401k to Roth IRA

[Matt S]

I'll premise this by saying I know financial advice can be tricky to give, so I am not asking for "advice", rather just maybe a recounting of experiences. There is just a wealth of info on the web, and I don't know anyone who has executed this type of thing. I also didn't find any old threads on this.

So, I have a 401k from my previous job that is just sitting out there. There isn't much money in it. I am 27 and personally, I believe that today's income tax rates are artificially low, unsustainable, and expect them to be higher when I retire, no matter what tax bracket I end up in at 65-70 (maybe even later for my generation). So besides taking advantage of my employer match on my current 401k, I think a Roth IRA is the way to go for other retirement investments and I should probably aim to max it out every year.

I am currently under the $100k income cap for contributions and know I have to pay taxes on whatever I convert. My question is this:

Can anyone recommend a good mutual fund company, bank, whatever to do business with? There are seemingly an infinite amount out there. I'd like low fees and expense ratios, but also don't want a place that is a nightmare to deal with. Is there any value in going with a "traditional" mutual fund firm like Vanguard rather than an online brokerage like Scottrade or E-Trade?

Secondly, if I've read correctly, to pull this off I open up a traditional IRA at wherever I choose to do it, get a check from my 401k (which isn't penalized because its a roll over), and I have 60 days to deposit into the IRA before I get penalized. Then I convert the traditional IRA to a Roth and pay my taxes.

I appreciate whatever experience someone can share, and any corrections to an incorrect assumption I may have made here. Maybe I should just start converting the money to gold bars and shoving it under my mattress.

 

[Matt S]

And I just saw the retirement account thread below here. I searched for "IRA" before and got nothing.

 

[Hawkeye5]

Vanguard.

 

[Black Adder]

I'd recommend Vanguard, too. They have a huge range of mutual fund portfolios to choose from, and have low to no maintenance and management fees. I found that they were accessible both online and by phone, and I'm sure they'd be able to help you with your conversion process. It's been a while since I've had an account with them, but I felt it was always a good relationship.

Don

 

[nole1]

Yes that is proper procedure for what you need to do to go about converting your 401(k) to a Roth. I would, however, recommend sitting down with an independent fee-only financial planner (with at least a CFP or ChFC designation) to see what would be the best option for you. Most of the huge firms are asset-gatherers first, planners second. You want someone who will look at your whole financial picture, not just at the commission check they will be receiving.

As a side note, I just want to point out that while you may feel that tax rates are low currently, there is no way to predict what tax rates will be in the future (same as no one can accurately and consistently predict market movements). Also realize that just because a Roth is after-tax dollars and the government is saying it will never be taxed doesn't mean its true. They also told people for years that income from Social Security would not be taxable but miraculously its taxed now.

Hope some of this helped. If you have any other questions shoot me a PM.

 

[SiBurning]

nole1 makes a good point about getting financial advice. You also want to separate the advice from who's holding your money. His second point leads to an alternative. Leave the money in a regular IRA and invest the money you'd spend on taxes. You lose the potential tax deduction (the taxes you'd have paid might be deductible for local tax purposes) and you'll have to manage it as a non-exempt account, but you'll have more money working for you.

I'd choose a brokerage firm that has good options for mutual funds. e-trade has a lot of funds where they don't charge any fees if you hold for 30 days or so. I'm sure there are others. The main reasons for choosing a brokerage are they're a lot more efficient when it comes to buying and selling, and they offer a lot more options, including ETFs and stocks, not to mention mutual funds from many companies. Vanguard might have a lot of options, but you're stuck with their offerings, and they're a lot slower at moving your money around. You can still choose many of their funds with a brokerage.

You might also consider converting slowly so you aren't paying the taxes all in one year.

You should also be able to transfer the money directly from your 401k into your IRA. If you're not in a hurry, it's probably easier to just have them give you a check. That way, you're in control of the transfer. I've had money sit there for a month with no one doing anything because there was something stupid missing in the paperwork.

 

[joglander]

I think when you request a check from your existing 401k they are REQUIRED to withold federal income taxes, so you will only have 75% of it to redeposit. To avoid this, you want to move your money from a 401k into a self directed IRA at Vanguard (or wherever you decide). Then have that company convert it from a Traditional to a Roth IRA. I think you initiate this process by going to the new company (i.e. Vanguard or whomever) and telling them what you want to do. They can contact your old employer and get the 401k transferrred without withholding. You don't touch the money. Every bit of financial advice I have read says that you should pay the tax from other funds, not out of the IRA.

