Author Topic: Roth Pipeline - a little confused  (Read 489 times)

FLStache

  • 5 O'Clock Shadow
  • *
  • Posts: 9
Roth Pipeline - a little confused
« on: November 14, 2017, 12:40:04 PM »
As I outlined in a recent case study, it looks like I will FIRE about a year from now.  Part of my strategy includes using a Roth Pipeline to start moving some of my 401k funds over for accessibility in about six years when I turn 55.  I believe my current income ($160,000) is too high to open a new Roth IRA.  I do have an existing one that I must have opened many years ago with Fidelity, so would it be correct that I can rollover the 401K funds to the Fidelity Roth IRA?  My preference would be opening a new one in Vanguard, but I think the income limitation prohibits that. Is my understanding of that correct?  I feel like these are basic questions, but beyond socking away a good bit, I haven't previously had much in the way of strategy or financial education.

Thanks!

CowboyAndIndian

  • Handlebar Stache
  • *****
  • Posts: 1056
  • Location: NJ, USA
    • KOWines: Deep discount wine/spirits store.
Re: Roth Pipeline - a little confused
« Reply #1 on: November 14, 2017, 01:01:38 PM »
As I outlined in a recent case study, it looks like I will FIRE about a year from now.  Part of my strategy includes using a Roth Pipeline to start moving some of my 401k funds over for accessibility in about six years when I turn 55.  I believe my current income ($160,000) is too high to open a new Roth IRA.  I do have an existing one that I must have opened many years ago with Fidelity, so would it be correct that I can rollover the 401K funds to the Fidelity Roth IRA?  My preference would be opening a new one in Vanguard, but I think the income limitation prohibits that. Is my understanding of that correct?  I feel like these are basic questions, but beyond socking away a good bit, I haven't previously had much in the way of strategy or financial education.

Thanks!

Yes, you can use your existing Roth IRA for a Roth pipeline.

You can transfer your Fidelity Roth IRA to Vanguard. Talk to Vanguard, should be very easy and may take a couple of days.

Laura33

  • Handlebar Stache
  • *****
  • Posts: 1466
  • Location: Mid-Atlantic
Re: Roth Pipeline - a little confused
« Reply #2 on: November 14, 2017, 02:03:40 PM »
I think you might be mixing up a couple of different things.

If you have any tIRAs, you can convert those to a Roth at any time.  But note that any amount you convert is counted as income and taxed at your normal interest tax rates (so if you make $160K and convert $40K from tIRA to Roth, your income for the year is $200K, and that's what you pay taxes on).  This is why many people wait until they retire to do these kinds of conversions, so they can do it at a lower tax rate.

If you want to contribute to a new IRA, your current salary would likely prevent you from directly opening a Roth, and it likely also prevents you from opening up a deductible tIRA.  But what you can do now, and each and every year from now in which you have earned income, is to open up a nondeductible tIRA and then immediately (as in the next day) convert it to a Roth.  If you do not have any other tIRAs out there, you can convert that tIRA to a Roth with minimal tax impacts (you pay tax only on the amount of any increase in value from the day you opened the tIRA to the day you converted it to a Roth -- which means, if you convert it to a Roth the day after you open it, there should be minimal gains).  If you do have other tIRAs out there, the tax treatment gets more complex, so asterisk here.

The Roth pipeline is a big version of this that you do after you retire.  Basically, you quit your job, and you roll over the contents of your 401(k) into a tIRA -- you cannot roll your 401(k) directly into a Roth, you have to stop at a tIRA first.  At that point, you have, say $500K in a tIRA.  You then convert part of that 'stache to a Roth every year, exactly as under the first option above -- usually, you convert what you think one year's expenses will be in a few years; the entire amount of the distribution counts as taxable income in the year you do the rollover, so you usually spread the conversions across several years to keep the tax hit low.  You also have to wait 5 years before you can make any withdrawals from that Roth account, so you always want to have enough $$ available to cover your costs for those first five years.*

*I do not know whether you could combine your Roth Pipeline Roth account with your pre-existing Roth account.  You existing Roth account allows you to withdraw your contributions at any time, and to withdraw earnings penalty-free after 5 years and after 59.5 -- but the reason the ladder works is that any amount that you convert from a tIRA is counted as a contribution.  So as is, you could take your contributions out of your existing Roth any time, as long as it has been open for at least 5 years, whereas your new Roth pipeline will need to wait another 5 years before you can take out those contributions.  Because of that difference, I don't know if you could combine them.  But you could certainly very easily open a new tIRA account with Vanguard and convert that to a Roth easily, regardless of what you do with your existing Roth.
Laugh while you can, monkey-boy

justchristine

  • Bristles
  • ***
  • Posts: 304
Re: Roth Pipeline - a little confused
« Reply #3 on: November 14, 2017, 02:36:01 PM »
I think you might be mixing up a couple of different things.

