401k - Rollover to IRA - Roth - ?

[cinderella]

I would like to take my 401k from my very recent former employer and rollover to a Roth IRA.

 

My understanding is I would pay taxes at my ordinary rate on the rollover? Is that correct? For this year, I have contributed 8k to my 401k from my former employer. However, if am to pay taxes on the 401k conversion to the Roth, then wouldn't my contribution limit for my 401k for this year be at a full 17,000 remaining? Yes, I've contributed 8k at my former employer to date, but since I would like to rollover to a Roth IRA, I have to pay taxes on that 8k contribution. Wouldn't that leave my remaining contribution for the year at the full $17k?

 

Also, would I still be allowed to contribute 5k to a roth IRA in addition to my 401k rollover/conversion to a Roth? I don't think next year I will be allowed to contribute to a roth based on income, so I would like to hit the Roth as much as possible this year while I still can.

 

Any thoughts or suggestions?

Edited June 20, 2012 by cinderella

[Baddies4Breakfast]

I can answer your second question: The 401k rollover does not count towards your $5000 IRA contribution limit. Not sure about the first question, whether transferring a 401 plan to an IRA undoes the fact that it was a contribution up to that point. I wouldn't get my hopes up, but I'll let someone else answer.

[hegemony]

I am pretty sure it is 17K a year whether you roll the old 401k or not.

[Kevin20]

First, you cannot rollover directly from a traditional 401k into a Roth. You first have to roll into a traditional IRA, because of the similar tax-treatment. THEN, you can convert the traditional IRA you've established into a Roth IRA. It's at that point of IRA conversion that you experience the taxable income and must heed all the various rules and ramifications relating to such an IRA conversion.

 

Now, you'll be experiencing income and tax based on an IRA conversion -- you will NOT be subtracting or reversing a 401k contribution. Not at all. Therefore NO, that does not allow you to put more than $17,000 into a 401k for the calendar year tax deductible.

 

And yes, after all that you can still contribute $5000 into a Roth for the year. The annual contribution limit does not apply to conversion money ... after all, you could have someone convert far more than 5K doing such a conversion, so that cannot affect the normal limit.

 

Caution ... depending on how much you'll be converting, since that conversion money counts as income, that may affect your ability to contribute to the Roth, if it makes you exceed the limit. I'm not sure about that detail though, but you should look it up. You could check IRS pub 590 from the IRS.gov site, which gives guidance on IRA's. Sorry, if I had more time I'd check into it.

Edited June 29, 2012 by Kevin20

[Kevin20]

BTW if that sounds unfair or like a legal oversight, keep in mind your benefit: you'll now have more money in a Roth 401K than would otherwise be possible. You are simply trading the benefits of having money in a tax-deferred account (401k or Traditional IRA) with having that same money in a Tax-free account (Roth). You can't expect to make that even trade, yet still get one over on the system by being allowed to pump extra money into a 401k.

 

If that were allowed, rich people could move decades of accumulated 401k into a Roth and then dump hundreds of thousands of dollars of new money this year into a 401k. The tax man ain't dumb.

[Baddies4Breakfast]

First, you cannot rollover directly from a traditional 401k into a Roth. You first have to roll into a traditional IRA, because of the similar tax-treatment. THEN, you can convert the traditional IRA you've established into a Roth IRA. It's at that point of IRA conversion that you experience the taxable income and must heed all the various rules and ramifications relating to such an IRA conversion.

 

Now, you'll be experiencing income and tax based on an IRA conversion -- you will NOT be subtracting or reversing a 401k contribution. Not at all. Therefore NO, that does not allow you to put more than $17,000 into a 401k for the calendar year tax deductible.

 

And yes, after all that you can still contribute $5000 into a Roth for the year. The annual contribution limit does not apply to conversion money ... after all, you could have someone convert far more than 5K doing such a conversion, so that cannot affect the normal limit.

 

Caution ... depending on how much you'll be converting, since that conversion money counts as income, that may affect your ability to contribute to the Roth, if it makes you exceed the limit. I'm not sure about that detail though, but you should look it up. You could check IRS pub 590 from the IRS.gov site, which gives guidance on IRA's. Sorry, if I had more time I'd check into it.

 

This is a great post. It filled in some gaps for me. I would like to add that it is indeed possible to go straight from 401k to Roth IRA in one step depending on who you're dealing with. I did a direct transfer/conversion combo from my Fidelity 401k to my Vanguard Roth IRA in one transaction. I did not have to rollover into my Vanguard Traditional IRA then convert to the Roth IRA. Vanguard was able to do the 1) direct transfer from 401k to them, and 2) Roth conversion in one step for my convenience. Sure, behind the scenes it's 2 steps, but things are getting more convenient nowadays.

[cinderella]

First, you cannot rollover directly from a traditional 401k into a Roth. You first have to roll into a traditional IRA, because of the similar tax-treatment. THEN, you can convert the traditional IRA you've established into a Roth IRA. It's at that point of IRA conversion that you experience the taxable income and must heed all the various rules and ramifications relating to such an IRA conversion.

 

Now, you'll be experiencing income and tax based on an IRA conversion -- you will NOT be subtracting or reversing a 401k contribution. Not at all. Therefore NO, that does not allow you to put more than $17,000 into a 401k for the calendar year tax deductible.

