The bankruptcy protections for retirement funds are largely a matter of state law so any advice in that area would need to be state specific. I do think that keeping rollover funds separate from other qualified accounts is a good idea, though, regardless.
As noted above, tax diversity is a very good thing. The post-tax could be Roth or just non-retirement accounts.
I’ll admit that the case for conversion for this scenario is less compelling than the case for go-forward contributions to a Roth (for someone at age 25).
Whether or not conversion at marginal 22% makes sense depends on your future assumptions about income and tax policy. I think anyone who has had the discipline to save nearly $30K for retirement by age 25 has potential to build significant wealth over a lifetime, at which 22% tax rate will seem like a gift. I don’t want to take this down a potentially political thread, but I do have the opinion that the federal tax rates for 2018 will in the future be viewed as the good old days, possibly as early as next year.
Yes, I think general advice is fine (like put everything into 401k match, then Roth, then back to 401k) is ok, but it’s been taken too far. It’s not always the best decision for everyone. One thing which may weigh in favor of converting now is if OP’s kid’s income will go up beyond the threshold of allowance for Roth contributions and he wants to put money into an IRA, he’d have to convert that traditional IRA at that point. So the important marginal rate wouldn’t necessarily just be his marginal rate in retirement, but may actually be the marginal rate at it’s peak (assuming no law changes).
ETA: He wouldn’t have to, but then he’d be stuck with a nondeductible traditional contribution.
I was sloppy in my wording; sorry. I did an in-service rollover a couple years ago and got specific legal/financial/insurance advice on the topic of protecting rollover IRA from creditors. So while I was thinking rollover IRA, as is being discussed in this topic, I wrote retirement funds which is incorrectly broad. Even with rollover IRAs from ERISA plans, the bankruptcy protection has been codified to flow with the rollover (would the Roth conversion lose that, though? Just asking.). However, protection from creditors outside of bankruptcy (liability suit, angry ex-wives, etc.) is a matter of state law.
The 22% rate starts at $38,701 (for single) so there isn’t a whole lot of lower tax bracket to fill in. And that’s at (what I opine) are the lowest federal tax rates we have seen for a while nor will see in the future. Again, just my opinion … I’m not suggesting anyone else’s crystal ball is less accurate.
I find that even with zero earned income, and a portfolio that is painstakingly designed for tax efficiency (though not at the sacrifice of returns needed for the goal), it is very difficult to have taxable income come in that low, much less zero. I’m certainly not saying it can’t be done; merely saying for the purpose of advising a stranger, I would consider that an edge case, not typical scenario.
I don’t follow. First, why would he have to convert? Second, there’s no “threshold of allowance for Roth contributions” as long as there’s a backdoor. And he could roll the traditional IRA into his 401k for a proper backdoor.
In order to use a backdoor Roth, he’d have to convert the money in the traditional IRA. So, either do that now at a lower marginal rate, or do it later to use a backdoor Roth, when he’d likely be in a higher bracket.
Sure, he could avoid that tax by rolling the traditional IRA into a 401k later, but doesn’t that defeat the whole purpose of moving the money from the old 401k to the traditional IRA now? (honestly asking, there could be considerations I’m missing).
The purpose of moving the money from the old 401k to IRA is because it may not be free to keep the money in the old 401k after separation, and because he’ll have unlimited investment choices in the IRA. His new job may have better choices in the 401k, but even if it does not, it would probably still make more sense to roll the IRA into the 401k for the backdoor instead of converting and paying taxes.
I wanted to follow up on the good advice above about moving your old 401k into an IRA when you leave. I had a little money in an old 401k left behind at the old 401k admin company when the firm switched vendors to a new 401k admin. It’s been several months trying to figure out how to get this little piece out, and while it’s less than $1k, I don’t want to throw it away but it sure would have been a whole lot easier to do it back when the admin company was the same one as the firm currently used.
Besides limited options of 401k in general, old employer especially if smaller company or one managed by relatively small 3rd party company, they can charge very high amount of fees without much repercussions, as ERISA would do little for sudden increased astronomical fees on such 401Ks – speaking from experience
Move to Roth as others have said… anything but the old 401K
Not sure what you mean. Are you suggesting that if one maxes out their Traditional IRA limit then the Roth would be more advantageous to go to after the traditional IRA?
