Author Topic: Rolling over a 401k  (Read 6992 times)

Coloradostache

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Rolling over a 401k
« on: June 09, 2015, 09:53:32 AM »
I recently switched jobs and have a 401K with Fidelity that I can no longer contribute to since I no longer work for the company.  Does it make sense for me to roll it over into an IRA with Vanguard?  I already have a taxable account with Vanguard and it would be nice to have it all with Vanguard.  What are the up and downsides of this?  Is there any tax concerns?

Thanks!

Cheddar Stacker

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Re: Rolling over a 401k
« Reply #1 on: June 09, 2015, 09:57:57 AM »
No tax concerns if you roll it over directly from Traditional 401K into a Traditional IRA, or Roth to Roth.

Benefits - Could be cheaper total expenses, but not necessarily. - Gives you access to invest in the funds of your choosing. - Convenience with everything under one roof.

Drawbacks - ??

dandarc

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Re: Rolling over a 401k
« Reply #2 on: June 09, 2015, 10:00:46 AM »
Do a trustee-to-trustee transfer and there should be no tax-consequences of rolling over.  The only thing I can think of is that this will complicate a backdoor Roth IRA if that is part of your plan now or down the road.  Backdoor Roth (not to be confused with Mega-Backdoor Roth) works best when there is no traditional IRA money in play.

Other than that, if you would rather have the Vanguard funds than whatever is available in your 401K, go for it.  Be sure to check expense ratios, as it is possible that you have lower ERs in the 401K than you can get at Vanguard - not necessarily likely but possible, particularly if you are coming from a large employer that has a large 401K that can, and does negotiate for good rates.

Coloradostache

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Re: Rolling over a 401k
« Reply #3 on: June 09, 2015, 10:06:53 AM »
Thanks for the replies.  I have done backdoor IRAs for the last number of years with Vanguard.  So if I roll the Fidelity 401K into a Vanguard IRA, I can no longer do a backdoor IRA?  Sounds like I should probably leave it parked with Fidelity then.  The options aren't bad with Fidelity, but I would prefer to have it with Vanguard. 

dandarc

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Re: Rolling over a 401k
« Reply #4 on: June 09, 2015, 10:21:42 AM »
Thanks for the replies.  I have done backdoor IRAs for the last number of years with Vanguard.  So if I roll the Fidelity 401K into a Vanguard IRA, I can no longer do a backdoor IRA?  Sounds like I should probably leave it parked with Fidelity then.  The options aren't bad with Fidelity, but I would prefer to have it with Vanguard.
So yeah, you're actively doing backdoor Roth IRA contributions, and you plan to continue.  Three options:

1.  Leave the money in 401K (assuming this is an option - check your plan documents to be sure)
2.  Roll-over the money and convert it to Roth.
3.  Transfer the money to another 401K, maybe you can do this at your current employer, if you like that plan better?

Option 2 would mean a taxable conversion.  Depending on the size of the conversion, that could be a lot of tax, or a little.  Given you're doing the backdoor Roth, your income is probably pretty high, so I'd bet 1 or 3 is better for you. 

What is the size of this account, roughly?  If we're talking about 100K, option 2 is probably a non-starter, but on a 3K account, maybe the tax hit is worth it for convenience sake.

Coloradostache

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Re: Rolling over a 401k
« Reply #5 on: June 09, 2015, 10:27:16 AM »
Its about $150K, so sounds like options 1 or 3 are the best.  I've got to work 3 months with the new employer until I can participate in their plan, so I will leave it put at Fidelity until I join my current companies plan and see if it makes sense to roll it into there. 

Thanks again for the advice! 

dandarc

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Re: Rolling over a 401k
« Reply #6 on: June 09, 2015, 10:41:48 AM »
Here's the why because apparently this thread is my procrastination outlet today, and possibly to benefit others who might stumble upon this thread.

When you're doing a backdoor Roth, you make non-deductible contributions to a traditional IRA.  Then you convert that money to a Roth IRA.  You only pay tax on earnings, because you didn't deduct the contributions, so if you do the conversion in short order, basically no taxes to be paid.

Now, when you convert from traditional IRA to Roth IRA, the IRS requires the amount to be pro-rated between your non-deductible and deductible IRA contributions.  So if you've got 150K in a traditional IRA, then try to do a backdoor Roth of $5500 for the year, you'll be sorely disappointed - 96.5% of your conversion will be subject to income tax.

So the optimal way is obviously to get your traditional IRA down to 0 before doing the backdoor Roth.

skyrefuge

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Re: Rolling over a 401k
« Reply #7 on: June 09, 2015, 11:00:02 AM »
2.  Roll-over the money and convert it to Roth.

