Hello Fooldom:

I am leaving my job shortly for another and would like to rollover my 401(k) into a self directed IRA. I have selected a discount broker and plan to employ Foolish investing practices, but I'm not sure how to complete the rollover. It seems to me that the money should be directly sent to the broker to avoid any penalties, but how can I make that happen without an account set up yet? I will not have a 401(k) with the new job, but rather a profit sharing program that offers a percentage of my annual income, 15% for the last 25 years.

Secondly, it was suggested to me to later convert that transferred money to a Roth IRA. Is that something that should be considered? Thanks in advance for your input, as always it is greatly appreciated.

Paul

<<It seems to me that the money should be directly sent to the broker to avoid any penalties, but how can I make that happen without an account set up yet?>>

This part is so easy it seems too good to be true--but it's in the brokers' interest to keep this sort of thing this easy. Have your new broker send you the forms for opening an account and for effectng a direct transfer. Fill them out and send them back to your new broker. They'll take care of the rest. Expect 3-6 weeks (typically) elapsed time from when you send back the forms before your money actually arrives.

<<Secondly, it was suggested to me to later convert that transferred money to a Roth IRA. Is that something that should be considered?>>

Always worth considering, but it's your decision. Some factors to consider:

Roth: has tax free withdrawals after you've met the criteria for withdrawing; has favorable (compared to traditional IRA) estate treatment; the converted amount, to the extent it was tax-sheltered going in, or represents the tax-sheltered growth, represents an income increment, the income tax on which is due in its entirety with the rest of your income tax for the year in which the conversion occurred.

Traditional IRA: absent the estate considerations, is generally (not always, just almost so) a better deal if you expect to retire to a lower tax bracket than you're in now. Tends to be a wash if you retire to the same bracket; Roth tends to be better if you retire to a higher bracket.

For all comnbinations, weigh the estate treatment against the other bennies/losses.

Hope this helps

Eric Hines

Warning, this ended up longer than I thought. :-}

<<Secondly, it was suggested to me to later convert that transferred money to a Roth IRA. Is that
something that should be considered?

Always worth considering, but it's your decision. Some factors to consider:>>

I am considering this because I am changing jobs soon, too. I have about 73K in my 401(k) and I am 31 years old. I make 80K a year, w/ a wife, 2 kids and mortgage. That puts me in the 28% tax bracket.

So is this right?: If I roll my 401(k) into a traditional IRA, and then into a Roth IRA I pay taxes on the full 73K like it was income?? If so, that'll put me in the 33% tax bracket and I'll only have about 49K to put in my Roth IRA.

Now the question I have is: Will this be better in the long run since I can make widthdrawals from the Roth tax free when I retire? Or will the lost base principle outwiegh the future tax benefits? Okay, wait, I know how to use Excel....

Okay, this is what I did:

Traditional IRA
Principle: 73K
Rate: 11%
Duration: 25 Years (300 Months) - retire @ 56
Future Value: $1,127,695

vs.

Roth IRA
Principle: 49K
Rate: 11%
Duration: 25 Years (300 Months) - retire @ 56
Future Value: $756,946

Now, assuming I take equal widthdrawals for the next 30 years and pay 15% or 28% tax on the Traditional IRA and 0% tax on the Roth I get:

Traditional IRA: $31,951(15% Tax Bracket) or $27,064(28% Tax Bracket)
Roth IRA : $25,231

So it would seem to me that I answered my own question. It would be better to keep the traditional IRA and pay the taxes when I retire.


Now, If I wanted ALL the money in one lump sum at age 60 (IE: let it ride for another 4 years) I would have:

Traditional: $1,747,475
Roth : $1,172,962

And taking the whole thing would put me in the highest tax bracket for that year for the Traditional IRA. That's what? 40%? After the widthdrawal I would have:

Traditional : $1,048,485
Roth: $1,172,962

So now the Roth IRA looks more attractive.
I guess it all depends on the way you want to take it out, huh? I'm sure there are other considerations but the tax issue seems to be the biggest differentiator.

If my math is wrong, blame Bill Gates, I used Excel. :)

But does this make sense? Or am I totally off?
Paul.

PJGeorge writes (in part):

If I roll my 401(k) into a traditional IRA, and then into a Roth IRA I pay taxes on the full 73K like it was income?? If so, that'll put me in the 33% tax bracket and I'll only have about 49K to put in my Roth IRA.

I reply:

I infer from this passage that you would pay the taxes from the funds to be converted. If so, then the case for conversion to a Roth IRA in your cicumstances is even worse than you've made it out to be. The withdrawal in order to pay taxes would be a premature distribution, and so would be penalized an additional 10%.

