401(a) and 403(b) ---> IRA or new employer 401K?

[rhcp0216]

Hello, fellow investors! I am pretty new to the scene, and wanted some advice before heading into the CPA and CFA's offices next month so I would have a slightly better idea what I'm talking about.

I'm a resident (33 yo) and spouse is in biotech (40 yo). Combined we make around $150K/year. He just joined a new employer who offer 401K, no match. He has 401a-$55K and 403b-$10K from previous employer. We are trying to decide whether to pay the taxes on the money and start him an investment Roth (he doesn't have one yet!) at TDAmeritrade or roll these funds into his new employer's 401K with Vanguard.

Also---we know it's not optimal, but are aware that there are restrictions on which types of accounts one can borrow from for first-time homebuyers, and wanted to keep this option open if possible as we are thinking about purchasing a small condo next summer.

Any advice much appreciated!!

[jfoxcpacfp]

1. Part of the 401a may be post-tax. Have you checked on that?


2. What year of residency are you in? iow, if you want to go the Roth r/o route, might you have 2 - 3 years to gradually convert and stay out of the 28% tax bracket?


3. What is the plan at the new employer like? Good quality, lots of choices, reasonably low-cost funds? Or not? That would affect my roll-in plans, cause once the money goes in, it's not likely coming out until he changes jobs.

I would lean toward #2, but I am very partial to Roth IRAs and you won't be in a relatively low tax bracket for much longer.

Your CPA can give you more specific advice, of course.

[Faithful Steward]

I think your future earnings potential will play a major role in your decision.

If your income, after residency, will push you into 33% bracket or higher, then I think converting as much as possible in the window before you finish residency makes a lot of sense. And, if you can gradually convert it all, in that window, and stay in the 25% tax bracket; then, I think that's a no-brainer for the Roth.

If your income, after residency, will only put you in the 28% tax bracket, then I think it's a tougher decision; but, I would still lean toward the Roth.

Also, jfoxcpacfp makes an excellent point about the fact that once you roll the money into your husband's new 401(k), it's probably there until he leaves that employer.

[Faithful Steward]

rhcp0216 wrote:

Also—we know it’s not optimal, but are aware that there are restrictions on which types of accounts one can borrow from for first-time homebuyers, and wanted to keep this option open if possible as we are thinking about purchasing a small condo next summer.

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Just wanted to clarify this, so you don't make a decision based upon incomplete or bad information.

If you roll your husband's old retirement accounts into his new 401(k), then you might be able to take a loan from the 401(k). That would indeed be a way to borrow for first-time home purchase. However, keep in mind that there are some downsides to borrowing from a 401(k).

However, if you convert to Roth, and use up to $10,000 from the Roth IRA for first-time home purchase; that is a withdrawal - not a loan. So, it cannot be paid back. You will have forever reduced your Roth by the amount you withdraw.

[rhcp0216]

Thanks for your prompt reply, Johanna!

1) I need to get him to call them, which will be tough but I'll do this ASAP. Could I tell this from his old paystubs?

2) I just started, first year of 3. This year will be easiest to stay out of 28% bracket because I will only have $25K income, and he will be around $85K this year since we both started the new jobs in July. Next year we will be barely under 28% before the rollovers (if any), which is why I'm trying to be proactive if this year is our best shot. I am partial to this option also...I just didn't know if we could borrow on the Roth IRA in case of extenuating circumstances surrounding the home purchase; we are saving cash for the down pmt, but may need a little boost to get where we want and in case the parents can't loan us money, we just don't want to close the door of opportunity until the purchase is complete.

3) Funds seem reasonable, he'll be putting in 6% of income pretax. Annual expense ratio 0.10% in the "automatic" fund, which is based on Target Retirement 2040. There are other options, but I need to get more educated before I fiddle with those, I think. There are Target Risk, Equity, Bond, MM, and REIT Index Fund Shares, but MM and REIT are 0.11% and 0.12% net expense ratios, respectively. I've heard REITs are the most tax-efficient funds, but again, I don't know enough about what I'm talking about to start messing with his 401K. Plus, it is pre-tax, so I'm not sure that this will make a difference anyhow...?

I sincerely appreciate your input. I may be giving you a call soon! :-)

[rhcp0216]

Good to know, thank you! We will keep this in mind. Don't want to hurt the Roth if we don't absolutely have to.

[rhcp0216]

Thanks, FS!

Yes, the bracket will go up once I'm finished w residency, which is why I am glad I asked about doing this now.

What do you think of the rest of the money that goes over the bracket and we cannot convert without going to 28%, would it be wise to just roll it over into the new 401K for simplicity's sake?

Appreciate your input and time!

[jfoxcpacfp]

rhcp0216 wrote:

1) I need to get him to call them, which will be tough but I’ll do this ASAP. Could I tell this from his old paystubs?

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Probably not.

Sorry, I forgot the part about borrowing:

• You cannot borrow from a Roth IRA, but you can take original contributions out at any time without tax repercussions. Unfortunately, rollovers are subject to a 5-year rule.


• You can borrow the lesser of $50k or 50% of the balance from your 401k, if your employer allows.


• You can also take up to a $10k distribution from a Roth or TIRA for a 1st-time home purchase.
  
  
  
  • If a Roth, you must have had the Roth for 5 years to qualify to do this. Otherwise, it is treated as an early distribution.
  
  
  
  

Don't choose a portfolio based upon the tax-efficiency of a fund but on optimal growth over the long term. Even the expense ratios aren't that important in the big scheme of things. All of yours sound relatively low, regardless.

Tax planning will help you make your decision about the Roth conversions - I recommend it.

[Faithful Steward]

rhcp0216 wrote:

What do you think of the rest of the money that goes over the bracket and we cannot convert without going to 28%, would it be wise to just roll it over into the new 401K for simplicity’s sake?

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If you can convert at the 25% or 28% bracket, I would do so. Chances are, if you both do a good job planning for retirement, that you will likely fall into at least the bracket that is currently taxed at 28%. In that case, you made out on the money converted at 25% and you basically break-even on the money converted at 28%.

However, do you think over the next 40 to 50 years tax rates are going to go down or up? There's no saying that, by the time you would retire, the bracket currently being taxed at 28% might not have become the 30% or 40% bracket. In that case, the tax arbitrage makes you look like a genius!

[Faithful Steward]

jfoxcpacfp wrote:

Even the expense ratios aren’t that important in the big scheme of things.

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Isn't that a form of heresy around here?   

[jfoxcpacfp]

Faithful Steward wrote:

Isn’t that a form of heresy around here? LOL

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yes.