It's probably fairly rare that, for someone doing backdoor Roth contributions, rolling a 401(k) to an IRA is a great idea (it seems it would require a combination of a relatively low 401(k) balance and bad 401(k) options).

But if it *is* the best option, does it matter if you do it the way you stated (roll over 401(k) to tIRA, then immediately convert it all to Roth IRA), or if you instead just roll over 401(k) to tIRA, stop, and then pay the pro-rated tax on backdoor conversions each year?

I've always assumed the math would work out to be the same in either case, but while I'm apparently interested enough to ask the question, I'm too lazy to run through the math myself!

Cheddar Stacker

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Re: Rolling over a 401k
« Reply #8 on: June 09, 2015, 11:06:50 AM »
sky, I think it all comes down to tax rates upon conversion. Doing it all at once would mean you are paying 30%+ tax assuming you're still working. Doing it over 10 years while still working and in the 25% bracket, you might be able to stay in the 25% bracket rather than jumping to 28/33/35%. Leaving it in the 401k is optimal unless you plan to quit the back door Roth. The tax hit you will take by converting while working is too much to overcome, even at high expense ratios.

I'd be inclined, if expense ratios were too high in the old 401k, to roll it into an IRA, stop back door Roth, and put any excess funds into a taxable account in low (or no) dividend holdings. There is plenty of tax deferral available in the taxable account if you use it properly.

dandarc

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Re: Rolling over a 401k
« Reply #9 on: June 09, 2015, 11:17:44 AM »
I'd be inclined, if expense ratios were too high in the old 401k, to roll it into an IRA, stop back door Roth, and put any excess funds into a taxable account in low (or no) dividend holdings. There is plenty of tax deferral available in the taxable account if you use it properly.
You could also start a side-business and roll your old 401K into a new Solo 401K or SEP-IRA, if you feel compelled to get out of the old 401K and don't have a destination for it.

Lots of options, really. 

Livewell

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Re: Rolling over a 401k
« Reply #10 on: June 09, 2015, 12:03:34 PM »
No downside, roll it to an IRA ASAP!

brooklynguy

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Re: Rolling over a 401k
« Reply #11 on: June 09, 2015, 12:20:21 PM »
No downside, roll it to an IRA ASAP!

Uh, what about the downside already mentioned (interference with backdoor Roth contributions)?  There are also other (usually less important) drawbacks, like potentially worse insulation against creditors.  If you would have taken the time to read the thread, you probably would have seen that the OP's best course of action (given the full set of facts disclosed so far in response to the excellent advice provided so far) is probably exactly the opposite of your enthusiastic recommendation.

MDM

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Re: Rolling over a 401k
« Reply #12 on: June 09, 2015, 12:21:14 PM »
No downside, roll it to an IRA ASAP!
Must be a different definition of "no downside" than most would use. ;)

Coloradostache

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Re: Rolling over a 401k
« Reply #13 on: June 09, 2015, 12:48:00 PM »
Thanks again for all the input.  I like hearing all the ideas.  I think the plan still remains the same though.

I just did some checking, and I can keep it in the Fidelity 401K for as long as I want.  Right now here is what I have:

~$115K in Fidelity 401K:  FUSVX 500 index fund with 0.07 expense ratio.  There are limited options that aren't' target date funds.
~$90K in Vanguard taxable account, split between VTSAX & VFINX
~$15K in Vanguard Roth IRA, have been contributing through backdoor IRA, VTSAX & VFINX
~$50K in foreign investments that I can't really touch as they are tax sheltered in Canada (I'm a permanent US resident, but am Canadian)
~10K in HSA
~$400K in home equity
~150K Annual income

Cheddar Stacker - What are you referring to when you say there are lots of tax deferrals available if you use the taxable account properly?  I'm just dumping funds in there after I've maxed my 401K.

Any other advice?

Thanks!

Cheddar Stacker

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Re: Rolling over a 401k
« Reply #14 on: June 09, 2015, 01:41:29 PM »
Cheddar Stacker - What are you referring to when you say there are lots of tax deferrals available if you use the taxable account properly?  I'm just dumping funds in there after I've maxed my 401K.

Sorry, that was a little misleading/confusing. Here's what I meant:

When comparing a Roth contribution, a backdoor Roth contribution, or a taxable account contribution/investment, they are all the same related to your current year tax return. You will pay taxes on the income you earn.

They differ in that the first 2 you will never pay taxes on them again. With the taxable account you may have to pay taxes on them depending on your circumstances, but you can defer the eventual taxes you might pay by investing in funds/stocks that are geared toward growth vs. buying dividend heavy stocks. When you retire, provided you can stay within the 15% bracket most of the time, you might never pay taxes on the capital gains you have developed.