If you have any tIRAs, you can convert those to a Roth at any time.  But note that any amount you convert is counted as income and taxed at your normal interest tax rates (so if you make $160K and convert $40K from tIRA to Roth, your income for the year is $200K, and that's what you pay taxes on).  This is why many people wait until they retire to do these kinds of conversions, so they can do it at a lower tax rate.

If you want to contribute to a new IRA, your current salary would likely prevent you from directly opening a Roth, and it likely also prevents you from opening up a deductible tIRA.  But what you can do now, and each and every year from now in which you have earned income, is to open up a nondeductible tIRA and then immediately (as in the next day) convert it to a Roth.  If you do not have any other tIRAs out there, you can convert that tIRA to a Roth with minimal tax impacts (you pay tax only on the amount of any increase in value from the day you opened the tIRA to the day you converted it to a Roth -- which means, if you convert it to a Roth the day after you open it, there should be minimal gains).  If you do have other tIRAs out there, the tax treatment gets more complex, so asterisk here.

The Roth pipeline is a big version of this that you do after you retire.  Basically, you quit your job, and you roll over the contents of your 401(k) into a tIRA -- you cannot roll your 401(k) directly into a Roth, you have to stop at a tIRA first.  At that point, you have, say $500K in a tIRA.  You then convert part of that 'stache to a Roth every year, exactly as under the first option above -- usually, you convert what you think one year's expenses will be in a few years; the entire amount of the distribution counts as taxable income in the year you do the rollover, so you usually spread the conversions across several years to keep the tax hit low.  You also have to wait 5 years before you can make any withdrawals from that Roth account, so you always want to have enough $$ available to cover your costs for those first five years.*

*I do not know whether you could combine your Roth Pipeline Roth account with your pre-existing Roth account.  You existing Roth account allows you to withdraw your contributions at any time, and to withdraw earnings penalty-free after 5 years and after 59.5 -- but the reason the ladder works is that any amount that you convert from a tIRA is counted as a contribution.  So as is, you could take your contributions out of your existing Roth any time, as long as it has been open for at least 5 years, whereas your new Roth pipeline will need to wait another 5 years before you can take out those contributions.  Because of that difference, I don't know if you could combine them.  But you could certainly very easily open a new tIRA account with Vanguard and convert that to a Roth easily, regardless of what you do with your existing Roth.

yes he should be able to use the existing Roth for the pipeline.  He would just need to make sure not to withdraw any newly added funds until the 5yr wait.  So say the Roth has 100K in it today and 60K of that is contributions.  Then you roll 25K from your rollover IRA to the Roth.  At that point you would be able to access your original 60K of contributions  but the 25K conversion amount would have to wait 5yrs. 

secondcor521

  • Handlebar Stache
  • *****
  • Posts: 1170
  • Age: 48
  • Location: Boise, Idaho
  • Big cattle, no hat.
    • Age of Eon - Overwatch player videos
Re: Roth Pipeline - a little confused
« Reply #4 on: November 14, 2017, 02:46:34 PM »
*I do not know whether you could combine your Roth Pipeline Roth account with your pre-existing Roth account.  You existing Roth account allows you to withdraw your contributions at any time, and to withdraw earnings penalty-free after 5 years and after 59.5 -- but the reason the ladder works is that any amount that you convert from a tIRA is counted as a contribution.  So as is, you could take your contributions out of your existing Roth any time, as long as it has been open for at least 5 years, whereas your new Roth pipeline will need to wait another 5 years before you can take out those contributions.  Because of that difference, I don't know if you could combine them.  But you could certainly very easily open a new tIRA account with Vanguard and convert that to a Roth easily, regardless of what you do with your existing Roth.

