversion, which I think makes sense to the extent I can do it without having it done in a higher tax bracket. Then again, I am in my peak earning years, and perhaps it makes more sense do to this once I'm actually retired, which will be no later than 59. Anyone do this or have things to do or watch out for during the process?

 

[WDDT]

In.

 

[cheeselog8]

FYI a backdoor Roth and Roth conversions are two separate things.

You can do a Roth conversion at anytime and whatever amount is converted from your 401k/Traditional IRA adds to that year's taxable ordinary income.

A backdoor Roth is where you make a non-deductible Traditional IRA contribution (non-deductible since you are over the income limits), then immediately convert the Traditional to a Roth. There is no tax due on this conversion since you have basis in the Traditional IRA. This strategy only works if you don't have any other Traditional IRA and/or Simple IRA balances. It's a good way to get extra money into a Roth if you don't have any other Roth options or are already maxing out your Roth options through your 401k.

 

[Tenacious E_rivals41982]

Relatedly, I have just done everything myself over the years. I am thinking perhaps I should get a financial planner on board, but I am loathe to pay someone for something I can figure out on my own. Thoughts on that?

 

[Tenacious E_rivals41982]

FYI a backdoor Roth and Roth conversions are two separate things.

You can do a Roth conversion at anytime and whatever amount is converted from your 401k/Traditional IRA adds to that year's taxable ordinary income.

A backdoor Roth is where you make a non-deductible Traditional IRA contribution (non-deductible since you are over the income limits), then immediately convert the Traditional to a Roth. There is no tax due on this conversion since you have basis in the Traditional IRA. This strategy only works if you don't have any other Traditional IRA and/or Simple IRA balances. It's a good way to get extra money into a Roth if you don't have any other Roth options or are already maxing out your Roth options through your 401k.

Aha, thanks. Yes, I am thinking of doing partial Roth conversions on an annual basis up to an amount where I would not have that count as income in a higher bracket. I was thinking about starting at age 55 because it would not be subject to state income tax here in Iowa at that point. It looks like you then have to wait 5 years before you can access the converted funds to avoid a penalty.

 

[dpic73]

I am 52 and to this point, I have taken a pretty hands off approach where I contribute the max and I get contributions from where I work on top of that. I have been reading about the backdoor Roth conversion, which I think makes sense to the extent I can do it without having it done in a higher tax bracket. Then again, I am in my peak earning years, and perhaps it makes more sense do to this once I'm actually retired, which will be no later than 59. Anyone do this or have things to do or watch out for during the process?

I'm not pretending to be an expert and may not understand exactly what you're trying to do but be aware that if you convert a traditional to a Roth, you will have to pay taxes on the full lump sum and it will need to be paid using cash from a regular checking or savings account, on top of the 10% penalty for removing before 59 1/2. Depending on the amount, it could also put you into a higher tax bracket. Also a Roth conversion has it's own distinct 5 year clock so if you withdraw the converted principal before 5 years have passed, even if you're over 59 1/2, you could be subjected to another 10% early withdrawal fee, though there may be an exception. It's a major financial decision so consider it carefully.

Edit : looks like cheeselog8 can provide better advice.

 

[cheeselog8]

Aha, thanks. Yes, I am thinking of doing partial Roth conversions on an annual basis up to an amount where I would not have that count as income in a higher bracket. I was thinking about starting at age 55 because it would not be subject to state income tax here in Iowa at that point. It looks like you then have to wait 5 years before you can access the converted funds to avoid a penalty.

That's a sound strategy that a lot of my clients are doing. I wouldn't worry about the 5 year rule too much, IMO your Roth should be the last place you pull funds from anyways.

As far as using a financial advisor, I personally use one for about half my portfolio. I do it because I get a ton of referrals from them but I agree that paying the fees is somewhat silly. They charge 1% per year and they aren't doing any more work than they did when the portfolio had less zeros at the end.

 

[cheeselog8]

I'm not pretending to be an expert and may not understand exactly what you're trying to do but be aware that if you convert a traditional to a Roth, you will have to pay taxes on the full lump sum and it will need to be paid using cash from a regular checking or savings account, on top of the 10% penalty for removing before 59 1/2. Depending on the amount, it could also put you in a higher tax bracket. Also a Roth conversion has it's own distinct 5 year clock so if you withdraw the converted principal before 5 years have passed, even if you're over 59 1/2, you could be subjected to another 10% early withdrawal fee, though there may be an exception. It's a major financial decision so consider it carefully.

