there are 401k Roth’s if you want to convert a 401k in that manner
Also, my husband converted his 401k to his IRA and didn’t pay the taxes then, he paid it when he converted to a Roth, so no double taxing.
Adding to srparent15’s excellent response, once your child funds the Roth, have him pull down Form 5498, in case he ever wants to withdraw the basis and/or moves his account to another brokerage firm.
My children started funding their Roths in college and have continued to max out to either the annual limit or their gross earnings. The only savings device I like more than a Roth is an HSA but my children are not eligible to fund those at the moment.
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Yes, when you rollover a pre-tax 401k into a pre-tax IRA, you pay no taxes. The issue is when you roll over an after-tax IRA into a Roth IRA and have other pre-tax IRA assets.
For example, let’s say you have $94K in pre-tax IRAs. You pay taxes on $6K and then put it into an after-tax IRA.
If you roll the after-tax IRA into a Roth, the IRS doesn’t let you just consider the $6K in the post tax IRA. You have to pro-rate the distributions across all of your IRA assets. In this case only 6% (6K/100K total) will be considered coming from the after tax IRA, and the other 94% will be considered to have come from the pre-tax IRA, which you will now have to pay taxes on.
So to get $6K into the Roth, you have paid taxes on the original $6K, and on 94% of $6K from the pre-tax IRA.
If you really want to convert $6K into a Roth at your current incremental tax rate, you are better off putting into the $6K into your 401k (if you aren’t already maxing out contributions) and then rolling over $6K of your pre-tax IRA.
Unless you think your overall tax rate on IRA withdrawals when you start distributions is higher than your current incremental rate, or you’ve max’ed out all pre-tax contributions, Roths may be worse. If you are in the 10% or 12% bracket it makes sense.
Yes, depending on your tax rates now/later some may view the Roth as being worse, but after talking to many financial advisors, and the historical nature of the market, and long term investment strategy for most people, even if income is lower later, it is still better for most to put the money in the Roth sooner than later. No one knows what the tax rates will be in 50 years or more and the compounding factor of tax free forever is a substantial benefit as opposed to paying the taxes on all of it at the time it’s taken out. To know I have dividends that are being paid that I’m not paying taxes on and then they’re reinvesting and I’m not paying taxes on and the compounding on that is huge. I’ve started to shift my portfolio away from dividend stocks and to put those into my Roth IRA.
@CT1417 100% agree re the HSA, of course if we’re lucky our kids will have great insurance plans provided by employers with low rates (or free) and low deductibles and flex spending plans where they won’t need to have HSAs but from a tax perspective for those of us that do, what a fantastic mechanism. My husband gets the extra $1k contribution amount also, so on day 1 of each year I try to max them out and rarely pull the money out, so it’s just sitting there growing tax free and we get the nice tax deduction every year. When we decide we want or need to use any of it, there are so many unreimbursed expenses to distribute it out for over the past x years that those epenses will far outweigh any money in those accounts. I just wish the limit were higher!
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There is also this quirk where a child may still be on the parents’ HDHP plan but is no longer a tax dependent. It is a narrow window–say ages 23- 26, but it can occur. If this happens, the child can fund his own HSA up to the family limit–I believe. (I should look that up to confirm that the child can fund to the family limit and not the individual.)
I agree with you in wishing the limit were higher. So many medical costs as we age.
One other advantage of Roth conversions is the ability to control income during Medicare eligibility years. This can be attractive if one’s income could trigger IRMAA surcharges for Medicare Parts B & D. This chart shows the Part B surcharges.
https://www.medicare.gov/your-medicare-costs/part-b-costs
I don’t know anything about medicare and it’s all really confusing to me!! I’m only 52 but my husband is 62 so we need to learn about it soon and I didn’t know that about the income levels. He has annual self employed income so yikes it sounds like what is in the SEP now better be converted prior to him turning 65 no matter what, correct?
What else will we need to know about planning for medicare? I know we can’t miss signing him up so I’m all over that. He won’t be taking social security at that time so I’m not sure if there’s anything else we need to do with regards to medicare either. I don’t want to make any mistakes that are permanent screw ups once he turns 65, so any help/guidance there would be great.