Emphasis added.

The bolded part is not correct.  Contributions to a Roth are always contributions.  Conversions to a Roth are always conversions.

As far as the government is concerned, from a tax point of view, everyone is treated as having one Roth IRA, even if you happen to have multiple accounts at multiple custodians with multiple investments inside them.

So it doesn't matter if one combines Roth IRA accounts or not.

You can always withdraw Roth contributions at any time, tax free and penalty free, regardless of whether the account has been opened for five years or not.

Withdrawals from a Roth are always deemed to be contributions first, conversions second (in chronological order, oldest conversions first), and earnings last.

Conversions may be withdrawn tax free and penalty free as long as they were converted 5 tax years previously.  So conversions made today in 2017 could be withdrawn on or after January 1, 2022.
Like Overwatch?  Check out this YouTube channel:  http://bit.ly/AgeOfEon

Laura33

  • Handlebar Stache
  • *****
  • Posts: 1466
  • Location: Mid-Atlantic
Re: Roth Pipeline - a little confused
« Reply #5 on: November 14, 2017, 06:35:57 PM »
*I do not know whether you could combine your Roth Pipeline Roth account with your pre-existing Roth account.  You existing Roth account allows you to withdraw your contributions at any time, and to withdraw earnings penalty-free after 5 years and after 59.5 -- but the reason the ladder works is that any amount that you convert from a tIRA is counted as a contribution.  So as is, you could take your contributions out of your existing Roth any time, as long as it has been open for at least 5 years, whereas your new Roth pipeline will need to wait another 5 years before you can take out those contributions.  Because of that difference, I don't know if you could combine them.  But you could certainly very easily open a new tIRA account with Vanguard and convert that to a Roth easily, regardless of what you do with your existing Roth.

Emphasis added.

The bolded part is not correct.  Contributions to a Roth are always contributions.  Conversions to a Roth are always conversions.

As far as the government is concerned, from a tax point of view, everyone is treated as having one Roth IRA, even if you happen to have multiple accounts at multiple custodians with multiple investments inside them.

So it doesn't matter if one combines Roth IRA accounts or not.

You can always withdraw Roth contributions at any time, tax free and penalty free, regardless of whether the account has been opened for five years or not.

Withdrawals from a Roth are always deemed to be contributions first, conversions second (in chronological order, oldest conversions first), and earnings last.

Conversions may be withdrawn tax free and penalty free as long as they were converted 5 tax years previously.  So conversions made today in 2017 could be withdrawn on or after January 1, 2022.

Thanks for the clarification of the details very helpful for my own plans. ;-) What I meant is that for tax purposes, the converted amount is treated the same as contributions are (i.e., you can withdraw that amount after five years without paying taxes or penalties).  Sounds like that part is still correct(?).
Laugh while you can, monkey-boy

secondcor521

  • Handlebar Stache
  • *****
  • Posts: 1170
  • Age: 48
  • Location: Boise, Idaho
  • Big cattle, no hat.
    • Age of Eon - Overwatch player videos
Re: Roth Pipeline - a little confused
« Reply #6 on: November 14, 2017, 07:17:18 PM »
Yes, I believe that is correct.
Like Overwatch?  Check out this YouTube channel:  http://bit.ly/AgeOfEon

seattlecyclone

  • Magnum Stache
  • ******
  • Posts: 3908
  • Age: 33
  • Location: Seattle, WA
Re: Roth Pipeline - a little confused
« Reply #7 on: November 14, 2017, 08:09:49 PM »
Thanks for the clarification of the details very helpful for my own plans. ;-) What I meant is that for tax purposes, the converted amount is treated the same as contributions are (i.e., you can withdraw that amount after five years without paying taxes or penalties).  Sounds like that part is still correct(?).

Not exactly. You can withdraw contributions the week after you put them in your Roth IRA and there's no tax due. If you withdraw your conversions within five years you pay a 10% early withdrawal tax.
I made a blog! https://seattlecyclone.com/

The Roth IRA was named after William Roth, who represented Delaware in the US senate from 1971-2001. "Roth" is a name, not an acronym. There's no need to capitalize the final three letters.

secondcor521

  • Handlebar Stache
  • *****
  • Posts: 1170
  • Age: 48
  • Location: Boise, Idaho
  • Big cattle, no hat.
    • Age of Eon - Overwatch player videos
Re: Roth Pipeline - a little confused
« Reply #8 on: November 14, 2017, 09:48:35 PM »
Yes, I believe that is correct.

