403(b) rollover - to traditional or Roth IRA?

June 29, 2016 5:04 PM

I have about $8K languishing in a 403(b) (similar to a 401(k) but for nonprofits). My current company doesn't have a 401(k). I just opened a Roth IRA, and I was going to rollover the 403(b) to the Roth, but then I realized I'll have to pay taxes on it, so now I'm not sure. Should I open a Traditional IRA in addition to the Roth, and rollover into that instead?

If it matters, I'm 33 and make about $85k/year and expect my income to increase in the future (which is why I opened the Roth in the first place).

posted by radioamy to Work & Money (11 answers total)

Rolling over the money to a Roth IRA is a bet that when you need the money at retirement, your tax rate will be higher than it is right now (which is why you'd be willing to pay the taxes on it now).

Rolling over the money to a Traditional IRA is a bet that when you need the money at retirement, your tax rate will be less than it is right now (which is why you'd be willing to defer paying taxes on it until then).

If your tax rate is the same now as it is in retirement, there's no difference between the two, with the minor exception that it is somewhat easier to withdraw money from Roth IRAs prior to retirement for emergencies.

Personally, I don't think current tax rates are sustainable in the long term, so I am fairly heavily invested in Roth tax-paid assets. However, that does come with the risk that future administrations will consider double-taxing Roth contributions for "fairness".
posted by saeculorum at 5:13 PM on June 29, 2016 [1 favorite]

Is there a reason you can't leave it in the 403b? If you want to move it because you don't like your investment choices, yes you can roll it over to a traditional IRA.
posted by cecic at 5:14 PM on June 29, 2016

Open a Traditional and roll it over to that. The tax you defer adds a significant compounding effect in the 30ish years you have until retirement. You'll have more in the Traditional than you would have in the Roth, even accounting for the tax.

You can also roll any or all of this amount into a Roth at any point in the future and pay tax on it then. For example, if you have a year where your income is low because you took six months off or something, you could convert some or all of it in that year and pay the tax at that lower rate.
posted by zrail at 5:17 PM on June 29, 2016 [1 favorite]

Open a Traditional and roll it over to that. The tax you defer adds a significant compounding effect in the 30ish years you have until retirement. You'll have more in the Traditional than you would have in the Roth, even accounting for the tax.

This isn't true. If the tax rate is the same now and in retirement, then the amount of taxes you pay when you withdraw from a Traditional IRA will be exactly equal to the amount of taxes you would have paid if you put in a Roth IRA + the compounding on that amount.

The math on this is relatively straightforward. Say you have 100 and your tax rate is 25%, both now and in retirement. And say that accounting for compounding, your money will grow X% before you withdraw it. Then your choices are:

Traditional: Put in $100, have it grow to $100*(1+X), and then have $100*(1+X)*0.75 after taxes.
Roth: Put in $100*0.75 after taxes and have it grow to $100*0.75*(1+X), withdraw it tax-free.

The pro/con is all about tax rates now versus retirement*, the compounding doesn't actually help you here.

*There's also the early withdrawal benefits that saeculorum laid out, but that again, nothing to do with compounding.
posted by matildatakesovertheworld at 5:25 PM on June 29, 2016

If the tax rate is the same now and in retirement, then the amount of taxes you pay when you withdraw from a Traditional IRA will be exactly equal to the amount of taxes you would have paid if you put in a Roth IRA + the compounding on that amount.

Not if you pay the tax with after-tax dollars. If you pay with 401k withholding and put less into the Roth, you're right. But that's why conventional wisdom is to convert 100% and pay the tax with other funds.
posted by jpe at 5:33 PM on June 29, 2016 [1 favorite]

Not if you pay the tax with after-tax dollars.

You will...always be paying tax with after-tax dollars?
posted by praemunire at 6:06 PM on June 29, 2016

If the tax rate is the same now and in retirement, then the amount of taxes you pay when you withdraw from a Traditional IRA will be exactly equal to the amount of taxes you would have paid if you put in a Roth IRA + the compounding on that amount.

In practice your effective rate at retirement will be lower than your marginal rate when you contributed that money. When you contribute to a tax deferred account you're by definition contributing at your marginal rate (25% at $85k for OP). When you withdraw in retirement it's taxed as ordinary income which means you're only paying your average rate (~17% at $85k).
posted by zrail at 6:14 PM on June 29, 2016 [1 favorite]

Definitely rollover to a traditional IRA. You will have to pay taxes at your marginal rate on the full amount, this year, if you roll over to a Roth. Keeping it in a pre-tax account lets you decide what to do with it later.
posted by mskyle at 6:23 PM on June 29, 2016

If you put stocks into the IRA and they appreciate dramatically you'll be better off with the Roth. Odds are you won't pick the next Apple, however.
posted by Johnny Wallflower at 7:53 PM on June 29, 2016

When you contribute to a tax deferred account you're by definition contributing at your marginal rate (25% at $85k for OP). When you withdraw in retirement it's taxed as ordinary income which means you're only paying your average rate (~17% at $85k)

This is not correct, at least not as you're framing it:

(1) Your contribution may well span two brackets, leaving you deferring, say, 15% on one segment of it and 18% on another.

(2) If your income is lower in retirement, such that you are in a different tax bracket even including the withdrawals, then, yes, your withdrawals will be taxed at a lower rate even if the overall tax-rate structure is precisely the same as it was when you made the contribution. This is obviously a real possibility for many and so a potential benefit of a traditional IRA as against a Roth for people to reasonably consider. Otherwise, no! If you have $80K of other income and then take $5K in withdrawals, that $5K is taxed at your marginal rate, like any other $5K would be. As a general rule, when considering the tax implications of taking income, you have to consider the money as being additional income, taxed at your marginal rate (or whatever rate is specified for that kind of income--but there is no special category for IRA/401K withdrawals per se).

You seem to be conceiving of that money as being at the margin in one scenario and in the base for another, which makes the comparison invalid.
posted by praemunire at 8:36 AM on June 30, 2016

The smart money people seem to say that, if you can afford it, you should shift your funds into a Roth. Check the marginal tax rate you expect for 2016 (that is the rate you will pay on earnings after your expected salary this year). That amount will be your tax for doing this transaction. Then consider that your principal and your earnings from now until retirement will be tax free. This may be important when you take into account the tax rate your will pay on the Social Security payments you will receive, plus and traditional IRA distributions. The smart money people think that your marginal rate now and your marginal rate then will not be significantly different.
posted by Midnight Skulker at 9:20 AM on June 30, 2016