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|Subject: Re: Roth 401k vs. Traditional 401k||Date: 9/28/2012 4:12 AM|
|Author: gdett2||Number: 70980 of 78164|
When choosing between trad vs Roth there are more things to look at besides current vs future anticipated income levels.
All funds in traditional IRAs and the "traditional" 401K/403B/SEP IRA/etc will be subject to Required Minimum Distributions, RMDs, in the year you reach 70 1/2. The first RMD is equal to the balance of all traditional accounts divided by 25.6. This is added to your taxable income. This will apply to a spouses account in the year they reach 70 1/2.
Failure to take RMDs out is penalized at 50% of the non-distributed portion of the RMD. If your RMD is supposed to be $20,000 but you only take $15,000 out, you will pay $2,500 in excise penalty.
Roth accounts, IRA and 401K, are exempt from RMDs.
If you have large amounts in these accounts, it can make a significant boost to your taxable income. In our case, it will nearly double our income and we do not need the IRA money for expenses.
RMD distributions are not eligible for Roth conversion. They need to be spent or saved in a taxable account.
Another factor about the future is the unknown. Will the tax rates be like they are today? Will they be higher?
If you do not have a traditional IRA in your name, you can make non-deductible contributions to it up to the standard limits for your age. Once the funds are booked into the IRA, do a Roth conversion of all the funds in the account. You are allowed to convert any amount to a Roth but are liable for any taxes due. Non-deductible contributions to a traditional IRA are not taxed on withdrawal. If the conversion is done the same or next day, you may have to pay tax on a couple cents earned in the money market account. Not a big deal. You will need to add an IRS Form 8606 to your taxes to track the non-deductible contribution and the conversion.
Do some planning on the accounts to see what the balances of your trad accounts might be. Calculate your first year RMD. On $1MM, the first RMD is $37,736 for most people.
The factors are in IRS Pub 590 at the IRS website.
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