Edit : looks like cheeselog8 can provide better advice.

FYI there's no 10% penalty on Roth conversions but you're right that you need to have outside cash to cover your taxes. I've had clients get caught because they took out $100k, withheld $20k in taxes with only $80k going into the Roth. There is a 10% penalty on the $20k that did not go into the Roth.

 

[dpic73]

FYI there's no 10% penalty on Roth conversions but you're right that you need to have outside cash to cover your taxes. I've had clients get caught because they took out $100k, withheld $20k in taxes with only $80k going into the Roth. There is a 10% penalty on the $20k that did not go into the Roth.

That's right, the 10% would apply as an early withdrawal only if you chose to withhold taxes directly from the converted amount.

 

[Rifler]

FYI there's no 10% penalty on Roth conversions but you're right that you need to have outside cash to cover your taxes. I've had clients get caught because they took out $100k, withheld $20k in taxes with only $80k going into the Roth. There is a 10% penalty on the $20k that did not go into the Roth.

Even after you're old enough for the early withdrawal penalty to not be in play, If an individual is looking to do a Roth conversion it's still best to use outside cash to cover the taxes as it allows you to maximize the converted amount, while remaining in a reasonable tax bracket, which I assume would be the primary goal....

 

[Tenacious E_rivals41982]

FYI there's no 10% penalty on Roth conversions but you're right that you need to have outside cash to cover your taxes. I've had clients get caught because they took out $100k, withheld $20k in taxes with only $80k going into the Roth. There is a 10% penalty on the $20k that did not go into the Roth.

Just so I am understanding, you only pay taxes on the amount converted, correct? Just to use round numbers, if there is a $1M balance in the 401k, and I convert $100K, I would only pay taxes on the converted $100K and not the entire $1M? Otherwise, that would a fucan spicy meatball to have to pay taxes on all of it at once...

 

[cheeselog8]

Just so I am understanding, you only pay taxes on the amount converted, correct? Just to use round numbers, if there is a $1M balance in the 401k, and I convert $100K, I would only pay taxes on the converted $100K and not the entire $1M? Otherwise, that would a fucan spicy meatball to have to pay taxes on all of it at once...

That's correct.

 

[Rifler]

The trick is to understand your other normal income streams well enough to then be able to determine how much of a Roth conversion you can do while keeping your total taxable income at a level that will only be taxed at a rate that you deem to be acceptable,... It varies for everyone.

 

[dpic73]

Just so I am understanding, you only pay taxes on the amount converted, correct? Just to use round numbers, if there is a $1M balance in the 401k, and I convert $100K, I would only pay taxes on the converted $100K and not the entire $1M? Otherwise, that would a fucan spicy meatball to have to pay taxes on all of it at once...

Correct, when I said full lump sum, that was assuming that's what you were withdrawing.

 

[baltimorened]

I'm not pretending to be an expert and may not understand exactly what you're trying to do but be aware that if you convert a traditional to a Roth, you will have to pay taxes on the full lump sum and it will need to be paid using cash from a regular checking or savings account, on top of the 10% penalty for removing before 59 1/2. Depending on the amount, it could also put you into a higher tax bracket. Also a Roth conversion has it's own distinct 5 year clock so if you withdraw the converted principal before 5 years have passed, even if you're over 59 1/2, you could be subjected to another 10% early withdrawal fee, though there may be an exception. It's a major financial decision so consider it carefully.

Edit : looks like cheeselog8 can provide better advice.

@LafayetteBear is in estate planning..he might be a good source

 

[baltimorened]

That's a sound strategy that a lot of my clients are doing. I wouldn't worry about the 5 year rule too much, IMO your Roth should be the last place you pull funds from anyways.

As far as using a financial advisor, I personally use one for about half my portfolio. I do it because I get a ton of referrals from them but I agree that paying the fees is somewhat silly. They charge 1% per year and they aren't doing any more work than they did when the portfolio had less zeros at the end.

on the other side, I use an advisor, affiliated with Schwab....I'm retired and am setting up my wife for sustainable income in the event I go first. And, while I agree that most of these advisors just follow the standard 60-40...some value, some growth, some international formula, etc...mine has put me into some structured agreements that pay solid returns - which I guess are available to other financial advising firms, but to individual investors....

depending on the value of your portfolio, you can often negotiate below the 1% fee.

