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401(k) to Roth IRA: Now and Later

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  • 401(k) to Roth IRA: Now and Later

    Could a conversion of a 401(k) to a Roth IRA early (relatively) in a career be more tax efficient in the long term, at least to the point where it would be worth doing?

    Here's some context for why I ask the question:

    I am 32, early in my career and currently make about $240k/year (gross), full time in primary care. I have an employer sponsored 401(k) with matching through Fidelity that I am maxing yearly, as well as maxing (or nearly) a 457(b), non-gov plan. Payout of 457(b) at retirement/severance is immediate vs deferrable lump sum or a 5 year plan with annual installments. I also have a backdoor Roth set up and maxed for both my spouse and myself yearly. I am generally investing on a 3 fund portfolio strategy. I may develop some passive income streams during my career that would continue into retirement, but plan on practicing medicine being the lion's share of my income until retirement (at least at this point). I am starting to wonder if my tax rate could be higher in retirement than it is now (my effective rate for 2 years running ~15%), and if so, could converting a 401 (k) to a Roth be more tax efficient. Or are there too many variables to confidently predict my retirement tax bracket?

    I am not worried about being financially sound in retirement, more curious if other medical professionals are finding themselves in higher tax brackets in retirement and wishing they had converted to a Roth, especially early in a career where they can enjoy decades of tax free growth and withdrawals once the initial tax burden of conversion is borne.

    Hopefully I have applied the proper attributes to each account type above, please offer corrections if I am not thinking this through properly.

  • #2
    Roth conversions make sense at some point, it's just a question of when and for how long.

    Does your spouse work? What's your combined income and combined fed + state marginal tax rate?

    I'm at 29% and have thought about converting up to the top of this bracket just because of the fear taxes will go up, but I've held off in hopes that my income will go down and that I may move to a no-income tax state in the next 5 years.


    • #3
      You can’t convert a 401k to Roth unless you’ve left employment. But then your 457 kicks in, which vaults you into a higher bracket. Also, your effective rate doesn’t matter. What’s your top marginal rate (Fed/state/muni)?


      • #4
        You can sometimes defer 457b distributions after leaving employment. Before considering Roth conversions the important short-term decision may be whether to switch the 401k contributions to Roth.


        • #5
          Huge Roth cheerleader here, but this specific strategy may not be one I’d recommend. I am definitely in favor of conversion. The difference is that, by converting in bear markets, you can take advantage of a temporary situation rather than forcing yourself to pay taxes at a sub-optimal time. Bear markets come along, on average, every 5.5 years. Your opportunity(ies) will come - just be patient and plan for the long game.

          You are doing that to an extent and you’re going in the right direction but I think you can improve on your plan. See Roth Conversions: When and How...
          My passion is protecting clients and others from predatory and ignorant advisors 270-247-6087 for CPA clients (we are Flat Fee for both CPA & Fee-Only Financial Planning)
          Johanna Fox, CPA, CFP is affiliated with Wrenne Financial for financial planning clients


          • #6
            Thank you all for your responses.

            My fed and state marginal rates in 2018 were 24%, 7.9% respectively. My spouse no longer works but still has a < $10k balance in her 401k. My 457b allows a one time deferral at the time of termination/retirement.

            jfox, thanks for the link. I am all for the long game. So if I understand correctly, sounds like I have more reading to do, but it might be of benefit to convert my wife's 401k in a bear market to minimize the tax burden, but if wanting to convert mine, not worth quitting my job over.


            • ENT Doc
              ENT Doc commented
              Editing a comment
              I’m usually the doomsday predictor here but at a marginal rate of 32% I can’t see it being beneficial to convert your wife’s 401k right now. Your current 401k balance and draw down plan also matters here.

          • #7
            No. You don't get a pass on math.


            • #8
              •”more curious if other medical professionals are finding themselves in higher tax brackets in retirement and wishing they had converted to a Roth”
              Have you ran any retirement income planners?
              Only you can determine how much your taxable income will be in retirement.
              •Last Christmas you barely touched a 20% drop. It certainly didn’t last very long. Johanna was a lone voice scouting for Roth conversion opportunities. Blink and you miss it or it continues going down. Basically spotting temporary drops is a difficult proposition.
              •Roth conversion calculators are available as well.
              It would be worth your time to run your numbers.
              At a gross of $240k, it all depends upon your projections. It sounded like you have a 401k and a 457. Employee of $19 each + employer/ $240+ employer is it 20%+? The savings strategy is probably more important to generate a greater income than the $240k. Running through the numbers will help you get your orientation of your future tax issues.


              • vennic
                vennic commented
                Editing a comment
                I have tried to run some numbers on some bankrate calculators, which is what sparked my original question. Do you have any calculators you suggest?

            • #9
              WCICON24 EarlyBird

              Whether you are looking for a retirement score or a retirement income calculator, Fidelity's retirement tools & calculators can help you plan for your retirement. Discover the financial guidance to help with your retirement goals.

              Look at the Retirement Income Score tool. It will show you all the way through RMD's and withdrawals. One of many.

              A simple spreadsheet is attached. Plug in the marginal tax rate you are anticipating both current and at withdrawal. This is only to illustrate how significant the tax paid up front impacts the wealth accumulation. Play with it and you can model a Roth. Bottom line is Tax Deferred will always outperform if everything else is equal.
              Why? It is in the math, paying funds to the IRS costs you more than the tax saving on the gains. No free lunch, yes the gains are sheltered but at a high marginal tax rate cost.
              Tax Deferred (401k)
              Tax Advantaged (Roth)
              It all is simply the marginal tax rates you pay sooner or later. Later is better if the tax rates are the same.

              The Backdoor Roth is on top of Tax Deferred, it allows you to pay less taxes on the gains that accumulate rather than a taxable.

              Johanna's planning depends on the future recovery and the time it takes to recover. 1929 it took to 1954, a lot different than the last year's recovery. It will work unless it doesn't. That is not a criticism, more food for thought. Johanna's FP is more than just math. That's how she adds value.

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