If we have a group insurance plan, where I’m the policyholder, do I just boot him off at 65 or do I need to keep him on for the secondary insurance? That’s also one part I’ve never understood. Our insurance is so expensive but this year we finally got a better plan and are saving $1k/month so its substantial, however, booting him off would save another $600 or so.
This statement is confusing to me. Until you make a withdrawal, earnings like dividends stay in the IRA and compound tax-free forever, regardless of the IRA type.
If taxes are the same at the beginning and the end, a traditional and Roth IRA are identical. For most people, taxes will be lower when they are retired. For many years I was in the 40% (federal+state) incremental bracket due to AMT, there is pretty much zero chance I will be in that bracket when I retire. Sure taxes could go up drastically, but there’s nothing sacred about a Roth either, Congress could start to tax earnings on it at any time.
Sorry—I am not much older than you so do not know much beyond what I wrote above. The only reason I know about IRMAA is because of the impact of RMDs and the rationale for Roth conversions in case one will be subject to IRMAA surcharges.
The IRMMA surcharges seem pretty small to me in the grand scheme of things. If I’m pulling down over $176K/year in retirement, an extra $60/month does not seem worth worrying about.
A bigger difference is that RMDs can cause some or most of your Social Security income to become taxable (which I believe is an unintended side effect of Roths, there should be an imputed (or actual) withdrawal counted for taxability of SS income, but I digress). In my case my other retirement income will most likely always be high enough to make SS fully taxable.
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Technically yes based on your logic, but not really because in a Roth when you withdraw you still won’t have to pay the taxes, but in the traditional when you withdraw that money that has compounded significantly, you will have to pay the taxes.
If you had a traditional IRA with 100k and were in the 40% bracket and converted it, you would be still be left with 100k because you could pay the 40k in taxes from other funds. THat 100k could be 1m for example in 10 years. Probably more based on how the market had done, but you only paid tax of 40k.
Or, you could’ve taken the tax deduction up front on the 100k which would’ve saved you 40k in taxes, the 100k in 10years would’ve gown to 1m and then let’s say even then you’re only in the 10% bracket which is unlikely because if you left it in an traditional IRA and are really taking it out at retirement, you’ll be forced to take it out at RMD, plus have taxable social security earnings, and any other possible taxable earnings, but regardless, let’s say 10% bracket. So 1m at the 10% bracket is 100k in taxes. So that initial 100k has now cost you 60k and that’s if and only if you’re in the 10% bracket which as I said is highly unlikely if you were in the 40% bracket initially and socking that much away in a traditional IRA based on the RMD factor and social security factor, and other income that people with that type of earning potential usually have. Additionally, the likelihood is that the money would be worth a lot more than 100k-1m. I know how much my IRA’s have increased and it’s definitely more than 10-fold. Most people also when they start out are not in the 40% bracket from the getgo.
My kids for instance, all have Roths and thus far were in the 0% bracket so that was free money to put into the Roth. One did ultimately have income limitations so had to put in traditional but then changed jobs and could convert then. There are always those windows of opportunity to look for at paying the taxes now than the unpredictability of paying higher taxes later.
See you sort of proved my point in my last post about why a Roth is good. It’s non-taxable income, doesn’t go in your AGI, doesn’t effect your Social Security or other surcharges as you’re speaking of in your reply.
If you’re pulling 176k in retirement, then you’re not going to be in the lowest tax bracket on any day of the year. If you have an RMD then a larger amount of your social security will be taxable, so you pay even more taxes, etc. So, if you make those Roth conversions all these issues are gone.
We actually just saw some of these issues disappear with my MIL for 2020 because she didn’t take her RMD since the CARES act allowed you to forego it in 2020. Her only income otherwise is social security and a pension, plus some minor interest income. Well, her taxes went down by thousands all because she didn’t have to take that mandatory RMD. Unfortunately, I wasn’t married to my husband early enough to know that his mother had her money in a traditional IRA or else it would’ve been converted eons ago, but by the time I did, it was way too late and now she just gets hit with these taxes every year for the RMD even though we haven’t had to use that money for her yet. It would be nice if there was either no RMD or she had it in a Roth since she could keep the money longer as opposed to paying taxes when it now just sits. But at 91 no point to do anything with it now.