I have had good luck with Schwab, but I have heard good things about Vanguard as well.

 

[nole1]

I think when you request a check from your existing 401k they are REQUIRED to withold federal income taxes, so you will only have 75% of it to redeposit. To avoid this, you want to move your money from a 401k into a self directed IRA at Vanguard (or wherever you decide).

The only way they are required to withhold taxes (as well as a penalty for early withdrawal) is if you are taking a distribution from your 401(k). If you request a rollover check to be deposited into an IRA they will not (and can't) withhold taxes since it is going from one pre-tax investment to another.

 

[Austin]

Send me a pm for a good guy that I use. He used to be a moderator here.

 

[raisindot]

Hi.

As someone who has worked in the financial industry for many years and whose actions are responsible for at least .000083% of the collapse of the market in 2008, I'd like to provide you with accurate information about this conversion process.

1. The old rule that said you had to first rollover from a 401(k) to a Traditional IRA and then convert to a Roth IRA are no longer valid. As long as you meet the income requirements, you can rollover directly from a 401(k) to a Roth IRA.

2. To do this, you must FIRST establish the Roth IRA. You may even have to make a small contribution just to have the money in there.

3. When you make your rollover request to your 401(k) plan administrator, try to have them roll over the money directly to the Roth IRA. If they don't do this, they will send you a check and automatically deduct withholding from your distribution (this doesn't happen when you rollover to a Traditional IRA). If this happens, send the check back to the 401(k) administrator and ask them to make a direct rollover of the entire amount, telling them you wish to pay the taxes out of your own separate taxable income, not out of the rollover amount itself. This may or may not be possible, depending on how your 401k is administered.

You may want to rethink your decision to rollover directly to a Roth IRA and instead rollover to a Traditional IRA. Here's why. Not only will you have no taxes withdrawn, but you will have the flexibility to covert from a Traditional to a Roth IRA when you want to. And you don't have to do it all at one time. For example, if (heaven forbid) you get laid off and are out of work for awhile, you're likely to be in a lower tax bracket, making a conversion much more tax advantageous. You may also want to time your conversions to when the market is at a low, so your taxes will be less because the total value of your account will be less. Simply take the cash and reinvest in the same funds in your new plan. Hopefully, you'll be able to catch the funds when their prices are still low.

Also, in 2010, if you convert everything from a Traditional IRA to a Roth IRA, you can actually spread your tax burden over two years, paying 50% of your owned taxes in 2010 and the other 50% in 2011. If you convert directly from a 401K to a Roth IRA, you'll have to pay all those taxes up front.

Another thing you need to consider when making a conversion is the effect of taxes on the long-term growth of your IRA. If you have to pay 20% in taxes out of your converted IRA, this means that your account will only be worth 80% of what it would be if you converted to a Traditional IRA. This means that if your Trad IRA earned 10% in a year, your Roth IRA would have to earn much more than that to catch up. In fact, if both Trad and Roth IRAs had the same investments and total returns, the Roth IRA would never catch up in value to the Trad IRA. This is why it's ALWAYS better to pay conversion taxes with money from a taxable account, rather than from the IRA account itself.

However, the advantages of the Roth IRA in terms of not having to make required distributions at retirement and (once the money has been in the account for five years) being able to withdraw money tax-free for use for higher education, emergency medical expenses, and first home purchases often makes it a better choice for those starting an IRA from scratch.

One other thing--when you convert, convert to a BROKERAGE IRA from a companies like Fidelity, Schwab, or other companies, rather than a mutual fund IRA. The reason? When you open a mutual fund IRA, you're limited to the funds the mutual fund company offers. You can't invest in stocks, bonds, ETFs or funds from other families. When you open a brokerage IRA, however, you can invest in all of these things and, depending on the company, you may have access to thousands of funds from different familes. Best of all, you never have to keep track of cost basis for your trades, because taxation of distributions (for Traditional IRAs) are based on the gross amout being withdrawn, while there are no taxes at all to pay on Roth IRAs that meet the tax-free distribution requirements.

Jeff in Boston