401K to Roth IRA Question

[NiceGuyEddie]

I can't believe I can't find the answer to this question online.

We all know you need to pay the tax when converting 401K money to a Roth IRA.

If you transfer $10,000 from the 401K to the Roth IRA, you'll need to pay probably about $3,000 in taxes the next year.

The question is: can you use THAT MONEY in the Roth IRA to pay the tax? Of course, you need to withdraw it, the value may have gone down, etc.

[F500guy]

I will take a shot, that may depend on situation. Are you still eligible to make contributions? Have you owned the account for more than 5 years? Are you older than 59.5? But, if you have to take the money out to pay the taxes, why do the transfer and incur the tax hit?

Instead, just stop contributing to the 401K and deposit a lesser amount in the Roth, take no money from the 401K.

Disclaimer, I am not a certified financial planner, retired at 57.7 years old and hope I do not run out of money before I am at my predicted death at 88.00 years old :rolleyes:

[NiceGuyEddie]

Fred is early 50s. He's had a 401K for 25 years and a Roth IRA for 10 years. He already maxes out both his 401K and Roth IRA, including any "catchup" contributions. He'd like to convert as much as possible of his 401K to a Roth IRA.

The tax year after the conversion, he thinks he has to pay taxes on the conversion out of his savings account, but he's not sure.

Can he just take "new" money out of the Roth IRA to pay the taxes? He understands the value of the fund may have gone down since the conversion/deposit.

[42Bfast]

Generally speaking, you can’t take money out of an IRA/401K, Roth or conventional, before age 59.5 WITHOUT incurring penalties.

After age 59.5 you can pay the taxes using the 401K money at the time of conversion.

I’m not sure what happens when one wants to do a conversion before 59.5 but any competent financial advisor should be able to help with that information.

(I am not an advisor, I’m just older than 59.5.)

[F500guy]

So, since the Roth account has been owned longer than 5 years, you can withdraw tax or penalty free any deposits that have been made in prior years, but being under 59.5, you can not withdraw any gains on said deposits. I do not think it would work since the individual is younger than 59.5 So, the crux of the problem is since the individual is younger than 59.5, the transfer would need to meet the transfer rules, or taxes and penalties could be automatically applied before they saw the money.

[i.e.427]

For financial and Tax advise, talk to your financial advisor and tax preparer.

[Dgc333]

So, since the Roth account has been owned longer than 5 years, you can withdraw tax or penalty free any deposits that have been made in prior years, but being under 59.5, you can not withdraw any gains on said deposits. I do not think it would work since the individual is younger than 59.5 So, the crux of the problem is since the individual is younger than 59.5, the transfer would need to meet the transfer rules, or taxes and penalties could be automatically applied before they saw the money.

Note: if the money in the Roth account has earnings you will have to pay tax on it. Example you contributed $10k but the account is now worth $15k you will pay taxes on the $5k of earnings.

[NiceGuyEddie]

For financial and Tax advise, talk to your financial advisor and tax preparer.

After 35 years, Fred's income tax guy retired. I had an in-person visit to a satellite of the company that holds my 401K and Roth IRA and I had a terrible experience. The whole thing was a waste of time and unless there are completely new people Fred could talk to, he doesn't want go go back.

[Jeff Kleiner]

For financial and Tax advise, talk to your financial advisor and tax preparer.

Oh come on Frank, a car forum is an ideal place to go for financial advice. Medical guidance too ;)

Jeff

[Ducky2009]

Don't forget that you'll have to pay a 10% penalty if under the age of 59 1/2, besides any taxes incurred. Ask a tax adviser before taking any action.

[JeffP]

You can roll it over without a penalty, your age doesn't matter. You'll pay the tax on it at your current income rate. Since you already have the Roth established, and assuming you've made at least enough contributions to it to cover the taxes you're wanting to pay then yes, you can use the money in the roth to pay the taxes. You can withdrawal contributions from a roth after 5 years penalty free.. se just consider the $3k you're using to pay taxes from the roth as money you deposited previously. 10% penalty only applies to any amount you don't roll over.

So Fred has $100k in a 401. and $20k in a Roth (15k contributions / 5k earnings) held for 10 years.

Withdrawals 10k from 401 and rolls it over into Roth. Tax time rolls around and Fred withdrawals $3k from Roth because he has $15k in eligible contributions he can withdrawal from and uses it to pay taxes.


For reference:

The Bottom Line
Although they are perfectly legal, complicated tax rules apply to retirement account conversions, and the timing can be tricky. The ideal candidate for rolling an employer-sponsored retirement fund into a Roth IRA is a person who does not expect to take a distribution from the account for at least five years.
Those ages 59½ and older are exempt from the 10% early withdrawal penalty, as are those who transfer the 401(k) funds into an existing Roth IRA that was opened five or more years ago. This exemption allows the rolled-over 401(k) funds to be withdrawn without penalty.

And If you want the IRS reference:
https://www.irs.gov/taxtopics/tc413

I am not an accountant, but I've got far too much experience with this exact scenario.

[NiceGuyEddie]

Jeffp's info is very useful. It looks like Fred must use previously deposited money in the ROTH, and the tax rate will be at one's current tax bracket. I just read every word in that irs link, plus all the links in the link but I still don't have a straight answer. That leads me to believe that one can NOT use the recently transferred money to pay the taxes. I think. I will keep reading.

[NiceGuyEddie]

Don't forget that you'll have to pay a 10% penalty if under the age of 59 1/2, besides any taxes incurred. Ask a tax adviser before taking any action.

I was unaware this applied to conversions. I'll keep reading!

[NiceGuyEddie]

Fred just learned that Roth IRA conversions are subject to federal AND state taxes. Fred may very well retire in a state with no state income tax, so the conversation may already be over.

[dukegrad98]

Fred may very well retire in a state with no state income tax, so the conversation may already be over.

Now Fred is thinking straight!

Cheers, John