Contributing to both the Roth IRA and 401(k)

[prohornblower]

Let's assume you are eligible for a Roth IRA and you are in your mid-20's. Say you have a 3% employer match on your 401(k), so you of course contribute 3% to your 401(k), then you max. out the Roth IRA for the year which is $4k...now you go back to contribute more to the 401(k), say you max it out at $15K for a total year retirement contribution to $19K.

Say you do this two years in a row and now have (negating earnings) $8K in the roth and $30k in the 401(k).

You leave your job, and roll your 401(k) to a rollover IRA, then convert it to a Roth (and pay taxes on the $30K).

You know have effectively contributed $38K to your Roth IRA in just two years, which is almost 5 times the "allowable" amount in that same time period.

Isn't doing this like pretty much the best possible thing a really young person with capital could do in terms of retirement investing? Assuming he has the money to pay taxes on 30k? You are basically adding 15K/year through a side-door, but totally legally.

Am I missing something here? This seems like a really good idea.

[Big TR]

Everything that has been done in that scenario is perfectly legal. Depending on the tax bracket you are in, it is probably a wise decision. If you have pulled this off, well done.

The only issue is that if the employer is a typical one, you probably have not vested in the employer match contribution on the 401k.

[prohornblower]

Vested or not, your own personal contributions would still help in this scenario.

I'm thinking this whole deal isn't really common practice because if someone had $19K to put away per yer just for retirement, they likely might earn over $100K anyway, and not be eligible for the Roth. I'm guessing there aren't many folks who could do this even if they tried.

[Dazarath]

With the new law coming into 2010 (or whatever year it is), would a professional poker player be able to contribute 40k/year to a SEP IRA and then convert it to a Roth when the law is put in place?

[Nottom]

[ QUOTE ]
I'm thinking this whole deal isn't really common practice because if someone had $19K to put away per yer just for retirement, they likely might earn over $100K anyway, and not be eligible for the Roth.

[/ QUOTE ]

I don't really agree. I think this could apply to a good portion of recent graduates. If I was pulling in 40K and and single and still living like a college student (especially if I could stay with parents or something for a couple years) it would be pretty easy to save a quite a bit of money. Of course most people in this spot go buy a new car and move into a house/apt they can't really afford and buy a bunch of stuff they don't really need while eating out every night instead.

[Big TR]

Yes, your personal money helps. You asked if you were missing anything. That was just one thing I could think of.

Also, you need to have cash sitting around to pay the taxes on the conversion. Let's say you have taxable income of $75k and convert $30k of the IRA to a Roth. This is taxed at the 28% rate. You will have to come up with $8,400 for the Feds, plus X% to the state, to cover the additional taxes you will owe on the conversion.

You must then consider if you will be in a lower tax bracket than 28% upon retirement.

There are a lot of things to factor in when converting to a Roth that not everybody takes into account.

[MrBlue]

This is absolutely correct.

One strategy that a friend is planning on using is to do the conversion when he goes back to school for an advanced degree. He knows he's going to quit his job and go back to school. While in school, his income will be 0. He'll be using those 2 years to convert the bulk of his retirement accounts into Roth IRA to take advantage of the lower tax bracket.

There are other strategies such as starting your own business. In the first couple of years, you may not have much income thus not draw much of a salary from your business. You can then use this time to convert any retirement accounts at a lower tax bracket.

If you're going to do any of these things, you should probably consult your accountant to verify that they do work.

edit:
I'm also going to add here that I believe taxes will only go up from here. The Bush tax cuts won't last past 2010. With all the talk about the huge national debt, I think it's unlikely we see any significant tax cuts. But it's hard to predict 30 years in the future. By that time, congress could pass a law that says we need to tax Roths! Now that would suck.

[ski]

Thx for the response blue,

One more quick question. I'm filing as a pro gambler right now, if I throw $12K into a SEP-IRA can I still move that over to a Roth IRA, can I move the whole thing or just $4K? (per year)?

Would it matter if I am no longer self employed?

[Big TR]

You last point about changing the taxation rules related to a Roth is an important one. Initially, I believe social security income was exempt from taxes, since you had already paid the income tax on those funds. Then they changed it so you are taxed on these benefits based on your income level.

I do a couple of tax returns for people each year. One is a retired grandma who earns SS and about $18k in interest, dividend and annuity income. She was taxed on about 50% of her SS earnings this year because of her income levels. It's not like she is living the good life.

This will delve into politics, but I'll go there anyway. The way I see it playing out, sometime down the road politicians will say that they are going to make Roth distributions taxable, but only to the rich. Then the thresholds will slowly be reduced over time, making more and more people subject to taxation, much like they have done with SS.

[black_russian]

I do what you have described above but I did not know I could roll my 401k into my roth IRA...how do you do that?