 

[Tenacious E_rivals41982]

on the other side, I use an advisor, affiliated with Schwab....I'm retired and am setting up my wife for sustainable income in the event I go first. And, while I agree that most of these advisors just follow the standard 60-40...some value, some growth, some international formula, etc...mine has put me into some structured agreements that pay solid returns - which I guess are available to other financial advising firms, but to individual investors....

depending on the value of your portfolio, you can often negotiate below the 1% fee.

I can do all of that myself. The thorny subjects I am studying now include paying for health care for the period between when I retire and when I can enroll in Medicare, and converting my deferred comp in my 401k to a Roth account so as to decrease my income when calculating Medicare premiums or health insurance on the open market, as well as to avoid RMDs down the road. And, of course, implicit in this is decreasing my overall tax burden.

 

[HoggI74]

59 is too early to retire. You're going to have productivity guilt. You can't get into a good pickleball group until you're at least 62 anyway...

 

[RockyMtNole]

I can do all of that myself. The thorny subjects I am studying now include paying for health care for the period between when I retire and when I can enroll in Medicare, and converting my deferred comp in my 401k to a Roth account so as to decrease my income when calculating Medicare premiums or health insurance on the open market, as well as to avoid RMDs down the road. And, of course, implicit in this is decreasing my overall tax burden.

Let me know what you figure out. I am getting closer and closer to pulling the plug on this whole work thing.

 

[Tenacious E_rivals41982]

Let me know what you figure out. I am getting closer and closer to pulling the plug on this whole work thing.

Others have lived it and have better firsthand info, but from what I have read, if you're at all similarly situated to me, you are getting no tax credits. From what I have read, I think it is about $25k per year for a couple, until you can get Medicare.

On the Roth conversion, I have done some noodling on the math and I don't think I will be doing any conversions until I retire, drastically decreasing our income. From that point, we can convert $403,500, less our income, per year from the 401k and keep within the 24% bracket before jumping to the 32% bracket, so long as we have the juice outside of retirement accounts to pay the extra income tax each year on the conversion...

 

[Tenacious E_rivals41982]

59 is too early to retire. You're going to have productivity guilt. You can't get into a good pickleball group until you're at least 62 anyway...

No way. It will be a mix of sleeping in, working out on my schedule, traveling, golfing, and dinking around the yard/pool. God willing, down the road some day it will be spending time with grandkids. I would do it now if I could.

 

[Hawkedup]

I can do all of that myself. The thorny subjects I am studying now include paying for health care for the period between when I retire and when I can enroll in Medicare, and converting my deferred comp in my 401k to a Roth account so as to decrease my income when calculating Medicare premiums or health insurance on the open market, as well as to avoid RMDs down the road. And, of course, implicit in this is decreasing my overall tax burden.

It is the thorny subjects that yo are paying the financial planner for. Not necessarily the investments. And for those that want nothing to do with the investments, it is an added bonus.

And an FYI. I wouldn't think conversions make a lot of sense for people still working. Just switch your contributions to roth instead of traditional.

 

[Tenacious E_rivals41982]

It is the thorny subjects that yo are paying the financial planner for. Not necessarily the investments. And for those that want nothing to do with the investments, it is an added bonus.

And an FYI. I wouldn't think conversions make a lot of sense for people still working. Just switch your contributions to roth instead of traditional.

Yeah, that is the math I posted later in the thread. As for doing Roth contributions directly, I am not eligible.

 

[Hawkedup]

Yeah, that is the math I posted later in the thread. As for doing Roth contributions directly, I am not eligible.

That is a good problem to have!! I meant more of the roth K option as opposed to IRA though. Also, consider the back door option if you don't have any other tax deferred IRA's out there. If you do, it would follow the pro rata rule which doesn't usually make sense for most.

 

[Hawkedup]

Yeah, that is the math I posted later in the thread. As for doing Roth contributions directly, I am not eligible.

And don't forget. This may give you a reason to retire even earlier. Get more of that money converted by the time RMD's kick in.

 

[Tenacious E_rivals41982]

That is a good problem to have!! I meant more of the roth K option as opposed to IRA though. Also, consider the back door option if you don't have any other tax deferred IRA's out there. If you do, it would follow the pro rata rule which doesn't usually make sense for most.

