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Author: 2old4bs Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75593  
Subject: Re: Retirement investing for Mom Date: 4/6/2004 10:05 AM
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Susan,

I thought you were able to transfer out of a 401-K plan into a traditional IRA and transfer into a Roth without tax implications

Any transfer (actually conversion) from a 401-K or traditional IRA into a Roth results in the taxation of amount converted/transferred at ordinary income tax rates. If you think about why this is, it will make sense. The contributions to the 401K and/or traditional IRA were deductible at the time they were made--thus taxes were never paid on those contributions--hence, there is no 'basis' (after-tax cost) in a 401K or TIRA, so all distributions are taxable at ordinary income rates. A Roth, on the other hand, is funded with 'after-tax' dollars because the contributions are not deductible--thus, in effect, you have to 'convert' those 401k/TIRA pre-tax dollars to 'after-tax' dollars before you can put them in a Roth. Make sense? The advantage of the Roth is that any appreciation/profit that occurs on the assets held in the account is tax-free, which is why it's so great for a young person who has many years left for that appreciation/profit to grow.

My biggest concern is the inability to take deductions for five years. Again, I thought since she was over 59 1/2, she wouldn't be penalized for early withdrawals.

The taxable effects of 401K/TIRA conversion to Roth is not a penalty, it's just the IRS not letting you get away with avoiding taxes altogether. The 5 year prohibition on withdrawals from a Roth conversion is also not a 'penalty', it's simply a prohibition that goes with the conversion. The penalty you're referring to is an additional 10% tax (over and above the ordinary income tax rate) that must be paid on early withdrawals from a 401K or TIRA--your mom is NOT subject to that penalty since she's over 59 1/2.

You might consider only converting to a Roth an amount that your mom will not need within the next 5 years, and then leaving it untouched for a period of at least 10 years. (To reap the benefits of the Roth, you really have to leave the dollars in there long enough for them appreciate--the greater the appreciation, the bigger the Roth benefit.)

IMHO, since your mom is in a low income/low tax rate situation, it might be best to rollover the 401K into a traditional and have her take regular payments out, forgetting the Roth completely.

Hope I helped with the explanations...

Irene

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