401k rollover

[jimmyengland]

Hi everyone,

I recently left my job and i have a 401k at my previous employer (4500). I was talking to the people at fidelity and they were telling me that i could roll this money over to my roth. Do you think it is better to rollover to a roth or to rollover to a traditional ira? From what i understand it will not affect my contribution for 08 and i will still be able to contribute the 5000 for this year.

Our combined income is 75000, can anyone tell me if i do the roth how much i will have to pay in income taxes and will i owe state taxes on this next year too? Anything else i am missing that I need to be cautious of if i do the roth?

Thanks for all your help

[noppenbd]

Yes, you will need to pay state taxes on the rollover/conversion. Your federal tax bill will depend on your taxable income, but you will likely be in the 25% tax bracket after your exemptions and deductions, so your federal tax bill would go up by about $1100. If for some reason you end up in the 28% bracket (unlikely) your federal bump would be $1260.

**EDIT*** Disregard my numbers, I was looking at the single filer tax brackets, should have been married filing jointly as described by Jim Ohio below.

[sweeps]

If you roll over to a Roth, yes, you will pay taxes on that $4500. And yes, it does not affect this year's Roth contributions in any way.

You may want to play around with the numbers in TurboTax or on a 1040 form to get an idea how the rollover will affect your taxes next year. $4500 isn't that much -- it's probably worth it just to convert. But sometimes you can be on the edge of a tax break and an increase in income could push you out of it.

I'm not sure if this is even an option, but be sure that Fidelity does not take the taxes out of your 401k balance. You should pay the taxes from your pocket.

[jIM_Ohio]

jimmy-

I would look to do the following-

roll the 401k to a traditional (rollover) IRA. Do this in 2008 (now?!).

Then do some tax planning. Look at your 2007 tax return- what was your TAXABLE income. If under 65k, this is important- because you are in 15% tax bracket. If not under 65k, look to do some tax planning for 2008 or 2009, then do the Roth conversion once the tax planning has taken effect.

Tax planning- if you have a new 401k, use that to try and lower taxable income to under 65k. If you constributed 13% to 401k, this would do the trick in and of itself.

If you itemize deductions, it's possible things like mortgage interest and property taxes also lower your taxable income below $65,100.

If you combine 401k with mortgage interest or other deductions (student loan interest, private business deductions etc...) you can probably lower taxable income significantly. Also factor in standard deductions for you and wife (any kids?) and you might already be in 15% bracket.

Your real goal is to lower taxable income below $60,600. ($65100-$4500=$60,600), so the $4500 will not put you over 15% tax bracket cap. If it did, I would only do a partial conversion in 2009, then convert the rest in 2010.

Do everything possible to stay inside 15% tax bracket when doing the conversion.

If you convert at 15% tax bracket and withdraw from Roth at 25% tax bracket, you did real good tax planning (saved yourself 10%). Not many places can give you a 10% return, so this technique is well worth the effort, IMO.

All planning assumptions above are for married filing jointly. Single filers have different numbers.

Our gross pay was 110k, AGI of 103k, and we had 62k of taxable income- 40k+ worth of deductions. Tax planning really makes a huge financial difference. Consider another 10k of the taxable income was put into a Roth and see what you can do.

Maybe change Roth contributions to traditional for the year (so you can claim the 5k as a deduction) to get 4500 into the Roth, then work on converting the traditional to a Roth as an ongoing thing. Always try to keep the conversions in 15% tax bracket should be the goal.

[jimmyengland]

jim,

you have a great deal in deductions. unfortuantely i find it very difficult to get over the standard deduction. I have no children, my student loans are in england and i seem to be unable to claim them on my return. (they do not send me any information until may on the interest that i have paid, then there is the exchange rate etc). Not sure if i can claim these or not and if it would even be worth the hassle to be honest. Last year we would have been under the 65000. but this year i would say that it will be unlikely that we would be able to get under this...... since we have both had significant raises in pay and are both not eligible to contribute to our 401k's until we have been at our companies for 6 months. (which will be in August and Sep - another reason it will be tough to lower our AGI for 08). Also I got a bonus for reffering a new employee to my new company 2500$ and plan on trying to refer a few more before the year is out. (also increasing my salary). So if I cannot get below the 65000 they are going to charge me 25%. does it not break down to less than 65000 15% above 65000 25%?? Is there any other way i can get around this?

[noppenbd]

I would just point out that tax rates are at historic lows, so even if there is no way around paying the 25% rate now, it is likely that when you withdraw it in many years, tax rates will be higher.

[jIM_Ohio]

jim,

you have a great deal in deductions. unfortuantely i find it very difficult to get over the standard deduction. I have no children, my student loans are in england and i seem to be unable to claim them on my return. (they do not send me any information until may on the interest that i have paid, then there is the exchange rate etc). Not sure if i can claim these or not and if it would even be worth the hassle to be honest. Last year we would have been under the 65000. but this year i would say that it will be unlikely that we would be able to get under this...... since we have both had significant raises in pay and are both not eligible to contribute to our 401k's until we have been at our companies for 6 months. (which will be in August and Sep - another reason it will be tough to lower our AGI for 08). Also I got a bonus for reffering a new employee to my new company 2500$ and plan on trying to refer a few more before the year is out. (also increasing my salary). So if I cannot get below the 65000 they are going to charge me 25%. does it not break down to less than 65000 15% above 65000 25%?? Is there any other way i can get around this?

There is no requirement you HAVE to convert to a Roth IRA in 08. 09, 10 and 11 are options which should be considered.

Here is what I would do:

1) consider using a deducatable IRA to get 10k worth of tax deductions for 2008. This might lower taxable income into 15% bracket.

2) contribute to a 401k when eligible. When this fully kicks in in 2009 (full year of contributions), consider looking at tax situation then.

3) consider doing a partial conversion in 2009 (up to cap of 15% bracket) then convert more in 2010 (up to cap of 15% bracket).

4) the way US taxes work is first $65100 is taxes at 15%- meaning you keep 85% of this after the standard deduction is applied. The next dollar you make (or convert) is then taxed at 25%. So the answer to your question is the entire amount is not necessarily taxes at 25%. The amount below $65100 of taxable income is at 15%, the amount at and above $65101 is taxed at 25%. There is a 28% tax bracket which starts around 130k.

All numbers assume married filing jointly.

If you will be in 25% bracket moving forward, my suggestion is DO NOT convert the rollover to a Roth. Wait 10 years- tax laws will change and when you see the chance to convert at less than the 25% you pay in taxes now, do it.

I earn well into the 25% bracket. Our expenses are only in 15% tax bracket (advantage of keeping expenses low). So I know when I stop earning money my tax bracket drops- at that point I look to do things like Roth conversions.

[anonymous_saver]

To be honest, I would just rollover to a Roth IRA anyway you look at it. $4,500 is a good chunk of change, but not astronomical, so I would just take the relatively small hit this year.

Good job on all of those bonuses by the way!

[Like2Plan]

jim,

... since we have both had significant raises in pay and are both not eligible to contribute to our 401k's until we have been at our companies for 6 months. (which will be in August and Sep - another reason it will be tough to lower our AGI for 08). ...

jimmyengland,
Are you limited beyond the IRS limit in your 401K contributions? If your company does not limit you, you could set aside money in savings the first 6 months while you are in a holding pattern and then you could double (or more) your contributions when you are allowed to participate. The money you set aside in savings would help cover the cash flow short fall resulting from the larger contributions....