What I read the question to be was if contributions or conversions were removed after 5 years, would they both be penalty and tax free.  That is correct.  What seattlecyclone writes (and what I wrote in my original reply) is correct as well, that contributions can be removed tax and penalty free without the 5 year waiting period.
Like Overwatch?  Check out this YouTube channel:  http://bit.ly/AgeOfEon

FLStache

  • 5 O'Clock Shadow
  • *
  • Posts: 9
Re: Roth Pipeline - a little confused
« Reply #9 on: November 15, 2017, 06:58:29 AM »
Thanks to each of you for your thoughtful replies and comments on the tax implications.

For clarity - can I rollover (convert?) funds directly from my 401K (employer sponsored) to my Fidelity Roth IRA or do I need to convert it to a tIRA first? (I think Laura33 is suggesting it needs to go through a tIRA first rather than my Roth directly).  (For the moment just leaving the transfer to Vanguard alone to avoid confusing the discussion).

For 2017 and 2018 I'll still receive my full salary ($160,00 each year).  I will be able to defer my severance package until 2019 so will have income that year of about $175,000 before taxes.  Only in 2020 will I drop down to income only from potential part time work.  I shouldn't need to start pulling from my mutual funds until 2021.

So really I'll only drop into that lower tax bracket in 2020...but, I may need to supplement my pension starting in 2024. 

Ideally I should hold off on initiating the Roth Pipeline until 2020, but I think I'll need to start it in 2019 to have the funds available in 2024.  Or perhaps the better move is to delay initiating the Roth Pipeline until 2020 and if I have to withdraw funds from the 401k in 2024, I just take the tax hit and penalty while in the lower tax bracket?

Somewhat talking out loud to myself, but appreciate any input/suggestions. 

Thanks,

Kat

secondcor521

  • Handlebar Stache
  • *****
  • Posts: 1170
  • Age: 48
  • Location: Boise, Idaho
  • Big cattle, no hat.
    • Age of Eon - Overwatch player videos
Re: Roth Pipeline - a little confused
« Reply #10 on: November 15, 2017, 09:54:26 AM »
You need to convert your 401k to a traditional IRA first.  Doing so is free, easy, and comes with no tax consequences.  If you want to be picky about it, you can (or your custodian will) convert it to a "rollover IRA" which is a special kind of traditional IRA that behaves like a traditional IRA in all respects with one additional feature:  You can roll over the traditional IRA back into another 401k if you for some reason decide to go back to work and if your new employer's 401k allows rollover contributions.

As far as the rest of your post, you'd have to do some tax math to figure out which is best in your situation.  Personally what I did was save up five years of expenses in taxable accounts while I was still working so I could start my Roth pipeline the year I retired (I retired in February so had relatively low income that year so the taxes on the conversion were reasonable).  Can you save five years of expenses out of the $160K / $175K that you'll be getting over the next few years?

My *guess* would be that having an underfunded Roth pipeline and taking the chance of a tax penalty supplementing withdrawals from your traditional IRA (not your 401k, remember, you rolled it over in my first paragraph) if needed would be better.  You might find that your expenses are lower than you predict, or you might accidentally make some money on the side that stretch your pipeline and have it become fully funded.  That is what happened in my case; YMMV.
Like Overwatch?  Check out this YouTube channel:  http://bit.ly/AgeOfEon

FLStache

  • 5 O'Clock Shadow
  • *
  • Posts: 9
Re: Roth Pipeline - a little confused
« Reply #11 on: November 15, 2017, 10:23:24 AM »
Thank you Secondcor!  Between your additional post and spending time rereading madfientist's blog posts on this topic, I think I've finally got my brain wrapped around the logistics of this.

Following my separation from my employer, I'll roll my 401k over to a tIRA.  Will let that sit until my taxable income drops in 2020 and then evaluate how much to convert to a Roth IRA.

I think I likely do have enough to get me through the five years - this is just happening sooner than I anticipated so obsessing a bit over 'will it be enough...'

Thanks,

Kat