 

And yes, after all that you can still contribute $5000 into a Roth for the year. The annual contribution limit does not apply to conversion money ... after all, you could have someone convert far more than 5K doing such a conversion, so that cannot affect the normal limit.

 

Caution ... depending on how much you'll be converting, since that conversion money counts as income, that may affect your ability to contribute to the Roth, if it makes you exceed the limit. I'm not sure about that detail though, but you should look it up. You could check IRS pub 590 from the IRS.gov site, which gives guidance on IRA's. Sorry, if I had more time I'd check into it.

 

This is a great post. It filled in some gaps for me. I would like to add that it is indeed possible to go straight from 401k to Roth IRA in one step depending on who you're dealing with. I did a direct transfer/conversion combo from my Fidelity 401k to my Vanguard Roth IRA in one transaction. I did not have to rollover into my Vanguard Traditional IRA then convert to the Roth IRA. Vanguard was able to do the 1) direct transfer from 401k to them, and 2) Roth conversion in one step for my convenience. Sure, behind the scenes it's 2 steps, but things are getting more convenient nowadays.

 

Yes, I did read somewhere about going straight from a 401k to a Roth.

 

It kills me to pay taxes on the conversion, although I do receive the benefit of tax free growth from the Roth. I am also planning on buying a house next year and was going to contemplating borrowing from the 401k, but if I converted to a traditional versus a Roth, I don't think I could borrow from the converted traditional because it had to have been established for two years.

 

Then I considered I will probably take off three months mid to late next year on disability and will receive disability pay which for those three months which should bump me into a ROTH income limit to contribute.

 

So much to think about how I am going to plan out the lingering 401k from my prior employer, I'm leaning towards traditional IRA and that I will still be able to contribute the max amount for both me and dh this year and next year if I am on disability for three months next year. Disability is non-taxable income. I've been putting off ankle surgery for several years now, it is never a good time to take three months off work. Next year, I'm doing it.

 

Reviewing my benefits has been a pain. Trying to figure out if it better to pay the extra on Cobra coverage versus taking my new employers health plan as I already have reached my out of pocket maximums with my prior employer and my new employer has some hefty deductibles before the co insurance kicks in. Then trying to figure out if I could use a new FSA amount to pay off a prior bill this year for a hefty co insurance bill I had. Ughh. Then I need to go make a trip to HR to push for HSA's versus FSA's so I can keep the money I contribute. I'd contribute the max to an HSA because I can always keep, but FSA's, I don't feel comfortable contributing $5k a year, I don't know if I would use it and stand to lose a significant chunk to the employer.

 

I am benefit analysis overload right.

 

Thanks everyone for the advice and tips!

[Kevin20]

 

So much to think about how I am going to plan out the lingering 401k from my prior employer, I'm leaning towards traditional IRA and that I will still be able to contribute the max amount for both me and dh this year and next year if I am on disability for three months next year. Disability is non-taxable income. I've been putting off ankle surgery for several years now, it is never a good time to take three months off work. Next year, I'm doing it.

 

Reviewing my benefits has been a pain. Trying to figure out if it better to pay the extra on Cobra coverage versus taking my new employers health plan as I already have reached my out of pocket maximums with my prior employer and my new employer has some hefty deductibles before the co insurance kicks in. Then trying to figure out if I could use a new FSA amount to pay off a prior bill this year for a hefty co insurance bill I had. Ughh. Then I need to go make a trip to HR to push for HSA's versus FSA's so I can keep the money I contribute. I'd contribute the max to an HSA because I can always keep, but FSA's, I don't feel comfortable contributing $5k a year, I don't know if I would use it and stand to lose a significant chunk to the employer.

 

I am benefit analysis overload right.

 

Thanks everyone for the advice and tips!

 

It doesn't surprise me actually that firms will let you do an apparent direct conversion nowadays, just a paperwork drill, but it's good to know what's really happening behind the scenes, since that explains why you can't do what you'd want to do.

 

Now to add to your confusion -- about disability, disability income is often taxable. Specifically, if the premiums are paid by your employer as an employment benefit, then the premiums are tax-deductible as a business expense and the disability income paid to you is taxable. On the other hand, if you yourself have been paying the premiums, that comes from taxable income -- hence the premiums were already taxed, so the benefit would not be taxable income.

 

The pattern is: either the premiums or the benefit payout is taxed, one or the other. If premiums are tax-free, then the benefit is taxed -- and vice versa.

 

So, maybe you've already looked into this, but it's important to know who was paying your premiums. (In my case, my employer pays them, so benefits to me would be taxed.)

 

As to the IRA, there's nothing wrong with keeping a traditional IRA. I personally like the idea of keeping a Traditional IRA bucket to dump old 401k's into as you march through life, and meanwhile putting new money into a Roth IRA when you can.

 

Also I urge you never to borrow from a 401k. Just don't do it. It's imprudent, too risky, and undermines your retirement savings. If you just happen to lose or quit that job while the loan is still outstanding -- which is always possible for everyone -- it all blows up in your face. That should only be your last gasp of desperation, not for something as discretionary as making it easier to buy a house.

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Edited July 9, 2012 by Kevin20