Roth IRA conversion from 401(k)?

July 11, 2011 7:29 PM

Should I roll over my 401(k) and then convert it immediately to a Roth IRA?

I am 36 years old, and I have approximately $180k in 401(k) plans from (previous) employers. Almost all of the 401(k) money is invested in Vanguard index funds (mostly VINIX, which tracks the S&P 500 and has a 0.05% expense ratio).

I’m about to start a new job, and because I’ve had a lot of downtime between the old job and the new job, my income this year is going to be significantly lower than it was in previous years -- probably around $70k in AGI.

I am considering rolling over some of the 401(k) funds into a traditional IRA and then immediately converting that into a Roth IRA. And I would hold Vanguard index funds in the converted Roth.

Right now my inclination is that a rollover/Roth conversion to take my AGI up to $139,350 makes sense, because ordinary income over that amount would be taxed by the federal government at 28% (as opposed to 25%). So converting this year as opposed to later would save me a couple thousand dollars in taxes.

As I see it, the downside of that conversion is that I’d have to come up with the money to pay taxes on the converted IRA, which would greatly decrease my liquidity. (I’d have to sell some non-tax-advantaged investments to cover the tax.) Besides weighing the liquidity hit and the need to speculate about what my retirement-age tax bracket is going to be, am I missing anything here?

YANMFP, etc. Using a sock puppet because, well, this is pretty specific personal finance info.

posted by anonymous to Work & Money (6 answers total)

When I asked this question, I was told that if I anticipated my income increasing in the future, I would be better off paying the taxes now. I was also told to consider rolling it over in chunks, rather than all at once, to avoid a big hit.
posted by Gilbert at 8:07 PM on July 11, 2011

Why do you want the money in a Roth IRA at all? Seems like having to sell stuff to pay taxes, just to save 3%, isn't a good idea.
posted by gjc at 3:31 AM on July 12, 2011

You seem to have a handle on everything. I'm not so sure how probable it is that you will be in a >25% bracket in retirement but depending on your situation it might happen. The other advantages of the Roth may compensate for that risk.

If you want more experienced eyes to look over this, I'd suggest posting over at the Bogleheads forum which is a bunch of Vanguard junkies who love to speculate about this kind of stuff.
posted by Durin's Bane at 4:41 AM on July 12, 2011 [1 favorite]

I would say that you have a good handle on all the issues in this decision. It call comes down to estimating future tax liability and present need for liquidity. I'm pretty sure you can do a partial conversion if you any stress about the liquidity aspects.
posted by dgran at 5:25 AM on July 12, 2011

It makes sense to me. You're not blowing your emergency funds to pay the taxes or anything, are you?

Also, you don't have to do anything 100%. There's nothing wrong with only converting part of it, if you don't want such a big tax hit.
posted by small_ruminant at 9:48 AM on July 12, 2011

there's a lot that can happen over the next ~30-40 years until you retire but given the current state of the economy, I have a hard time imagining that lower income taxes will be one of those things. I'd convert now.

Another reason is that borrowing against 401(k) accounts may be about to get a lot more difficult. Hopefully, this would never be an issue for you but it's nice to have the flexibility of the Roth for catastrophic emergencies.

I wish you'd done this in December. 2010 had a special rule allowing you to pay 50% of the taxes from a Roth conversion in 2011 and postpone the other 50% to 2012.

Nthing others not to borrow from emergency funds to do this and you can always convert a portion instead of the whole thing. (but i would move the 401(k) to a traditional IRA in any event)
posted by screamingnotlaughing at 5:54 PM on July 12, 2011