Assuming 50% tax rate for simplicity. If you contribute 5500 to a traditional, you’re contributing 2750 post tax. If you contribute 5500 to a Roth you’re contributing 5500 post tax or 11000 pretax. If the goal is to get as much into your retirement accounts as possible each year (tax advantageous assuming no problems with cash flow), you’re better off with the Roth.
One advantage of a Roth that I don’t think has been said is that there is no required minimum distribution, RMD, upon reaching age 70.5 vs. a traditional IRA. If a person has done well financially and does not need to withdraw from an IRA, then there is no RMD to worry about. A RMD may push income into a higher tax bracket.
Yes, for cases when your current marginal tax rate is fairly close to your expected average retirement tax rate, going for Roth because it’s bigger, no RMDs, etc, is a good tiebreaker. Said another way, when you do a traditional, the taxes you save end up in a taxable account and are invested without the benefit of tax deferral, etc, while if you put the whole thing in a Roth, every dollar contributed gets the best tax sheltered instead of half or whatever.
I don’t have the cites for this, but when I was kicking the tires on what to do with my 401k when I left my place of employment in ~2012, one of the key points I was trying to ascertain was asset protection. A 401k (at least at that time) appeared to have slightly better protections than an IRA and this was particularly true if it was a plan at an employer with other individuals in it (presumably that’s where your son’s money is now). Based on that, if he can leave it where it is, without paying extra fees (and if the fees and options available in the plan are good), I would consider doing that. That’s what I did. My old employer’s plan is ridiculously cheap as far as administration fees and has access to all the Vanguard funds, so that’s what I did with that 401k.
If he can’t keep it there (or if the fees/options are bad), I would consider opening a Solo 401k that lets you roll 401k --> 401k. At the time of doing research in 2012, Fidelity was the only place available for that option. IMO, Fidelity’s funds are on par with Vanguard, so you’re not missing anything by being at Fidelity and there is NO administration fees for a solo 401k at fidelity. I think you’d need to request an EIN for a “business” that your son can start, but that’s about all you need to do to open one. I recall this this version of a 401k was less protected than one at an employer with other employees, but still seemed slightly better than just being in an IRA. Obviously, I don’t have the cites right now and I’m just some dude on the internet, so you’d want to run that down for yourself, but it’s what I would do.
If I recall correctly, there has to be a legitimate business. There has to be a possibility (I don’t know the actual term they use) that the business will contribute to the 401k in the future.
The activity also would have to be engaged in for profit, so selling unwanted items on Ebay for instance wouldn’t count.
The consequences of screwing things up with retirement accounts can be devastating. I take some aggressive positions in other areas, but I don’t do anything fancy with retirement accounts for that reason. If you are doing weird things with these accounts you need to be willing to accept the risks. In my view they rarely outweigh the benefits just because the risk is so high. But to each his own.
This is true, I guess I probably skimmed that too much. For me, my Solo 401k is definitely “legit” as it was my sole employment for a while (and still is a significant business), so how much one can create a side business only for this purpose was not something I researched a lot. One should talk to a tax professional, but generally it needs to be a legitimate, ongoing, for-profit activity. I guess I just kind of glossed over it under the idea that most people on a forum like this are probably engaging in some kind of side hustle for profit and (presumably) are already reporting that income for tax purposes, etc., so taking it a step further and getting an EIN for that side hustle would not be a huge deal. (I don’t think something like churning credit cards would make for a good business, but a lot of other side hustles probably are).
Anyway, it’s not for everyone and I agree that it gets over-recommended probably, but is something I think people should kick the tires on when leaving a previous employer.
Also, remember that if your side hustle gets really profitable, this doesn’t effectively double your contribution limits or anything. You still have the same max employer/employee contributions, but since my W2 employer doesn’t profit share, I do the employee contribution with that plan and profit share on my Solo 401k (and keep the total under the max contributions).
Factors affecting Roth positively:
High rate of return
Long time frame
Relatively high tax rates (even if they are lower in retirement)
Factors affecting Traditional positively:
Large difference between current marginal tax rate and withdrawal tax rate.
Hence, the opposite is true. The higher the rate of return the more efficient Roth becomes. This makes intuitive sense (larger end balance, more taxes), but feel free to plug it into a calculator and report back (obviously assuming that the tax savings from traditional are also invested).
It would seem to depend on what is limiting the amount of the contribution. If it’s the contribution limit for both, then it would weigh toward Roth. But if it’s the amount one can afford to contribute, it would weigh toward traditional. (Just thinking out loud. Possible the math wouldn’t actually flip it to weigh toward traditional).