Author Topic: roth 401k conversion ladder?  (Read 3932 times)

MoonLiteNite

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roth 401k conversion ladder?
« on: August 04, 2016, 05:09:50 AM »
So i understand
401k  > IRA > change to roth IRA > wait 5 years > can pull out any contributions, but not gains.

Does the same hold true for a roth 401k?
I would assume it goes
roth 401k > roth IRA > wait 5 years > can pull out contributions but not gains.

I have searched up and down and all i ever get is the same thing about a normal 401k and how simple it is and blah blah, I just wanna know if it will work the same with a roth 401k :D
« Last Edit: August 04, 2016, 05:13:48 AM by MoonLiteNite »

Dezrah

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Re: roth 401k conversion ladder?
« Reply #1 on: August 04, 2016, 07:06:16 AM »
I think you have the right idea.

The strategy behind using a traditional 401k first is that you defer paying taxes when put the money in.  Then when you're in a lower tax bracket, you strategically rollover just enough into a Roth so that you pay no or very low taxes on the amount.  Starting with a Roth 401k will get you the same access advantage but not the tax savings.

DoubleNickels

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Re: roth 401k conversion ladder?
« Reply #2 on: August 04, 2016, 07:40:56 AM »
I'm not sure if this answers your question, but if you have access to a Roth 401k, it can be one of the best opportunities as compared to a Roth IRA.   You can contribute more than the "normal" $5500. There are also no income limits, as there are with Roth IRA contributions.  Of course, there are no income limits on conversions from IRA to Roths. 

If you are still working at the company, they usually won't let you roll your 401k over to an IRA product, whether it is a Roth or a Traditional.  The exceptions being that some companies allow inservice distributions. You would have to check your SPD (Summary Plan Document) or with your administrator.  However, if you are planning on leaving the company, you've outlined it perfectly.

If you are eligible to contribute to a Roth IRA, I would go ahead and open it now. That starts the 5 year clock ticking.   You'll likely have to put something in it. Then, you can contribute to a Roth 401k, max it out for 5 years, quit work, then roll over your Roth 401k into the Roth IRA.  Then you would be eligible to take the contributions (not the gains). I would keep careful records (your statements will suffice) to help your eventual tax planning, as your Roth IRA custodian will likely not be able to help you on your contributions vs. gains at the 401k. 

seattlecyclone

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Re: roth 401k conversion ladder?
« Reply #3 on: August 04, 2016, 08:56:55 AM »
Does the same hold true for a roth 401k?
I would assume it goes
roth 401k > roth IRA > wait 5 years > can pull out contributions but not gains.

No, this is not right. Moving money between different types of Roth accounts is not a taxable conversion that triggers a five-year waiting period. Instead when you do this Roth 401(k) to Roth IRA rollover, the amount that you originally contributed to the Roth 401(k) will be treated the same as if you had contributed it directly to the Roth IRA: can be withdrawn immediately without penalty. The amount that the money had grown within the Roth 401(k) is treated the same as if it had grown within the Roth IRA: taxed at your marginal tax bracket plus 10% early withdrawal tax if you take it out before age 60.

Jack

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Re: roth 401k conversion ladder?
« Reply #4 on: August 04, 2016, 11:44:57 AM »
Does the same hold true for a roth 401k?
I would assume it goes
roth 401k > roth IRA > wait 5 years > can pull out contributions but not gains.

No, this is not right.

IMO the question that would have made more sense to ask is that if you can do this:

traditional IRA -> convert to Roth IRA (pay tax) -> wait 5 years -> pull out contributions but not gains

...can you also do this:

traditional 401k -> convert to Roth 401k (pay tax) -> wait 5 years -> pull out contributions but not gains

(My response to that would tend to be "why would you want to, when you know you can roll over to an IRA and do the first thing instead?", but maybe there's an angle I'm missing, such as the very rare situation of a 401k with lower expense ratios than a Vanguard IRA.)

seattlecyclone

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Re: roth 401k conversion ladder?
« Reply #5 on: August 04, 2016, 01:31:02 PM »
You generally should avoid making early withdrawals directly from a Roth 401(k). The reason is that these withdrawals will be pro-rated between contributions and earnings, so if your Roth 401(k) has appreciated at all there's no way to make a tax-free early withdrawal of even $1. This is different from Roth IRAs where the withdrawals are ordered in a more favorable way: tax-free contributions come out first, tax-free-after-five-years conversions come out next, and the taxable earnings come out at the very end.

The good news is that if you roll your Roth 401(k) into your Roth IRA before making withdrawals, the favorable ordering rules apply to the money that was originally in the 401(k).

MoonLiteNite

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Re: roth 401k conversion ladder?
« Reply #6 on: August 04, 2016, 02:03:28 PM »
Does the same hold true for a roth 401k?
I would assume it goes
roth 401k > roth IRA > wait 5 years > can pull out contributions but not gains.