Wouldn't I run into the same obstacles doing the backdoor as I would conversion? I'm still in the tax bracket I'm in, but I could very well be not fully understanding it yet.

 

[Hawkedup]

Wouldn't I run into the same obstacles doing the backdoor as I would conversion? I'm still in the tax bracket I'm in, but I could very well be not fully understanding it yet.

If you are being hit with the pro rata rule then yes, it is basically the same as a conversion and not really something you should do, imo. If it doesn't, then you are converting a non deductible contribution and converting directly to a roth. You aren't receiving any tax benefit by making the contribution so it isn't a taxable event, i.e, (roth conversion adds ordinary income to your taxes where as a non deductible conversion does not.), when you convert. You need to fully understand the pro rata though. Do you have any tax deferred IRA's out there? (Traditional, simple or sep)

 

[CJ Beat Hard]

OPs mom knows all about the back door

 

[Tenacious E_rivals41982]

OPs mom knows all about the back door

I tried so hard to word things to avoid that joke.

 

[Tenacious E_rivals41982]

If you are being hit with the pro rata rule then yes, it is basically the same as a conversion and not really something you should do, imo. If it doesn't, then you are converting a non deductible contribution and converting directly to a roth. You aren't receiving any tax benefit by making the contribution so it isn't a taxable event, i.e, (roth conversion adds ordinary income to your taxes where as a non deductible conversion does not.), when you convert. You need to fully understand the pro rata though. Do you have any tax deferred IRA's out there? (Traditional, simple or sep)

No, just my 401k which is all tax deferred compensation .

 

[alaskanseminole]

I am 52

...and to this point, I have taken a pretty hands off approach where I contribute the max and I get contributions from where I work on top of that. I have been reading about the backdoor Roth conversion, which I think makes sense to the extent I can do it without having it done in a higher tax bracket. Then again, I am in my peak earning years, and perhaps it makes more sense do to this once I'm actually retired, which will be no later than 59. Anyone do this or have things to do or watch out for during the process?

I plan on doing this when I retire starting around 62. Should have it all done before the mando distros.

 

[Tenacious E_rivals41982]

I plan on doing this when I retire starting around 62. Should have it all done before the mando distros.

Mi compadre, mi amigo - two peas in a pod per usual!

 

[Urohawk]

Relatedly, I have just done everything myself over the years. I am thinking perhaps I should get a financial planner on board, but I am loathe to pay someone for something I can figure out on my own. Thoughts on that?

The financial planner will do a few things for you. Mine takes a percent of my retirement but then it's capped out at a certain amount which is 40% of my current portfolio (so 1% of 40% that he manages). The other 60% is in my work retirement accounts. What he says is there isn't enough flexibility in my work accounts to make it fair for him to bill me because he can't do much with that money. He does have a look at it once per quarter to rebalance it which is for free.

There are lot of people that will do a one time plan for a fee. You're paying them a consulting fee for a one time look.

My planner does a lot for me:
1. Has an accountant on staff that does my taxes for free.
2. Helps me work on alternative investments- real estate, business investments, etc.
3. Helped with decision making on 529 for kids. Better to spend it now with a Freshman or wait and save until grad school. Talked a lot about cash flow and such.
4. Stopped investing in 529s. Better to invest into a brokerage account. You can withdraw the principle for free if you need to to pay for college, it's not tied down for education rules, doesn't take a tax hit if you need to withdraw, and if my kids don't go to school or don't need all the money then I can use it for retirement instead.
5. Biggest thing he helped me do is fight fear. That is multifaceted. He told me you're saving too much money. Biggest issue his clients have is that they hoard money and die. He said go travel and experience the world, give it away to charities while alive to bask in the benefit you give to others, etc. Don't take it with you to the grave. No one loves you more based on the size of their inheritance. I keep worrying we won't have enough if one of us gets sick and has to quit early, the market crashes, etc. He's modeled all that for us so I don't need to squirrel away more. It's an extra set of eyes to make sure what you're doing is correct. It's also objective and takes away some of my fear mongering/anxiety.
6. Estate planning, tax reduction, asset protection strategies, etc.
7. Insurance- We are basically self insured with regards to life insurance. We had 20 year term life that expired. He recommended getting enough to pay for everyone's college and no more, so something short term.
8. Finally contacts and networking- He makes a lot of calls to friends to refer business like my estate attorney. It's useful to have someone you can trust because they have a working relationship. He also gets answers for specific problems for free.