In case you haven't read this before, here's someone that makes a much more convincing argument than I ever could:
http://www.gocurrycracker.com/roth-sucks/

MDM

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Re: Rolling over a 401k
« Reply #15 on: June 09, 2015, 01:48:01 PM »
In case you haven't read this before, here's someone that makes a much more convincing argument than I ever could:
http://www.gocurrycracker.com/roth-sucks/
While Roth may or may not be better than Traditional for a given situation, the analysis should be done strictly on marginal rates, not marginal vs. overall as that article suggests.

Cheddar Stacker

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Re: Rolling over a 401k
« Reply #16 on: June 09, 2015, 01:50:07 PM »
Sorry, you kind of have to dig in that post to see what I'm talking about. At the end he begins to discuss the benefits of the Roth, and how it fits some cases, but when compared to a taxable account it can sometimes be a wash.

This is towards the end of the linked post.
Quote
For many, however, a brokerage account is just as good.  If during your retirement years you expect to earn less than ~$90k/year, staying below the 25% tax bracket, then all Long Term Capital Gains and Qualified Dividends are already taxed at 0%.  At these income levels, a brokerage account effectively has a 0% tax rate for stocks, much like a Roth

The brokerage account also has the advantage of being able to harvest capital losses, and to spend dividends or gains anytime before Age 59.5

And in the addendum:
Quote
Why a Roth last?  As can be seen in the comments, this is a contentious topic

What if you have already maxed out a 401k, an HSA, are not eligible for a deduction on a Traditional IRA, and have quite a bit of money remaining to be invested.  Isnít putting $5,500 into a Roth better than putting those funds into a Brokerage account?

No

Because we aspire for a long retirement, our portfolio is stock heavy.  As explained in our classic post, Never Pay Taxes Again, taxes on Long Term Capital Gains and Qualified Dividends is 0% for incomes below ~$94k.

This is the same tax profile as a Roth, but with one distinct difference

We can spend those capital gains and dividends whenever we want, whereas the earnings in a Roth cannot be touched until Age 59.5 without facing a penalty and taxation (you can only access the Contributions)

MDM

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Re: Rolling over a 401k
« Reply #17 on: June 09, 2015, 02:13:37 PM »
At the end he begins to discuss the benefits of the Roth, and how it fits some cases, but when compared to a taxable account it can sometimes be a wash.
Yes, all those points (quoted in the linked post) are good.  It's the "traditional vs. Roth" part of the discussion where it seems the analysis is not correct.

Cheddar Stacker

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Re: Rolling over a 401k
« Reply #18 on: June 09, 2015, 02:20:29 PM »
At the end he begins to discuss the benefits of the Roth, and how it fits some cases, but when compared to a taxable account it can sometimes be a wash.
Yes, all those points (quoted in the linked post) are good.  It's the "traditional vs. Roth" part of the discussion where it seems the analysis is not correct.

I didn't dive into the analysis of that comparison much. I've seen it before, and in most cases traditional wins.

This was the first time I'd seen someone make a convincing argument for completely skipping a Roth though, so it stood out and I think it's worth mentioning here.

In case you haven't read this before, here's someone that makes a much more convincing argument than I ever could:
http://www.gocurrycracker.com/roth-sucks/
While Roth may or may not be better than Traditional for a given situation, the analysis should be done strictly on marginal rates, not marginal vs. overall as that article suggests.

Can you elaborate on this? Is there were you are saying you disagree with the Roth vs. Traditional analysis?

MDM

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Re: Rolling over a 401k
« Reply #19 on: June 09, 2015, 03:02:14 PM »
In case you haven't read this before, here's someone that makes a much more convincing argument than I ever could:
http://www.gocurrycracker.com/roth-sucks/
While Roth may or may not be better than Traditional for a given situation, the analysis should be done strictly on marginal rates, not marginal vs. overall as that article suggests.
Can you elaborate on this? Is there were you are saying you disagree with the Roth vs. Traditional analysis?
Yes.  There is some discussion to that effect in the comments section.


A slightly different but related issue: the more one contributes to traditional, the more likely Roth would have been better (because the trad withdrawals increase the retirement marginal bracket) - and the more one contributes to Roth, the more likely traditional would have been better (because Roth withdrawals keep one in a lower marginal bracket). 

In other words, when we compare (Tnow = tax now, Tlater = tax when withdrawing)
Roth = P * (1 - Tnow) * (1 + i)^n
      vs.
Traditional = P * (1 + i)^n * (1 - Tlater)
...the Tlater variable is actually a function of P, i, and n.  The higher P, i, and/or n, the higher Tlater.

brooklynguy

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Re: Rolling over a 401k
« Reply #20 on: June 09, 2015, 03:40:07 PM »
A slightly different but related issue: the more one contributes to traditional, the more likely Roth would have been better (because the trad withdrawals increase the retirement marginal bracket) - and the more one contributes to Roth, the more likely traditional would have been better (because Roth withdrawals keep one in a lower marginal bracket). 

