Dec 19

With the new rule in effect as of March 2008 allowing a direct 401k rollover to Roth IRA, could you shed some light on this scenario: A couple, both over 60 files jointly and will be earning less income when retired. Currently both are working and earn 100,000. When retired their income will be 46,000. They have 300,000 combined in their 401k and would like to know if it makes financial sense to rollover to a Roth Ira. Thank you for your help.


one comment so far...

  • Brian Said on December 19th, 2009 at 10:27 pm:

    The short answer is – it depends on the tax rate. Let’s take 3 scenarios: Tax rates stay the same, your taxes are lower in retirement and finally your taxes are higher in retirement.

    Assumptions:
    1) You pay for the conversion out-of-pocket (as opposed to funding it with monies in the 401(k)).
    2) If you do not convert, you invest what you would have paid in conversion costs in a taxable account.

    Currently, your marginal tax rate is 28% and in retirement it will be 25%. Paying 28% now, when you can pay 25% later makes a ROTH less attractive. If the government decides to raise taxes, when you retire, a ROTH makes more sense.

    Now, there are other subtle differences between the types of accounts, like required minimum distribtions, that effect estate planning. This example does not consider this.

    You can make a case either way if the government will raise or lower taxes in the future. Since we do not know with certainty, I suggest another option. Rollover 1/2 of your account. Keep some in a pre-tax account (401k) and some in a post tax account (ROTH).

    This is a different kind of diversification – tax diversification. See the source that I listed from vanguard.

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