On the other hand, you are entitled to convert only part of your traditional IRA. If you can pay the taxes without raiding the IRA, then IMHO, the biggest determiner as to whether the Roth IRA conversion makes sense is whether you expect your tax rate on retirement to be higher than your present tax rate. But you have to run the numbers (as you did). You always have to run the numbers.

One other point. If you already have a traditional IRA with a non-zero basis that you plan to convert, do so before rolling over the 401(k). Otherwise, you will find your basis spread over the sum of your previously existing IRA and the rollover funds, decreasing your basis in the converted funds and increasing your tax hit. Good luck! --Bob

Backing up to a previous reply:
<<Expect 3-6 weeks (typically) elapsed time from when you send back the forms before your money actually arrives.>>

This is if your plan is valued on a daily basis.
I was in a daily plan that took 3 months to complete the rollover. My spouse was in an annually valued plan and quit right after year end. It took 16 months to get those funds rolled over. Thankfully they were in good investments. My spouse was then in a quarterly valued plan that was 2 years in arrears in it's recordkeeping... you got it, it took 1 1/2 years to get those funds, only because they were trying to do a catch-up to convert it to a daily valued system.

<<Now the question I have is: Will this be better in the long run since I can make widthdrawals from the Roth tax free when I retire? Or will the lost base principle outwiegh the future tax benefits? Okay, wait, I know how to use Excel....

Okay, this is what I did:

<much snipping> >>

An excellent analysis. Yes, it does matter how you take the money. It also matters when you take it. To expand on my earlier post's remark about estate tax effects: with a traditional IRA, you MUST take the money--you can't leave it beyond your actuarial lifetime. And if you're rude enough to die before your time and have a sizable chunk of money left in that IRA, your heirs get bit big by Uncle Sugar's estate taxes. With a Roth, you don't ever have to take it out (and with your $1M outcome, you should be able to live on $50K/yr withdrawals while your Roth actually continues to grow forever--run the numbers on that one--assume you live to 90 (actuarially, you'd be dead by then, and so would have had to have taken all of your traditional IRA by then) and see what the pile works out to). Still a large chunk of estate taxes, but off a much bigger pile, and (Pixy will correct me/fill in the details), Roths get (so far) better estate treatment than traditional IRAs. Leaves more money behind for your heirs.

Enjoy your retirement....

Eric Hines

Eric sez:

<<An excellent analysis. Yes, it does matter how you take the money. It also matters when you take it. To expand on my earlier post's remark about estate tax effects: with a traditional IRA, you MUST take the money--you can't leave it beyond your actuarial lifetime. And if you're rude enough to die before your time and have a sizable chunk of money left in that IRA, your heirs get bit big by Uncle Sugar's estate taxes. With a Roth, you don't ever have to take it out (and with your $1M outcome, you should be able to live on $50K/yr withdrawals while your Roth actually continues to grow forever--run the numbers on that one--assume you live to 90 (actuarially, you'd be dead by then, and so would have had to have taken all of your traditional IRA by then) and see what the pile works out to). Still a large chunk of estate taxes, but off a much bigger pile, and (Pixy will correct me/fill in the details), Roths get (so far) better estate treatment than traditional IRAs. Leaves more money behind for your heirs.>>

No need for me to add anything except to say that those with a large, potentially taxable estate should definitely look at the mandatory distribution issue plus the problem of how much ultimately will go to heirs. Converting large traditional IRAs to Roth IRAs can make sense. It's really a choice of the owner paying income taxes during life or the heirs doing so afterwards. Paying income taxes in life may reduce estate taxes because it will probably reduce the assets left behind (these can't be avoided), plus it allow sthe remainder to grow and pass income tax-free to heirs. The ultimate result is the total tax burden (income and estate) can be reduced substantially. It's definitely an area that needs to be examined and analysed in detail.

Regards..Pixy

TMFPixy, Bob78164, Bobbcat, bacon

Thanks for the great responses. There was certainly more here than meets the eye. (And I thought my post was already too long! ;)

I think I am going to leave that $ in a traditional IRA instead of a ROTH. My goal is to use up that money in the early (first 15-20) years of retirement and live off my new 401(k), other taxable investments and two newly created Roth IRAs after that. I only have one goal for retirement: http://www.aboard.co.uk/boatfile/b000115

That, and a measely income to buy gas, suntan oil, food and send postcards. :-) See, I'm a man of simple needs.

Paul.