rolling a traditional 401(k) into a Roth 401(k)

Ironically, I JUST did this, back in January. :lol:

A couple considerations (and some of this I just coincidentally learned last night in conversation with my roommate). First, yes, if you can afford to pay the taxes on it (and you're better off actually paying them out of pocket, rather than having the taxes taken off the top of the conversion since this shrinks the balance available to compound in future growth pretty significantly), converting it into a Roth is probably not such a bad idea. The market isn't quite as depressed as it was even six months ago, and it's possible we have another drop coming, but there's a strong argument that we're not yet trading at fair value.

The other thing to keep in mind though is that you can always withdraw the total value of your contributions from a Roth penalty free before retirement age. So, in some ways it can be advantageous if the value of the contribution is a bit higher - you'll likely be taxed a bit more on capital gains, but in a pinch you'll have access to a larger pool of money in an emergency later in life.

I'd say go for it, but maybe not just yet - give it another month or two and see if the market starts to drop again. If it goes down another 10-20%, then that's that much less money you have to pay taxes on (and remember that this will be taxed at your top marginal rate, not your average tax rate). And if it stabilizes and continues to rise, well, you're not much worse off and you can at least draw down that much more later on if you need to - say, as a down payment on a house, or to cover a stretch of unemployment, or whatever.

Chris said:

Inform me on this then, big D.

A buddy of mine has a stagnant 401k with around 15k in it. His company is just hanging on, so while it's still a traditional 401, neither he nor his employer are contributing to it any more. What's his best bet? My thought would be to roll it into a Roth, but I'm not sure how the feex/capital gains taxes would work out.

Click to expand...

Sorry, missed this.

It depends on a whole slew of factors, really, but the biggie is if he rolls it over, because he hasn't paid income tax on the 401k and he'd be moving it into a post-tax account, then his earned income for the 2010 tax year would be bumped up by (I believe) the total value of the 401k (It's possible he'd only declare the total value of his contributions, the 'cost' of the 401k, as regular earned income, and any gain on top of that as a capital gain/capital loss, but unless the portfolio has performed spectacularly or very poorly that's a pretty minor point).

It's possible to have the estimated taxes deducted from the portfolio as it's rolled over, but considering that's an immediate 30% hit, and considering he's a long ways off from retirement and the impact of not taking that hit, compounded for say 30 years, is pretty big, he's probably going to want to pay taxes out of pocket. So, if he can afford to pay an extra $5k in income taxes this year (and I'd STRONGLY recommend increasing his IRS paycheck deduction to prepay that so he doesn't get penalized, rather than waiting until April and writing a check), then it probably makes sense.

If not, as long as the cash is invested in something and it's still compounding away, he's probably in good shape. A Roth would be more tax advantageous down the road, but at the end of the day, that you HAVE retirement savings counts way more than whether or not you need to pay income tax on it.

I'd say go for it, if he can afford it, provided he's pulling down less than the $90k cap or whatever it is this year...