work 401k to work roth conversion

[rcs4787]

age 54, I have a work 401K but is give an option to covert to company Roth. The 401k has a pre-tax amount and a company matched amount. Should I convert everything to the Roth?

[Opus 17]

Since the company match is also pretax, the entire balance of the 401(k) will be taxable when you convert it to a Roth option 401(k).  Whether or not this makes sense for you is extremely complicated, and you might want to pay for competent advice from a financial planner.

Here are some thoughts, in no particular order.

1. The biggest question is, do you want to pay taxes now or later? If you leave the money in the pretax account, you will pay income tax as you withdraw. If you do the conversion, you will pay the income tax now, and no tax when you withdraw in retirement.  Most people will be in a lower tax bracket when they retire. However, you might believe that tax rates will increase, or you might expect such a large retirement income that you won’t have a tax rate difference between now and later.

2. If you convert the money to a Roth 401(k) at some point between now and retirement, Roth accounts do not have an RMD. This gives them an advantage over traditional pretax 401(k)s and IRAs.

3. When you retire, up to 85% of your Social Security benefit may be taxable if you have other taxable income, but if you have no other taxable income then your Social Security benefit is tax free.  Therefore, we can imagine a situation where, if your retirement account was pretax, withdrawing money for your living expenses will be taxable plus you will pay taxes on your Social Security, but if your retirement money is in a Roth account, then your withdrawals are not taxable and so your Social Security will also not be taxable.

4. Can you even afford to pay the taxes on the conversion? For example, if you want to convert $100,000 to a Roth account, you will have to come up with a minimum of $22,000 in federal income tax from other sources; you can’t withdraw part of the money as cash to pay the taxes on the rest of the conversion.  (you could of course make smaller conversions; if you converted $10,000 a year for the next 10 years, you would have to come up with $2500 per year for the income tax, and that might be affordable for you.)

Ultimately, a decision to do a Roth conversion means paying tax now instead of later. Whether that is right for you depends on many factors.  

[Critter-3]

Are  you sure you can even convert the 401K to a ROTH 401K  or   did they just tell you of your option to make contributions to the ROTH 401K  in addition to the regular 401K ?  The second situation is common  where the first is unusual. 

[Opus 17]

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@Critter-3 wrote:

Are  you sure you can even convert the 401K to a ROTH 401K  or   did they just tell you of your option to make contributions to the ROTH 401K  in addition to the regular 401K ?  The second situation is common  where the first is unusual. 

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@rcs4787 

If you mean, "change over my contributions to the Roth option" (and not "convert my existing pretax assets to a Roth option") then here are my thoughts:

1. You obviously lose the tax deduction.  Suppose you can afford to contribute $1000 per month pre-tax, that will actually reduce your take-home pay by around $750, so you could afford to contribute $750 to a Roth option for the same result to your monthly bottom line.

If we compare contributing $1000 pre-tax and paying income tax when you retire and withdraw, versus contributing $750 after tax and withdrawing it tax-free, the results are pretty similar as far as what you will have to spend in your retirement years.

1a. However, if you do end up at a lower tax bracket in retirement than you are in now, there is a slight financial advantage to making pre-tax contributions now.  That depends partly on your expected income and partly on politics. 

1b. You might want to consider the state you are living in now, and the state you plan to retire to, if you plan to move.  If you are living in a high tax state and plan to move to a low tax state after you retire, that increases the financial advantage of keeping your contributions in the pre-tax account.  

2. Having both pre-tax and after-tax retirement accounts gives you some additional flexibility when making withdrawals as to where to take the money from, that may be useful.  For example, you might normally take your income from the pre-tax account and pay the taxes.  Then if you need a lump sum for a new car or house renovation, you can take that from the Roth account and it won't raise your taxes on the rest of your income.

3. As before, Roth accounts do not have an RMD, so that represents additional flexibility when you retire.

I personally contribute to both pre-tax and Roth option accounts at my current workplace, I think having both is likely to be to my benefit in the long run.  Which is best for you, again may require personalized professional advice.