No, this is not right. Moving money between different types of Roth accounts is not a taxable conversion that triggers a five-year waiting period. Instead when you do this Roth 401(k) to Roth IRA rollover, the amount that you originally contributed to the Roth 401(k) will be treated the same as if you had contributed it directly to the Roth IRA: can be withdrawn immediately without penalty. The amount that the money had grown within the Roth 401(k) is treated the same as if it had grown within the Roth IRA: taxed at your marginal tax bracket plus 10% early withdrawal tax if you take it out before age 60.

So this is better than i thought, no 5 year wait.
This seems like the plan for me then.
Reach nearly FI at age 45 or so, then get a part time job, or fun type job to just assist in paying for some  "fun money" and just roll over all my roth 401k into my roth ira and pull out maybe 20k a year to live in.

And if i do go over how much i had put in, i will only be taxed on the gains
« Last Edit: August 04, 2016, 02:05:19 PM by MoonLiteNite »

MoonLiteNite

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Re: roth 401k conversion ladder?
« Reply #7 on: August 04, 2016, 02:07:54 PM »
You generally should avoid making early withdrawals directly from a Roth 401(k). The reason is that these withdrawals will be pro-rated between contributions and earnings, so if your Roth 401(k) has appreciated at all there's no way to make a tax-free early withdrawal of even $1. This is different from Roth IRAs where the withdrawals are ordered in a more favorable way: tax-free contributions come out first, tax-free-after-five-years conversions come out next, and the taxable earnings come out at the very end.

The good news is that if you roll your Roth 401(k) into your Roth IRA before making withdrawals, the favorable ordering rules apply to the money that was originally in the 401(k).


So my understanding from what you said is.
At ANY time, i can pull out money from my roth 401k, and make withdraws (after leaving company), but i will ALWAYS be taxed. It is % based on my gains? So if i put in 10, and made 1 over 10 years. And i take out 1, i will be taxed at say 1.15 (15%)

I thought this too, but i kept reading you HAVE to be at 59.5 before you can withdraw...
« Last Edit: August 04, 2016, 02:18:59 PM by MoonLiteNite »

seattlecyclone

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Re: roth 401k conversion ladder?
« Reply #8 on: August 04, 2016, 03:03:49 PM »
So my understanding from what you said is.
At ANY time, i can pull out money from my roth 401k, and make withdraws (after leaving company), but i will ALWAYS be taxed. It is % based on my gains? So if i put in 10, and made 1 over 10 years. And i take out 1, i will be taxed at say 1.15 (15%)

As a concrete example, suppose that you contributed $100k to your Roth 401(k) over the course of your career. By the time you retire, the account balance is $300k. That means your account is one-third contributions and two-thirds earnings. Every withdrawal will be taken out of those two buckets proportionally. This means that if you withdrew $3,000, $1,000 would come out of contributions and be tax-free. The other $2,000 would come out of earnings, which would count as ordinary income that would be taxed at your current tax bracket, plus 10% added on for the early withdrawal tax. If you're in the 15% tax bracket at retirement, you would need to pay $500 in taxes (15% + 10% of $2,000) in order to withdraw $3,000.

If you first moved the money to your Roth IRA, you would be able to withdraw the $100,000 in contributions tax-free right away. Any withdrawals after that, prior to 59.5, would be taxed at your current tax bracket + 10%. Note that withdrawals of Roth earnings don't count as income at all after you're 59.5, so withdrawing these amounts early should probably be avoided if at all possible. There's a big difference between paying an extra 10% to take money out of your traditional retirement accounts early, compared to paying an extra (tax bracket + 10%) to take out your Roth earnings early.

Quote
I thought this too, but i kept reading you HAVE to be at 59.5 before you can withdraw...

The idea that you must be 59.5 to withdraw from your retirement accounts is an over-simplification. Instead, there are various taxes that may apply to pre-59.5 withdrawals that would not apply to post-59.5 withdrawals. Whether those taxes act as a sufficient incentive for you to avoid these withdrawals is something only you can answer, but there's nothing in the law preventing you from withdrawing your entire IRA balance at any time, or from withdrawing your entire 401(k) balance at any time after you leave your job as long as you're willing to pay the tax that may apply.

MoonLiteNite

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Re: roth 401k conversion ladder?
« Reply #9 on: August 04, 2016, 03:14:44 PM »

As a concrete example, suppose that you contributed $100k to your Roth 401(k) over the course of your career. By the time you retire, the account balance is $300k. That means your account is one-third contributions and two-thirds earnings. Every withdrawal will be taken out of those two buckets proportionally. This means that if you withdrew $3,000, $1,000 would come out of contributions and be tax-free. The other $2,000 would come out of earnings, which would count as ordinary income that would be taxed at your current tax bracket, plus 10% added on for the early withdrawal tax. If you're in the 15% tax bracket at retirement, you would need to pay $500 in taxes (15% + 10% of $2,000) in order to withdraw $3,000.

