I am 49 with $660K in a 401(k). Should I max out the 24% bracket with annual Roth conversions?

 

There’s been a lot of buzz lately about converting funds from a 401(k) to a Roth IRA. Whether or not it’s a wise decision for a 49-year-old depends entirely on the specifics of their situation. Before deciding one way or the other, they should ask themselves the following questions:

Are the perks worth it?

It’s easy to understand why Roth IRAs are so popular and equally easy to understand why a person may want to convert a portion of their 401(k) to a Roth. Here are a few of the sweetest Roth IRA benefits that make conversion so tempting:

• Tax-free growth and withdrawals in retirement: Money grows tax-free, and qualified withdrawals in retirement are tax-free.
• No required minimum distributions (RMDs): Unlike pre-tax retirement plans like 401(k)s and traditional IRAs, Roth IRA owners are not required to withdraw funds from their account at age 73 or 75.
• Flexibility: The account holder can withdraw contributions (although not earnings) at any time without penalties.
• Tax diversification: Experts say that having a mix of taxable and tax-free accounts can help minimize a retiree’s tax burden.
• No required minimum distributions (RMDs): Unlike pre-tax retirement plans like 401(k)s and traditional IRAs, Roth IRA owners are not required to withdraw funds from their account at age 73 or 75.
• Tax-free to heirs: Unlike other retirement plans, Roth IRAs can be passed down to heirs tax-free.

Anyone considering a Roth conversion will want to consider these perks because they’ll be weighing them against the potential downside of making a Roth conversion at a relatively young age.

Am I willing to take a hit for making withdrawals before age 59 1/2? 

A couple of things will happen to the person who withdraws money from a pre-tax account, like a 401(k) and converts it to a Roth IRA.

Penalties

An account holder can expect to pay a 10% early withdrawal penalty: Each year they remove money from their retirement account before 59 ½, they’ll be met with a 10% penalty on the funds withdrawn. Say their annual rate of return for the past two years has been 5%. That penalty means losing out on two years of growth.

There are exceptions for hardship, such as medical expenses, potential eviction, funeral expenses, and federally declared disasters, but they’re not guaranteed.

Income taxes

Before taking the plunge, a person should look closely at their current finances and determine whether they can afford to pay federal and state income taxes on the converted money. Those funds will be added to anything they earn this year, and taxes due by April 15 of the following year.

Am I in my peak earning years? 

Peak earning years are typically thought to be the late 40s to late 50s, with figures showing women peak between 35 and 54 and men between 45 and 64. For anyone considering a Roth IRA conversion during peak earning years, there’s a very good chance they’ll pay more in taxes now than they will following retirement.

Those considering a Roth IRA conversion should examine their retirement savings and calculate their approximate retirement income, including Social Security, pensions, annuities, rental properties, and other sources.

There are exceptions. For example, if a person knows they have a large inheritance coming or plan to sell multiple properties during retirement, they could have more income and benefit by making tax-free IRA withdrawals. However, the only way to know is to calculate their post-retirement income based on current information.

Have I considered a professional’s opinion? 

Like most important financial considerations, it pays to weigh the pros and cons. Comparing potential gains against potential losses is the only way to determine whether converting a 401(k) to a Roth IRA is the right move, and there’s no one better than a fiduciary advisor to help you get your retirement plan in line.

What makes this subject important

It’s never too early to begin planning for retirement. Research indicates that individuals with a formal financial plan have two to four times more wealth as they enter their golden years, but formal financial plans sometimes require tweaking. Rather than becoming one of the millions of Americans who worry they’ll never get to retire, it pays to consider every option, including the impact of post-retirement taxes. 

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