YART: Financial Questions regarding retirement and Roth IRA

[minendo]

Just over 6 months ago I left my old company and joined a new company. I had the option to leave my 401k with my original company, but I chose to rollover my 401k into a rollover IRA with Vanguard. Now I want to move that into a Roth.

Is it in my best interest to move those funds into a Roth and take the tax hit now or just start a Roth once I can save up the initial $3k investment? Either way I will have to pay taxes on the rollover IRA (whether it be now or 50 years from now) so which is my best option and why?

 

[coaster831]

This is a pretty complicated question that depends on how much you make now, when you will retire, and what you expect your tax rate to be when you retire.

If you know for sure your tax rate will be lower when you retire, then typically it makes sense to keep the money in the traditional IRA (because all that money that would have been paid in taxes right now can instead be used to invest and provide growth until you withdraw it in retirement, when (hopefully) your tax rate will be lower).

If you have a 401k at your new job, your best bet might be to:
1) Leave your old 401k money in your traditional IRA
2) Fund your current 401k to the company match
3) Fund your Roth IRA to the $4k limit
4) If there any money you still want to invest for retirement after steps 2 and 3, continue to fund your 401k/traditional IRA.

This plan gives you the most flexibility w/ regard to taxes- pay some now, pay some later (since, if you're young, you can't guarantee your tax rate will be lower when you retire).

 

[minendo]

Originally posted by: coaster831
This is a pretty complicated question that depends on how much you make now, when you will retire, and what you expect your tax rate to be when you retire.

If you know for sure your tax rate will be lower when you retire, then typically it makes sense to keep the money in the traditional IRA (because all that money that would have been paid in taxes right now can instead be used to invest and provide growth until you withdraw it in retirement, when (hopefully) your tax rate will be lower).

If you have a 401k at your new job, your best bet might be to:
1) Leave your old 401k money in your traditional IRA
2) Fund your 401k to the company match
3) Fund your Roth IRA to the $4k limit
4) If there any money you still want to invest for retirement, continue to fund your 401k/traditional IRA.

This plan gives you the most flexibility w/ regard to taxes- pay some now, pay some later (since, if you're young, you can't guarantee your tax rate will be lower when you retire).

I am already maxing out my 401k (with respect to company match) at my new job. In the meantime I have been putting $100/wk towards my rollover IRA. I should be able to withdraw/convert that money to the Roth with no tax hit since I have already paid taxes on it. However, I would still need to take about $900 from my rollover IRA to make the $3k minimum for the roth. If I understand correctly I would only have to pay the taxes on that? If so, I think I'll just do that and leave the rest in the rollover IRA.

Am I correct in my understanding?

 

[coaster831]

Sure, taking that $900 to make the $3k roth minimum makes sense, if only for being able to actually create the roth account.

However, funding $100/month towards your rollover IRA probably doesn't make sense. If you can put that money in your 401k instead, you can get in pre-tax, whereas funding your traditional IRA is post-tax and then only partially tax deductible. Unless your company's 401k plans is really limited, I can't see a good reason to keep adding money to the traditional- you should just fund the 401k and the Roth.

 

[minendo]

Originally posted by: coaster831
Sure, taking that $900 to make the $3k roth minimum makes sense, if only for being able to actually create the roth account.

However, funding $100/month towards your rollover IRA probably doesn't make sense. If you can put that money in your 401k instead, you can get in pre-tax, whereas funding your traditional IRA is post-tax and then only partially tax deductible. Unless your company's 401k plans is really limited, I can't see a good reason to keep adding money to the traditional- you should just fund the 401k and the Roth.

I put the $100 in the rollover IRA since I was not eligible for the 401k until 6 months with the company. I figured something was better than nothing. Now that I am in 6 months I will no longer put anything in the rollover IRA.

 

[coaster831]

OK, that makes sense. I wonder if that money that you invested in the traditional while you couldn't invest in the 401k is fully tax deductible- if your company doesn't offer a 401k, it is completely deductible, but I don't know about this type of situation.

 

[OulOat]

For Traditional to Roth IRA conversions, are there any penalties or additional taxes besides the normal tax on the conversion amount? I was warned by a Scottrade representative that there is an additional 10% tax for converting. I'm not having much success finding information about this additional tax online; the closest thing I can come up with is the 10% penalty you incur if you must withdraw money from the Roth IRA to pay for the normal tax on the conversion amount.