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In a comment to May 4’s post, “Financial Planner Atlanta” (if that’s your real name) raised a good question. How does the timing of a 2010 distribution from a 401(k) plan and follow-up IRA rollover affect the decision to convert a traditional Individual Retirement Account to a Roth IRA?
The fortunate answer is that the timing of the rollover is irrelevant to the tax cost of converting a pre-existing IRA to a Roth IRA.
Let’s say the IRA is worth $200,000 and the 401(k) is worth $1,000,000. By rolling over the $1,000,000 to a traditional IRA, that $1,000,000 is excluded from your Adjusted Gross Income and from your taxable income. So when you add the $100,000 IRA balance to your other 2010 income to figure your tax cost, the $1,000,000 doesn’t appear anywhere or affect any of your tax calculations.
And the same is true if you elect to have the $200,000 taxed in 2011 and 2012, $100,000 each year. The $1,000,000 rollover disappears from those tax calculations as well.
And the same is true whether the 401(k) rollover occurs before or after the Roth IRA conversion. Or even if the Roth IRA conversion happens during the up-to-60-day period between when the 401(k) plan distributes the $1,000,000 and you roll it into your IRA.
Finally, once the dust settles on the rollover, you have th rest of the year to decide if you want to Rothificate some of it in addition to the original $200,000. At a greater tax cost, of course.
I hope that answers the question.
Friday, May 8, 2009
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Thanks Marty. In this particular case, and referencing your numerical example, does your response change if we have $100,000 of non-deductible contributions in the IRA? If the client rolls the 401(k) into the IRA in 2010, does the timing matter in terms of the pro-rate rules? The goal is to convert the existing $200,000 IRA to a Roth IRA in 2010 without having to account for the 401(k) in the tax calculation, while still being able to roll the 401(k) out of the company plan in 2010. Thank you in advance.
ReplyDeleteIs that a Burton G. Rothification?
ReplyDeleteWhy am I the only old-school chum posting comments? speak up, the rest of you.
Why do I always have to go through the posting comment process twice, with the first attempt always failing? I enter the secret word (no winning a hundred dollars), but it is never accepted the first time.