There are times the news is so exciting I’d like to queue up the musical piece Thus Spoke Zarathustra, you may know it as the theme from 2001; A Space Odyssey.
You know already that we’ve gone Over The Cliff and Back Again. But, chances are good you didn’t know that H.R.8, “An Act to extend certain tax relief provisions enacted in 2001 and 2003, and to provide for ex- pedited consideration of a bill providing for comprehensive tax reform, and for other purposes” had a hidden gem, the ability to convert funds from your traditional 401(k) to your Roth 401(k) when you wish.
The conversion isn’t right for everyone, but it opens up the opportunity to maximize your Roth savings like never before. First, the Roth 401(k) has only been available since 2006, compared to the traditional 401(k) being launched in the early ’80s. This means most 401(k) money is currently of the pretax variety even if many folk wish it weren’t.
Even if you started with the Roth 401(k) when it was introduced, your employer match is still pretax money. So, for those who wish to end their career with a 401(k) that will have no tax on withdrawal, now’s the time to start the conversion process. Before we queue the music again, let’s look at the situations that might make the Roth 401(k) conversion a compelling move:
- You are young, and in a bracket sure to go up in the next few years. A series of partial conversions each year to fill your present bracket can help minimize your lifetime tax bill.
- For whatever reason, you have losses that would otherwise offset ordinary income pushing you down into a lower bracket. Why not use some of it to offset a Roth Conversion?
- You’re well off. Enough that the estate tax will impact what you leave to your loved ones. A conversion now will reduce the tax your estate will need to pay and give your beneficiaries an inherited plan with no further taxes due.
- Your traditional pension plan(s) will already put you in a high bracket at retirement, by biting the bullet now, you keep your retirement accounts from making this worse.
- And last – you wish to avoid The Phantom Tax Rate Zone – the strange situation where your Social Security gets taxed based on other income and a $1000 IRA (or 401(k)) withdrawal can raise your tax by 46.25% even though you are in the 15% bracket.
Fade to black, roll the credits…. the Roth IRA and Roth 401(k) aren’t for everyone, nor is the conversion a windfall for all. These are just another tool in our financial toolbox. The key is to be aware of what’s available to you and use it wisely.
Happy New Year!