Take a 401k distribution to roll into an IRA? | Ed Slott and Company, LLC

Take a 401k distribution to roll into an IRA?

Hello, Would you ever advise a 60 year old to take a partial, ( say 50 % ) distribution on a 401k, and roll into an IRA, based on the expectation that taxes will be higher in the future? Say I would have a marginal tax rate of 25% on a $50k Distribution today. I understand I could roll that into a T-IRA, and from there into a R-IRA, with taxes due at that point.

Did you check to see if the 401k plan will allow a distribution like that? Most restrict inservice distributions. Currently a Roth IRA can be created by a distribution from a qualified plan, it wouldn't be necessary to roll it to an IRA first. The IRA rollover could be a first step if you wanted to create more than one Roth account for different types of investments.

Yes, I already know my plan does allow in-service distributions. What I'm wondering is if there is any collective wisdom to suggest that the tax hit might be smaller now, (by taking distributions to create an IRA) while values are still reduced, and before tax rates increase, which seems possible now, if not likely, given the state of our economy. It's probably safe to assume tax rates won't go down. Thanks, Tim

Currently if Congress does nothing the maximum income tax rate in 2011 will be 39.6% instead of the current maximum of 35%. If someone rolls funds from either a 401k or an IRA in 2009 to a Roth IRA, the maximum tax rate will be 35%. However there is a modified adjusted gross income threshhold of 100k and marrieds filing separate returns don't qualify. If someone rolls funds from either a 401k or an IRA in 2010 to a Roth, there are no limits based upon income or filing status. The taxpayer can choose to pay all of the tax in 2010 or pay the tax on one-half of the income in 2011 and one-half the income in 2012. The question will be whether it makes sense to defer tax on a lower amount at a higher rate or to pay the tax right away. We know taxes will go up in 2011, but they could also be increased for 2010 - which puts all of us in a position that we have to watch what happens. Traditionally people would roll money into an IRA first before doing the Roth conversion. Now that IRS allows qualified plan beneficiaries to roll benefits to a Roth IRA but does not allow a rollover to Roth from an inherited IRA, many are recommending that the funds be retained in the 401k for a longer period.

Tim, The general consensus is that tax rates will rise in the future, but it is less certain at what level or in what manner. There are some who expect that a valued added or national sales tax will be put in place in lieu of income tax rates increases or to control the amount of such increases. These types of additional taxes would somewhat dilute the relative value of Roth IRAs. If you have no Roth or the share of your Roth assets is very small in relation to tax deferred assets, just the idea of diversifying your tax picture somewhat would argue in favor of conversions. The real question is how much to convert per year. You should not convert so much that your current tax bracket is increased to a level that is higher than your estimated average marginal rate in retirement. For example, if you are currently near the top of your 15% federal bracket, you might consider converting just enough to fill that bracket, and doing this for a number of years. After your Roth assets reach about 20% of your other retirement assets, then your criteria for conversion might toughen up because every dollar you convert eventually contributes toward a lower tax rate in retirement because your TIRA RMDs will be less. There is no single Roth calculator that addresses the many facets of this decision, such as whether you are basically a spender or a saver, whether you have or will buy long term care insurance, what type of assets you wish to leave to heirs, whether you have non IRA funds to pay the conversion taxes, whether you expect the Congress to ever break faith on Roth taxation laws, what state you will retire in, whether you have after tax amounts in your TIRA or qualified plan, etc etc. The Roth is a hedge to allow you to retain more of your successful efforts, whereas leaving the funds in non Roth accounts is a hedge against financial setbacks, economic meltdowns etc. Since none of us really has a crystal ball, for most people measured conversions seem to make sense in that you will have a balance in both types of accounts to draw down as it suits you from year to year in retirement.

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