401k to Traditional to Roth IRA make sense for high income?

[finteresty]

Currently we have a 401k from previous employer, but we're in the 33% marginal tax bracket due to two high income salaries. Trying to decide what to do and we're still in the midst of researching while trying to be Mustachian.

Mainly, would it make sense to do a rollover and then convert a portion to a Roth IRA (and continue backdoor contributions to a Roth IRA)? We're planning to retire in 10 years at 37 years of age, and hoping to live off of investment income and maybe low wage jobs, which would place us at today's 15-25% tax bracket - so a lower tax rate.

It would have to be a rollover to a nondeductible traditional IRA first. We really can't understand the the tax benefits if any to continue converting to a Roth IRA then, though rolling over to a Vanguard IRA would allow us better access to funds (have to lookup if it'd be cheaper to stay with 401k institutional funds though). We have time on our side for our earnings to compound and tax-free + ability to withdraw contributions after 5 years I suppose in a Roth IRA.

We figure then wouldn't it make more sense to wait to convert any funds to a Roth IRA once we retire, so we'd be taxed at the lower tax rate when we no longer work vs at our high rate now for a conversion? It's not clear if there are conversion limits to us.

And secondly, until then, does it make sense to just keep contributing the $5500/yr into the traditional IRA account and any excess invested in a taxable brokerage account? We still think going the Roth IRA makes sense somehow, but it's so much information to take in. Thanks for your experience and advice.

[The_Dude]

Do you have any larged traditional IRA money right now?  Unless there are zero fund options in your current 401K or it has crazy fees consider leaving the money in the 401k.  This will allow you to do backdoor Roth IRA contributions for your current and future tax years tax free.  Then once you retire and drop your income way down it *might* make sense to rollover your 401k and convert small portions to Roth as you go. 

Recommended reading: http://www.bogleheads.org/wiki/Backdoor_Roth_IRA 

[chucklesmcgee]

We figure then wouldn't it make more sense to wait to convert any funds to a Roth IRA once we retire, so we'd be taxed at the lower tax rate when we no longer work vs at our high rate now for a conversion? It's not clear if there are conversion limits to us.

It depends on what you think your tax rates would be at the time you might take the later conversion and when you're actually taking distributions. That involves considering both your future income and distributions to determine which bracket you fall into and what the actual tax brackets will be in the future.

My personal guess is that the tax rates will go much higher for above average incomes and might even increase a bit for modest incomes, depending on the US debt situation. Looking at taxes historically, brackets have been much, much higher for most tax payers.

You're presently in the 33% bracket, what will your taxable income be during retirement? If it's going to be low, say $50k, a traditional 401k/IRA will probably be best as your taxes will be near 0 after the standard deduction. If you expect it will be just a bracket below at 28%, say you're earning $300k today and expect to have $150k in taxable income during retirement, it's much more questionable. It's only a small difference in tax rates and rates could increase a lot in the future. An early Roth conversion will also make your tax situation much more predictable and could make retirement planning easier. Even if a conversion to a Roth turns out not to be in your favor, it will still give you peace of mind in not being so concerned during debates about tax increases.

This of course assumes that if you keep a traditional IRA/401k you will also invest the taxes you don't have to pay from the IRA contributions into taxable savings accounts. If you're going to be spending your tax savings, the Roth IRA is going to be way better!

There are no conversion limits. To this.

[finteresty]

Thanks The_Dude, no current large traditional IRA funds.

We're hoping our retirement income will be 50k or less and intend for both of us to fully stay at home  (and maybe one of us work low wage part time for fun), so we imagine the marginal tax bracket definitely will be lower than our current 33% (may be 35% this year from the looks of things ugh).

I think I agree with both of you and leaving the 401k as it is is fine and rolling over into an IRA doesn't seem very wise at the moment, at least until our tax bracket situation is lower - then it may make sense to rollover but we'd have to reassess at that time of course.

However, chucklesmcgee is right in our thinking that it would make the tax situation more predictable.

It seems the best compromise is to leave the 401k alone (has pretty good funds, or rollover into next employer's 401k if it's good to make things simple; current employer's 401k's funds aren't great) and hedge my tax future by making regular max contributions to a backdoor Roth IRA, especially if we end up making more money in retirement than expected.

[finteresty]

Just thought of another question then.

Does it make sense to max out traditional non-deductible IRA contribution (lump sum) and then convert to Roth IRA immediately or wait to convert the traditional IRA to Roth IRA when tax rate is low in the future? Seems simpler to just convert and have tax-free earnings right away.

[The_Dude]

Just thought of another question then.

Does it make sense to max out traditional non-deductible IRA contribution (lump sum) and then convert to Roth IRA immediately or wait to convert the traditional IRA to Roth IRA when tax rate is low in the future? Seems simpler to just convert and have tax-free earnings right away.

Under the presumption that markets tend to go up over time you are better off converting a traditional IRA contribution to Roth as close to the original contribution date as possible so as to have little to no appreciation that would trigger taxes.