In other words, when we compare (Tnow = tax now, Tlater = tax when withdrawing)
Roth = P * (1 - Tnow) * (1 + i)^n
      vs.
Traditional = P * (1 + i)^n * (1 - Tlater)
...the Tlater variable is actually a function of P, i, and n.  The higher P, i, and/or n, the higher Tlater.

This is an incredibly astute observation.  I would just note that it assumes that tax laws will not change in a way that renders the analysis obsolete (as an extreme example, consider the situation if income taxes were to be completely replaced with value-added taxes) -- strictly speaking, I think the formulas still work (where Tlater = zero), but it's no longer necessarily the case that the more one contributes to one, the more likely the other would have been better (and, in my extreme "for example," the replacement of an income tax with a consumptive tax actually means the Roth withdrawals get (indirectly) taxed just the same as Trad withdrawals, if those withdrawals all get deployed towards consumption).

Now, I don't think it's advisable to act on one's predictions about future changes in tax law, which are inherently unpredictable - I think the better approach is to plan for tomorrow using the tax regime as it exists today.  But for purposes of the Roth vs. Taxable debate (which admittedly you were not addressing in your post), I think it makes more sense to consider handicapping the odds of potential changes in tax laws and taking that into account as part of the equation.

MDM

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Re: Rolling over a 401k
« Reply #21 on: June 09, 2015, 04:49:48 PM »
This is an incredibly astute observation.  I would just note that it assumes that tax laws will not change in a way that renders the analysis obsolete (as an extreme example, consider the situation if income taxes were to be completely replaced with value-added taxes) -- strictly speaking, I think the formulas still work (where Tlater = zero), but it's no longer necessarily the case that the more one contributes to one, the more likely the other would have been better (and, in my extreme "for example," the replacement of an income tax with a consumptive tax actually means the Roth withdrawals get (indirectly) taxed just the same as Trad withdrawals, if those withdrawals all get deployed towards consumption).
Agreed - Roth doth indeed suck (vs. traditional) if Roth withdrawals become taxed.

Quote
Now, I don't think it's advisable to act on one's predictions about future changes in tax law, which are inherently unpredictable - I think the better approach is to plan for tomorrow using the tax regime as it exists today.  But for purposes of the Roth vs. Taxable debate (which admittedly you were not addressing in your post), I think it makes more sense to consider handicapping the odds of potential changes in tax laws and taking that into account as part of the equation.
Now you're getting into the whole "Optimization Under Uncertainty" field.  To scratch the surface one can look at http://neos-guide.org/content/optimization-under-uncertainty
It is (well, I find it...) an interesting field.  Interesting in that truly excellent mathematical programming is available to solve very difficult problems - once one has predicted values for the probability of things such as future tax changes. 
The devil is in those predictions...and it's certainly easier to "plan for tomorrow using the tax regime as it exists today" as you suggest.  That gets us from supercomputer clusters down to simple spreadsheets. :)

Cathy

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Re: Rolling over a 401k
« Reply #22 on: June 09, 2015, 08:04:58 PM »
Now you're getting into the whole "Optimization Under Uncertainty" field.

I remember in my Machine Learning class in university, there was an assignment that I didn't much feel like doing by the posted due date. The syllabus stated that assignments could be submitted late, but that a penalty "might apply". I asked the professor to quantify the penalty, and he responded by asking why it mattered. I said I needed to know the penalty structure so that I could make a rational decision about whether to put in the effort to complete the assignment on time. In response, he said that "making decisions in the face of uncertainty is part and parcel of rationality". He declined to specify the penalty structure.

MDM

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Re: Rolling over a 401k
« Reply #23 on: June 10, 2015, 01:21:23 AM »
I remember in my Machine Learning class in university, there was an assignment that I didn't much feel like doing by the posted due date. The syllabus stated that assignments could be submitted late, but that a penalty "might apply". I asked the professor to quantify the penalty, and he responded by asking why it mattered. I said I needed to know the penalty structure so that I could make a rational decision about whether to put in the effort to complete the assignment on time. In response, he said that "making decisions in the face of uncertainty is part and parcel of rationality". He declined to specify the penalty structure.

And with the "high compute cost" to evaluate that penalty function surface, and with limited evaluation time, one might guess you chose to accept a hard constraint instead of evaluating that function?  Unless the objective function itself was very flat for you. ;)

Dee18

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Re: Rolling over a 401k
« Reply #24 on: June 10, 2015, 08:19:36 AM »
I wish I had waited to roll my IRA over until I had done back door Roth with other money.  I did not know of that consequence when I did the rollover.  Take the time to sort that out.