401(k) to which kind of IRA

A transfer of a "traditional" 401(k) to a traditional IRA has no tax consequences. She would have to pay taxes on a transfer to a Roth IRA.

-- Arthur Rubin, CRTP, AFSP, Brea, CA

Thanks. That is what I thought, but wasn't sure.

Money that goes into a Roth must have income tax paid on that money in the tax year that the money goes into the Roth, whether it's an original contribution out of salary, or a rollover from a traditional

401(k).

There is such a thing as a Roth 401(k), but few companies have implemented it. If your daughter's 401(k) is that type, then she would roll it into a Roth IRA with no tax consequences. But if she has the much more common traditional 401(k), then either she rolls it into a traditional IRA with no tax consequences at time of rollover, or she rolls it into a Roth but declares the value as income and pays taxes on it.

The usual advice is not to convert from traditional to Roth if you would have to pay the taxes out of the value of the IRA, because then you reduce the amount you're investing and lose the appreciation on that part of the investment.

The younger she is, though, the more a Roth makes sense, because the greater will be the growth in value before she retires. And all that growth will be tax free, unlike with a traditional IRA. If she can't afford to pay the tax on a total conversion, maybe she could convert part of it, according to how much tax she can afford to pay.

She's 41. How would that play into this question?

until they decide to tax Roths, too.

When you're doing retirement tax planning, it's impossible to take future changes to the tax code into account, because there's no way to predict the future. It's almost as possible that they'll decide to give a tax CREDIT to Roths as they would to decide to tax them.

Unless there's a current tax reform proposal that appears to have a decent chance of being passed, the best you can do is assume that the future will be roughly the same as the present. Anything else is like making life insurance decisions based on advice from a fortune teller.

Can you really roll directly into a Roth? Don't you have to do the "backdoor Roth", where you first roll into the traditional IRA, then convert it to Roth?

There's one other thing: If your 401(k) allows after-tax contributions, you can roll that portion directly into a Roth. There's no tax consequence because you've already paid taxes on it. And unlike regular

401(k) contributions, you don't have to wait until after you've left the employer to take this kind of rollover.

Your question(s) have been answered but no one has addressed the potential negative of rolling a 401K into an IRA. Specifically, NUA (Net Unrealized Appreciation). This may exist in her 401K if she invested in employer stock.

NUA is simply the difference between the cost basis of the employer stock purchased and the current market value. When you take a distribution from your IRA of employer stock, you pay ordinary income tax rates on the cost basis and long-tem capital gains rate on the NUA. This is highly advantageous when you have employer stock that has greatly appreciated over time.

If you rollover an IRA with NUA into a 401K the NUA disappears. Any distribution is taxed at ordinary income tax rates.

I should have added that there are some rules that need to be followed to take advantage of NUA and it does not necessarily work for every one.

E.g, if only some part of the 401K assets are employer stock, it may be advantageous to rollover tax-free to an IRA the entire part that is not stock and transfer the stock into a taxable investment account. This only works when the whole 401K is liquidated. Someone in the 15% tax bracket, would only pay tax on the cost basis. This works for someone who has a lot of appreciation on the stock and is not in a high tax bracket.

a ROTH credit? not likely at all.

When I was in the fifth grade, many years ago, I realized there would be big problems with social security. I planned accordingly. Anybody who thinks they better not hedge against some changes to the "ROTH windfall" is not thinking straight. All it will take is some rich presidential candidate to have revealed that he has a ton of money in his ROTH, and the torches and pitchforks will come out railing against all the ROTH fat cats (meaning everyone).

She's got a quarter of a century to retirement. How do YOU think it would play?

Should she get a quarter of a century of tax-free growth, at about 6% a year on average, or should she avoid taxes now but pay taxes on roughly 429% of that amount (1.06 to the 25 power) 25 years from now?

And that's without even considering the fact that you _have_ to start withdrawing a traditional IRA at age 70½, and you never have to withdraw from a Roth unless you need it -- but it still keeps appreciating, tax free.

I don't see any reason why you do. But as an individual investor, I would call Vanguard and ask them. Their second-level people are VERY knowledgeable, as I have found. And the OP's daughter will not get a better expense ratio anywhere.

No employer stock. All in Fidelity. She worked for Doctor's offices and Realtor's. Not a lot of employer stock in those. :)

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Since 1980 taxes have for the most part done nothing but go down. Whenever a change has been made that might increase taxes, it's only be prospective. While it's not impossible, it is highly unlikely that Congress will make any changes that will affect anything that has happened up until the time the law changes.

Mark my words.

So I am thinking about sitting down and doing some more indepth analysis of the Roth v Traditional IRA roll over. Could someone either tell me, or point in the proper direction to see what I need to include in what she would have to pay taxes on if we go Roth? The whole enchilada? Just the original money? Just any profits? Any difference between employer share and her part?

The difference is between the lower amount that goes into the Roth IRA but not paying any tax on the back end, compared to the higher amount in the traditional amount, but paying tax when it comes out.

You should run the numbers under both scenarios.

I did a very quick calculation and comparison, and came up with essentially the same numbers whether looking at five or 25 years to retirement. But only you know the numbers and tax brackets that will apply in your case.

Over the years, I've written quite a bit about this topic. My thoughts -

I'd never do a traditional 401(k) to Roth IRA conversion. Traditional

401 to traditional IRA leaves far more flexibility. Since I have nothing more than her age, I'll give more general advice.

Today it would take over $1M to generate a $40K/yr income. (4% rule) That would put her comfortably in the 15% bracket in retirement, with some money taxed at 0%, 10%. If she is in the 25% bracket now, why pay

25% when her average rate in retirement will be far less? Again, to be clear, tax on a conversion is all at the top, at the marginal rate. But in retirement, it's at the average. Those who benefit most will use Roth when in the 10-15% bracket, and then shift to pre-tax when income grows to push that money into 25%. This creates a nice mix at retirement, and possibly averaging one's marginal rate down to 15% or less.

All that said, next. If she has the money to pay the tax now, and the brackets make sense, I'd suggest a certain strategy. Don't convert at once. Do it by moving money by asset class into different end accounts. A simple example - she has $10K each in cash, a high tech ETF, and a financial ETF. Convert all 3 to 3 different Roth accounts. At tax time in the next year, keep the one class that performed best in the Roth, and recharacterize the other 2. Say the Tech ETF is up 30%. She converted $10K, and pays tax on $10K but has $13K in the Roth. The concept can be broken into as many account as her patience dictates, but it offers the chance to avoid the opposite, converting $10K and after a crash to $6K, still owing tax on the full $10K. The strategy insures the converted amount is at least a gain. You lose this with the direct conversion. I coined (I think!) the phrase "roth roulette" for this approach, and you can find my article by searching on that phrase.

Do you have Roth and regular IRAs switched here? If you converted all three to Roth accounts, wouldn't you pay tax on all three now?