If you first moved the money to your Roth IRA, you would be able to withdraw the $100,000 in contributions tax-free right away. Any withdrawals after that, prior to 59.5, would be taxed at your current tax bracket + 10%. Note that withdrawals of Roth earnings don't count as income at all after you're 59.5, so withdrawing these amounts early should probably be avoided if at all possible. There's a big difference between paying an extra 10% to take money out of your traditional retirement accounts early, compared to paying an extra (tax bracket + 10%) to take out your Roth earnings early.


Awesome, that right there is what i wanted to see and have cleared up :)

So as long as my roth 401k has enough contributions put in. Then i roll it all over to a roth IRA. I can pull out as much as my contributions tax free, at any time. I only start getting taxed highly when i go through contributions and start pulling out my gains.
Once i hit 59.5, all is fair game.


Dezrah

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Re: roth 401k conversion ladder?
« Reply #10 on: August 04, 2016, 05:04:41 PM »
I felt like I was missing something, so did a little reading.  This is from Investopedia.  It looks like you should go ahead and fund a Roth IRA ahead of time if you want to use your Roth 401k contributions immediately.

From Roth 401(k) to IRA
If the rollover is to a Roth IRA instead, the holding period within the Roth 401(k) does not carry over. That is, if the client has an existing Roth IRA, once the Roth 401(k) distribution is in the account, it has the same holding period as the Roth IRA funds. For example, let's assume that the Roth IRA was opened in 2000. You worked at your employer from 2006-2009 and were then let go or quit. Because the Roth IRA that you are rolling the funds into has been in existence for more than five years, the full distribution rolled into the Roth IRA meets the five-year rule for qualified distributions. On the other hand, if you did not have an existing Roth IRA and had to establish one for purposes of the rollover, the five-year period begins the year the Roth IRA was opened, regardless of how long you have been contributing to the Roth 401(k).

Read more: Know The Rules For Roth 401(k) Rollovers | Investopedia http://www.investopedia.com/articles/retirement/09/roth-401k-rollover.asp#ixzz4GOptqBhG

seattlecyclone

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Re: roth 401k conversion ladder?
« Reply #11 on: August 04, 2016, 06:26:59 PM »
The five-year period for having the Roth IRA open only matters for the purpose of determining whether your withdrawal counts as a qualified distribution. If you're withdrawing money prior to age 59.5 and you don't have another exception that applies (disability, education expenses, first-time home purchase, etc.), your distribution wouldn't be qualified anyway. It just so happens that there's no tax due on certain non-qualified distributions, such as withdrawals of your direct contributions and five-year-old conversions. Whether you've had the account open for five years doesn't matter at all in this case.

boarder42

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Re: roth 401k conversion ladder?
« Reply #12 on: August 04, 2016, 06:42:42 PM »
And then Congress passes fair tax and all this time we've spent managing a ridiculously complex tax system goes poof the year after you fire 

In all seriousness. Contribute to trad accounts unless you can't you'll retire faster.

MoonLiteNite

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Re: roth 401k conversion ladder?
« Reply #13 on: August 04, 2016, 08:16:14 PM »
And then Congress passes fair tax and all this time we've spent managing a ridiculously complex tax system goes poof the year after you fire 

In all seriousness. Contribute to trad accounts unless you can't you'll retire faster.

Would be nice if fairtax happens. Go garyjohnson!

Anyways, yeah i have flipped over to 100% normal 401k at this point, but i have a bit of money in roth. At the i figured i would just eat the 10% fee when i retired early. I never had really read up on things like this :D Now with about 15ish years left, i started looking into it and found this site and tons of info on how to pull money from a 401k without paying fees.

boarder42

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Re: roth 401k conversion ladder?
« Reply #14 on: August 05, 2016, 08:42:50 AM »
And then Congress passes fair tax and all this time we've spent managing a ridiculously complex tax system goes poof the year after you fire 

In all seriousness. Contribute to trad accounts unless you can't you'll retire faster.

Would be nice if fairtax happens. Go garyjohnson!

Anyways, yeah i have flipped over to 100% normal 401k at this point, but i have a bit of money in roth. At the i figured i would just eat the 10% fee when i retired early. I never had really read up on things like this :D Now with about 15ish years left, i started looking into it and found this site and tons of info on how to pull money from a 401k without paying fees.

yeah i used to be roth before i found this.  we are 8 years away and have researched this so you will be fine it rolls to roth and can be withdrawn on the contribution side immediately.  the employer match roles to trad. and can be rolled and used 5 years later.

big fan of fairTAX as well - gary johnson just supports it - it was just brought up last year - its gaining traction in congress.  it makes more sense than anything else in a nation full of spenders.