[Edit: Looks like I generated a lot of questions, so here are some more details. I'm 60, married, and retired early with a pension and living in a very HCOL area. For the next several years I'll be in the 24 percent marginal federal tax with taxable income of just over $200k after deductions without ROTH conversion withdrawals. This is because I'll be making large gifts to my adult kids and spending a shitload of money on myself to make up for my ridiculously frugal lifestyle and childhood poverty the past 60 years. State marginal tax rate here is 9.3% for me, so total marginal fed+state tax rate is actually 33.3 percent. I'm exploring Roth conversions even at 24% (fed) because if I die, the combined tax rates for my surviving wife will be very high as a single filer.]
I've been looking into likely converting a couple hundred thousand each year from my traditional 401k to Roth to mitigate the amount of RMD I'll need to make in 15 years. Most of these discussions mention that it works best to use pre-existing cash holdings to pay this tax.
But I don't keep cash like that around. If I'm withdrawing an extra $200k, then all of it will be taxed at about 30% ($60k tax) state+fed, so I end up with about $140k going to Roth and $60k going to taxes. I'm fine with that.
Obviously, if I had $60k post-tax cash laying around, I could use that pay the taxes and my $200k conversion will result in $200k going into Roth. Or I could convert just $140k, pay the $42k tax with cash, and have $140k in Roth.
I get that paying income taxes with part of the 401k withdrawal means less going into Roth, but I don't consider that a "downside." What am I missing?
401k roth conversions will obviously trigger significant immediate income tax obligtions. Any non-obvious downside to using 401k funds to pay for taxes vs pre-existing cash holdings?
byu/RandomQueefs inpersonalfinance
Posted by RandomQueefs
10 Comments
Paying 30% tax to do roth conversions now? How big do you expect your RMDs to be? Having a very hard time believing this is a smart move.
You’d need like a 400k RMD
In today’s dollars (assuming MFJ) for this to pencil out
It may be wise to keep your 401k in traditional/pre-tax and then build up your Roth IRA and your after-tax IRA Roth conversions (mega backdoor Roth). Then you can combine Trad/Roth to maximize tax efficiency when you need it.
> around. If I’m withdrawing an extra $200k, then all of it will be taxed at about 30% ($60k tax) state+fed, so I end up with about $140k going to Roth and $60k going to taxes. I’m fine with that.
That seems exceedingly tax inefficient and inconsistent with prudent wealth management unless you are amazingly rich and your RMDs will exceed several hundred thousand dollars
Since you’re over 59.5, it doesn’t really matter since you can make withdrawals without a penalty. It matters before 59.5 because the amount withhold is penalized
The immediate downside is using tax advantaged funds to pay taxes. Losing those tax advantaged contributions.
The longer term downside may be paying a higher tax rate due to fear of future taxes. It’s unclear since you didn’t post your current income, pretax balance, and estimated expenses in retirement. But 24% federal plus 6% state is a high tax rate.
Edit- read OP’s post history. His pension is only $75k. But he withdrew $210k from his 401k last year with a $2m balance. RMDs will not be an issue lmao.
It sounds like your missing an emergency fund. That is where your additional tax payments should be coming from. Not your future self.
There’s been a lot of Roth conversion interest since Vanguard released their BETR calculator.
As long as the tax bracket you’re paying out now is lower than the future expected tax bracket, there are no downsides. It’s best to keep as as much as you can in the Roth to maximize tax free growth, but having that kind of cash lying around isn’t always possible.
Can you explain WHY you’re looking to do this?
Have you factored in the 10% penalty you would pay on the 60K you withdraw but don’t rollover?
The reason to have the cash outside of accounts for Roth conversions is because you do lose the growth of the money that would have been invested. It keeps all the money in the market.
You are only 60. You have until 73 or 75 until RMDs. That gives you at least 13 years to do conversions. I understand that it is said to fill up the “tax bracket” to do conversions. That does not mean you have to fill up the tax bracket.
I suggest you project what it would take to get your 401k to about $1MM by the time RMDs start. You do not need to or want to dwindle your 401K to $0. Remember the standard deduction is about $30k.
By doing such large conversions you are also bringing IRMAA into play, the tax torpedo and you are already thinking about the widows tax. Take the 12-14 years you have until RMDs happen to convert a smaller amount than $200k each year. If you do not account for IRMAA you could be pushing your tax rate up over 40% when your conversions are all said and done. Your tax year at age 63 would be the look back year for age 65 for IRMAA.
Also you could save the 9% and move to a different state.
It seems like you have even more going on to think about than just the lost gains on paying the tax due from the amount you withdraw.
You might consider using the software at [boldin.com](http://boldin.com) and buying the subscription that includes Roth conversion strategies. You can tell it to fill to certain tax brackets, pay taxes from the 401K or other funds, when you plan to take social security, minimize IRMA, maximize how much you spend vs. how much you leave to your family, etc. It will develop a plan based on the inputs. You can create multiple scenarios, too.
Boldin used to be called NewRetirement.com. Rob Berger walking through it: https://www.youtube.com/watch?v=E_XK6UZPDfo