Then you’ve essentially invested $140K, not $100K. the equivalent comparison would be starting with $60K in the Roth, which would only grow to 600K in your scenario.
This paper is a bit thick, but it’s worth going through. The conclusions were eye-opening for me:
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I can’t comment on the 401k issues as I haven’t done much analysis with it. I have a small corp and my salary is 100% paid into my 401k employee contribution and employer contribution is maxed. It’s always tricky to find the right mix to calculate the right amount to pay me so the company can also reap the biggest tax deduction. I have a substantial amount in there since I draw no actual income, so I will run into a big problem if I convert to a Roth 401k which I know has different attributes than regular IRA to Roth, so I try to just ignore the 401k money, which I really shouldn’t, but maybe I won’t ever need it and it can be my kids problem! 
As for the other example, it is still a 100k investment, not 140k because the money in the Roth is the net and the taxes are paid from another source. What I didn’t account for however is what you could do with that 40k if you didn’t pay into taxes from another source and did pay it out of the Roth conversion money instead, but then in that example you are left with less money (the 60k in your example) to which your money would not grow as much, which is why it is better to just pay it from other sources and start off with the 100k in the Roth just as you would have the 100k in the traditional IRA but one would be tax free already and one wouldn’t and one would have saved you 40k in taxes while one would have cost you 40k in taxes up front. So technically the compounding of the 40k is indeed something to factor in, although then there’s also taxes on that because it’s not from any IRA and one would have to assume it’s invested. Many many ways to think about it.
I know people, not me since I’m not old enough, who have all their assets in tax free investments and Roth IRAs, converted when they were young, so that they now qualify for Obamacare for free. Of course, that’s just a fluke that it happened, but who would have ever thought that is a mechanism?
I would answer but I see you’ve already received a couple of excellent responses.
If he doesn’t need the money soon, once he’s significantly older he an withdraw all of it without paying additional taxes.
Generally speaking, contributing to ROTH in the early/making less money days is great.
it’s an article that’s been around for awhile, but to me, the $450k threshold is ridiculous. A couple with say, $80k income is much better off in a Roth today.
btw: I’m sure if the authors updated their article, they’d also factor in taxes to the heirs. With the new tax law changes, passing an IRA to the kids upon death means that the kids will have to take the cash out at their marginal tax rate. If they are making bank in say, NYC, that tax hit could approach 50%. In such cases, the parents paying 28% today for a conversion makes perfect sense.
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Maybe. $80k is in the 12% bracket, their overall rate will almost certainly be less in retirement.
The inheritance aspect is interesting with the recent changes. A family could easily get stuck having to take an RMD while applying for financial aid.
why would you think a couple (staring out) making $80k today will see no big promotions? They could be making 2x that in a few years.
Well you didn’t specify ages or future potential earnings. If future earnings will be substantially higher, a Roth makes sense until you get out of the 12% bracket.
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Regarding LTC, across half a dozen parents/in laws I know we saw one person buy LTC fairly early, lived nearly to 100 and never claimed it. It would have paid for 4 years of care at a limited rate per day (maybe $200.) When that person was failing and wanted in home care there was not ADL qualification. For example, feed yourself means spoon to mouth, not plan, shop, and cook a meal. The others are bathing, toileting (get to the toilet), continence(control), transferring/mobility, & dressing.
We saw another senior severely limited, requiring LTC quite early, but lived 30 more years, so would have used it for only 4 years.
Another died in their 70s, could have used some help (MS) but was not qualified on ADLs.
A couple others lived to mid 80s-mid 90s and would not have qualified other than the last week or maybe a few months.
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My experience with LTC is that it is very hard to collect. They are strict in interpreting the ADLs and make it so hard. My aunt paid for an expensive policy. She who has COPD and needed help with food preparation, shopping, cleaning, getting in and out of shower couldn’t qualify. She wasn’t being fed, being washed, or getting help getting out of bed. She has an independent streak. Her home help agency finally convinced her to give in so they could get her qualified.
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