401k to Roth IRA
From 401k to Roth IRA
Homer’s Dilemma
401k to Roth IRA: A Brief History
In 2006, Congress added a few new items to the retirement savings menu, making it look a lot more complicated, but actually putting hard-working Americans more than ever in charge of their company-supported retirement plans. Congress added the Roth 401k and the Roth 403b to employees’ choices, creating hybrid plans that combine the best of the old Roth IRA’s with the strongest features of the conventional 401k’s. Growth on the new Roth plans will not be taxable when people begin collecting their funds at 59 ½, so that holding the traditional 401k next the Roth IRA plans, the Roth options will have the greater value by virtue of their exemption from income taxes on distributions. Although Roth customers lose the pre-tax benefits that come with the old-fashioned 401k, they still come out ahead in the end. Best of all, the new Roth plans are available to far more workers than ever before.
The 401k to Roth IRA comparison becomes far more complicated and abstract as the details unfold. A story illustrates the choices better than explanation ever could.
401k to Roth IRA: The Showdown
Homer, a happy, healthy, productive associate at the big home improvement retailer, has contributed to the corporation’s 401k plan from the very first moment he became eligible. And he always has contributed the max. He expected his contributions to the old 401k would continue just as automatically as pulling on his vest every day.
The manager announced the Happy Home Hardware Headquarters, reluctantly, had added the new Roth 401k to associates’ retirement choices. Although it meant they would pay extra administrative costs, the Headquarters honchos believed the associates deserved the best of everything. They expanded the choices to go all the way from 401k to Roth IRA—with the option of “both” right in-between.
When Homer heard all the details about the new Roth IRA, he knew he was hung on the horns of a dilemma. He can stick with the old 401k, which works like clockwork and feels perfectly familiar. Or he can rollover $20, 500—this year’s maximum retirement contribution–from his existing 401k into the new Roth product, setting it up so that his payroll d3eductions will go to the Roth 401k form now on. Or, if he really cannot make the either-or decision, he can wimp-out and do a little of both.
The 401k to Roth IRA question troubles Homer night and day. What to do? What to do? And, more importantly, how to decide?
Finally, unable to decide for himself, Homer seeks professional assistance. The expert financial planner works out the 401k to Roth IRA question simply on the basis of taxes, and consideration of taxes alone makes the case. Homer should go with the Roth. “Go from the 401k to Roth IRA,” the ace financial planner instructs.
Under the new laws, employers continue matching contributions as they always have, putting them into the 401k, the Roth IRA, or both. “Trust me,” the ace financial advisor assures, “put it all in the Roth. More growth and no taxes. Remember, taxes tell all.”
Because Homer has faithfully maintained his traditional 401k thro8ughout his 20 years of service, he has built-up considerable wealth in that account, and he has “snowballed” his tax savings into certificates of deposit and government bonds. Great to have all that safe, secure wealth stashed away, but not so great when distribution time comes, because he will have to pay income taxes on all those hefty installment payments. Homer should not rollover his old 401k, but he should go with the Roth IRA from now on, because when distribution time comes for the Roth product, it will come home to Homer tax free.
401k to Roth IRA: The Showdown Decided
Homer mulled it over a little while longer, until he agreed “taxes tell all.” He marched right into the HR’s office, saying proudly, “Move me from the 401k to Roth IRA.” And she did, and Homer felt happy.