Home  >  Financial Articles and Q&A  >  Should I convert my traditional 401k to a Roth 401k...

Should I convert my traditional 401k to a Roth 401k because of the new fiscal cliff deal?

If I think I'll be in a higher tax bracket at retirement, this switch seems to make sense. I'm 27 and expect that I will be in a higher tax bracket later in life, and while that isn't guaranteed, I still think there are benefits to being taxed now rather when I start taking distributions in retirement.

Jan 10, 2013 by Frank from Kiev, Kyi in  |  Flag
9 Answers  |  11 Followers
Follow Question
28 votes

Frank, way to be ahead on the fiscal cliff small print! At age 27 converting and then contributing into a Roth 401(k) has many advantages. The key is the ability to pay for the conversion with outside assets. Please consult your tax advisor on the consequences of such strategy.

Comment   |  Flag   |  Jan 10, 2013 from Denver, CO

1|600 characters needed characters left
12 votes
Eric Level 17

While I can't tell you what to do with so little information I will tell you my personal thoughts on this topic. In my belief it is always good to put as much money as you can into a ROTH when you are young and probably not hitting the limits on the annual contribution. The thought process of this is the tax benefits of deducting it today are not that great unless you are earning significant money, in which case you can't do a ROTH. The added benefit is time. The more money you put in early the more time it has to accumalate gains that will not be taxed (in theory and under current tax code).

Not knowing your current cash position or your tax bracket I can't recommend you do something or not on a public forum, but I can say that you just need to way the pros and cons of your current tax liability vs the growth over the next 35 years and you'll probably come up with the correct answer.

Comment   |  Flag   |  Jan 10, 2013 from Denver, CO

1|600 characters needed characters left
11 votes
Herbert N Glass Level 18

Yes, because you are very young and your Current tax bracket is probably very low, I think that you are in a perfect position to make use of the 401k Roth benefits. In fact, you should consider not only rolling your pretax 401(k) monies to the Roth 401(k) account, but also, you should consider making your new employee elective deferrals to the Roth 401(k) account choice as well.

Just one more thing, because tax free compounding is so powerful, and that you are young, and that the Roth account has such good features that will benefit you long into the future, I recommend that you further consider trying to save the maximum amount of employee payroll deductible elective deferral possible and put it into the Roth 401(k) account. All studies have shown that savings plans started at an early age are infinitely more powerful then savings made at a later age. Therefore, you are in a very enviable position to take advantage of the the Roth features and Benefits.

Good luck to you for many years to come.

Herbie Glass

Comment   |  Flag   |  Jan 10, 2013 from Franklin, MI

1|600 characters needed characters left
8 votes

Frank, the advice given has been excellent. One added thought is you do not have to convert all your 401(k) to a Roth 401(k). Converting a portion might be a great compromise. This will give you flexibility in your income planning once retired. Remember no one can tell you what taxes will do in the future, so all strategies will carry risk. Also seek the advice of a tax and financial planning professional.

Comment   |  Flag   |  Jan 10, 2013 from Green Bay, WI

1|600 characters needed characters left
6 votes
Adi Benyishay Level 13

It may sound odd to you, but I don’t agree with what you have read. Like you, I believe that future taxes are going to be at a higher rate. And if this is the case, you’re better off paying the taxes at a known rate than an unknown future one. With unknowns, all you can do is increase the probability of outcomes.

Comment   |  Flag   |  Mar 18, 2013 from Southampton, PA

1|600 characters needed characters left
5 votes
Alfred F Level 13

Frank - the bottom line is you will not get a definitive answer from this forum since this is a VERY specific question that must be addressed by obtaining a host of personal information from you. My fathers general rule of thumb for the last 50 years as a former IRS agent, CPA and wealth advisor has always been : never pay the government money in advance - they can always change the rules. If you do there better be a huge potential benefit.

Comment   |  Flag   |  Jan 10, 2013 from Wayne, PA

1|600 characters needed characters left
2 votes

Frank - Two general thoughts on this topic: 1) Typically, younger workers are in the lowest tax bracket they will be in during their working career, so yes, a ROTH may make good sense to a certain earning point. 2) I've never heard it put that way, but Alfred's comment that you should never pay the government in advance because they can always change the rules. So, you know what tax rates are today and you have no idea what they will be in the future. I would suggest you see an advisor who can tell you up to what level of income it makes sense to do the ROTH vs the Traditional 401k. Good luck - Marcus

Comment   |  Flag   |  Jan 11, 2013 from Long Beach, CA

1|600 characters needed characters left
1 vote

I would recommend not basing your decision on any transient deals that come out of a "crisis" negotiation; however, I do think you should try to plan ahead along the lines that you are thinking. A basical rule of thumb (and remember that my thumb is probably bigger than your thumb so there really are no rules) is to try to get your total retirement assets to look like the following: -30% taxable (nonqualified investments) -30% nontaxable (Roth IRA, Roth 401k, munis, cash value life, tax credit realestate, etc…) -40% tax deferred (pension, IRA, 401k, 403b, etc…)

If you are like most folks (most of your assets tied up in pretax 401k type accounts), then you could definielty consider conveting some (maybe not all) of your pretax to the Roth. My basic point here is to not try to guess what the government is going to decide to tax you at 20 years from now. That is unknowable. Instead, try to diversify the way in which you may be able to choose to be taxed later.

View all 4 Comments   |  Flag   |  Jan 11, 2013 from Austin, TX
Michael Steven Greenberg, CFP®

David. Please read my answer below your comments. for your questions 1) Yes it makes sense 2) Instead of converting your traditional 401(k) to a Roth, you have the option of simply redirecting current and future contributions into a Roth account. If and when you are in a position to pay taxes on a conversion, you can do a partial or full conversion at that time and 3) You can pay the tax now, or you can pay the tax later. In your traditional 401(k) you have not yet paid taxes on the money, whether it is contribution or gain. As it comes out, either to a Roth account or other distribution, you need to pay Uncle Sam as earned income for that year. Hope this helps... Michael Greenberg

Flag |  Jan 31, 2013 near Delray Beach, FL

Michael - I wanted to thank you for your advice. I ended up converting part of the 150k. We're in the process of buying a house and I didn't want to deplete my dp in lieu of the taxes I would be assessed for the conversion, so I opted to converted about 25% now and we'll continue to do convert over the next two years (assuming the law/loophole does not change). I have become somewhat addicted to this forum and have noted a lot of your other comments, thank you so much for all of your insight!

Flag |  May 12, 2013 near Miami, FL

1|600 characters needed characters left
1 vote

Yes, I think you should consider converting to a Roth 401(k). No, I don’t think you should let any ‘fiscal cliff’ deal factor into your decision.

At 27, you are thinking and asking the right questions. I think any legislation passed this last year will have little impact relative to all the other legislation that will be passed in the next four decades or so before your retirement. There is very little way to even fathom a guess as to what tax rates will be in the year 2053, my estimated date of your retirement.

Basically, in a Roth 401(k), you will pay the taxes now, and have presumably 40 years or more of tax-free growth, whereas in a traditional 401(k) you get your current tax deferral now, but as you stated, you will be taxed on distribution of everything you have contributed plus any growth.

Consider the argument that you may be in a higher tax bracket at retirement, but in my opinion, it is more compelling that if you can pay the taxes now, you will have tax-free growth for many decades to come.

Comment   |  Flag   |  Jan 31, 2013 from Delray Beach, FL

1|600 characters needed characters left