 

[Urohawk]

I can do all of that myself. The thorny subjects I am studying now include paying for health care for the period between when I retire and when I can enroll in Medicare, and converting my deferred comp in my 401k to a Roth account so as to decrease my income when calculating Medicare premiums or health insurance on the open market, as well as to avoid RMDs down the road. And, of course, implicit in this is decreasing my overall tax burden.

Healthcare- If you can work at a fedex facility for 20 hrs per week, they will give you full health benefits as of a few years ago. This allowed my patient to retire early and saved costs of insurance.

 

[Urohawk]

Others have lived it and have better firsthand info, but from what I have read, if you're at all similarly situated to me, you are getting no tax credits. From what I have read, I think it is about $25k per year for a couple, until you can get Medicare.

On the Roth conversion, I have done some noodling on the math and I don't think I will be doing any conversions until I retire, drastically decreasing our income. From that point, we can convert $403,500, less our income, per year from the 401k and keep within the 24% bracket before jumping to the 32% bracket, so long as we have the juice outside of retirement accounts to pay the extra income tax each year on the conversion...

See my post above about regular brokerage account for my kids college rather than a 529. Any unused money is going to pay taxes on the Roth conversion. Your analysis is what my finance guy told me. We are in highest tax bracket. One or both of us may retire early or go part time which will reduce our income Therefore the conversion will be at a lower tax bracket when we retire or closer to it.

 

[lucas80]

The financial planner will do a few things for you. Mine takes a percent of my retirement but then it's capped out at a certain amount which is 40% of my current portfolio (so 1% of 40% that he manages). The other 60% is in my work retirement accounts. What he says is there isn't enough flexibility in my work accounts to make it fair for him to bill me because he can't do much with that money. He does have a look at it once per quarter to rebalance it which is for free.

There are lot of people that will do a one time plan for a fee. You're paying them a consulting fee for a one time look.

My planner does a lot for me:
1. Has an accountant on staff that does my taxes for free.
2. Helps me work on alternative investments- real estate, business investments, etc.
3. Helped with decision making on 529 for kids. Better to spend it now with a Freshman or wait and save until grad school. Talked a lot about cash flow and such.
4. Stopped investing in 529s. Better to invest into a brokerage account. You can withdraw the principle for free if you need to to pay for college, it's not tied down for education rules, doesn't take a tax hit if you need to withdraw, and if my kids don't go to school or don't need all the money then I can use it for retirement instead.
5. Biggest thing he helped me do is fight fear. That is multifaceted. He told me you're saving too much money. Biggest issue his clients have is that they hoard money and die. He said go travel and experience the world, give it away to charities while alive to bask in the benefit you give to others, etc. Don't take it with you to the grave. No one loves you more based on the size of their inheritance. I keep worrying we won't have enough if one of us gets sick and has to quit early, the market crashes, etc. He's modeled all that for us so I don't need to squirrel away more. It's an extra set of eyes to make sure what you're doing is correct. It's also objective and takes away some of my fear mongering/anxiety.
6. Estate planning, tax reduction, asset protection strategies, etc.
7. Insurance- We are basically self insured with regards to life insurance. We had 20 year term life that expired. He recommended getting enough to pay for everyone's college and no more, so something short term.
8. Finally contacts and networking- He makes a lot of calls to friends to refer business like my estate attorney. It's useful to have someone you can trust because they have a working relationship. He also gets answers for specific problems for free.

5 has been the biggest one for us. Life can come at you pretty fast, but our guy cannot seem to convince my wife that we are locked in for a solid retirement. I want a cushion, and I want to leave a nest egg for the kids, no more. It's sad the number of friends and co-workers I have who are determined to be buried with their money.
For the other things you gave some good lists. I'll just say one thing I like with our guy is he takes care of the BS details and paperwork.

 

[lucas80]

Relatedly, I have just done everything myself over the years. I am thinking perhaps I should get a financial planner on board, but I am loathe to pay someone for something I can figure out on my own. Thoughts on that?

If you think you can figure it out, but you're asking this collection of randos for advice, you need a pro.

 

[Tenacious E_rivals41982]

If you think you can figure it out, but you're asking this collection of randos for advice, you need a pro.

Fair, but the unknown unknowns are what gitcha. Once I know what I don’t know and need to figure out, I have a few years - god willing - to get it lined up and executed!