My 30yo child has changed jobs and is considering rolling over her former employer 401k ($60k) to a rollover IRA. Everything is at Fido. She is single, childless, debtfree, and rents. I am running the calculators for converting it to a Roth instead and see the tax hit of ~$16k or so. Obvs that could come out of the IRA, at the sacrifice of future compounding of course. I am reading that you can spread the tax over two years maybe. Her tax rate is low but might be lower down the road if she ever owns a dwelling; other unknowns are marriage/children. Before we pay someone several hundreds for advice, I thought I would see if the wise souls here had thoughts or experience. Thanks much.
Comments
Ya make ya bets.
If you daughter has a Health Saving Account she could make a one time contribution to her HSA using $3350 of this $60K. I believe she could do this regardless whether it was from a 401K or from a SDIRA.
There maybe some advantages to keeping the 401K account. These advantages could be low fees, 401K loan provision, or maybe the 401K plan has a wide access to funds that might be load waived and / or institutional share class. Might be worth looking closely at whether she would be losing any advantages.
If she is considering doing Roth conversions she might consider this multiple Roth account conversion strategy:
https://kitces.com/blog/splitting-a-roth-conversion-into-multiple-accounts-to-isolate-investments-for-strategic-recharacterization/
- assuming tax rates are the same now and at retirement, the post-tax proceeds come out the same converting or not converting, if one pays from proceeds
- same assumptions, but add in the 10% early withdrawal penalty (age 30 < age 59.5), and it costs more to convert now than to keep the TIRA
- paying out of taxable account is a winner; you have the same number of dollars in the IRA, but now they're post tax in the Roth, meaning that you've effectively increased the amount of money you're sheltering.
Process. Two suggestions:- do a trustee-to-trustee transfer, not a rollover; the employer is required to withhold 20% on a rollover where your daughter takes possession of the cash
- Do the conversion the old fashioned way - transfer to TIRA, then convert. That may seem like more work than doing a direct conversion from the 401(k), but if the money's being split among multiple Roth IRAs, employer may have some difficulty handling its end of this.
Whether to transfer out of 401(k): @bee has some good points about a 401(k) plan sometimes being better. Also, some 401(k) plans with Roth options will allow you to do a Roth conversion within the plan. But unlike an IRA Roth conversion, you're not allowed to undo (recharacterize) a 401(k) Roth conversion. That takes away a lot of the options that Kitces talks about.Spreading taxes out: When Roths were first implemented, there was a one-time opportunity to spread the tax out over four years. Then when Congress got rid of the $100K contribution limit it created another one-time-only rule. If one converted in 2010 one could defer the tax and spread it over two years (2011 and 2012). No more.
Still, one could convert the whole amount and then recharacterize (undo) whatever kicked one into the next tax bracket, thus sort of spreading out the tax.
I'll get into IRA
http://fairmark.com/retirement/roth-accounts/to-roth-or-not-to-roth/roth-ira-rules-of-thumb/
See IRS Pub 969, Qualified HSA Funding Distribution.
As to whether funding an HSA out of an IRA makes sense ...
Pretty obviously not if you're funding from a Roth IRA, since the HSA distributions are tax free only to cover qualified medical expenses, while Roth distributions are generally tax free (with some minor exceptions).
Next look at funding from a TIRA. We'll assume that the single individual has $4,500 of ordinary taxable income and $4,500 in the TIRA. For simplicity, let's assume both a current and future (retirement) tax rate of approximately 25% (so that an income of $4500 leaves $3,350 after taxes).
The choices for funding the HSA are (1) from the TIRA or (2) from the ordinary income. Either way, the HSA is fully funded, and it turns out that the total post tax value of the other accounts (IRA and taxable) are the same.
In choice (1) the individual pays taxes now, leaving $3,350 in the taxable account ($0 in the TIRA).
In choice (2) the individual pays no current taxes, depletes the taxable account, and keeps $4500 in the TIRA (with a post-tax value of $3,350).
So the key difference is between having $3,350 post tax value in a taxable account or in a tax-sheltered IRA. The latter seems preferable. (If tax rates go down in retirement, the latter is worth even more, because the post tax value is greater than $3,350 based on the lower tax rate.)
Admittedly, there are a few corner cases where funding an HSA from a TIRA might have advantages. For example, if one needed the cash in the TIRA for medical expenses, one could tap the TIRA via this transfer without paying a 10% withdrawal penalty (I think). On the other hand, there is a medical exception to the early withdrawal penalty, but only for huge medical expenses, not ordinary ones.
Outside of such offbeat situations, I don't see any value in funding an HSA from an IRA.
There are no other accounts for funding.
There would be no circumstance where a 20% withholding would apply. Had not thought about the 10% penalty, which settles it.
Thanks v much, all. Now I have to figure out what to do myself next year taxwise @ 70.5 with combo of RMD and full SS. May be too late and no clever options
On a more practical note, you can make charitable contributions directly out of your IRA to satisfy your RMD. If you're itemizing, this has little effect, but if you're taking a standard deduction it gives you a way of reducing taxable income (it's as though you didn't take an RMD).
Even if you are itemizing, this direct from IRA contribution reduces your MAGI, possibly making less of the SS benefit taxable. Or if your income is in a higher bracket, this maneuver might drop your MAGI below the Medicare IRMAA threshold.
There are the usual games about bundling expenses every other year to get above the standard deduction threshold in even years, and below it in odd years. So instead of deducting just enough to beat a standard deduction every year, you get the full benefit of your deductions (by moving them to even years)plus the benefit of standard deduction in odd years.
To state the obvious, you may not need to take an RMD next year - the magic age is 70.5, not 70.
Of course, if you have no ordinary income (no bank interest, no non-qualified dividends, no earnings, etc.) then the IRA transfer looks good. But otherwise, all you're doing with the IRA transfer is saving the tax on the withdrawal while losing the equivalent deduction on ordinary income. No net tax difference.
Here are some columns saying the much the same things I've been writing; perhaps they say it better:
Can a Taxpayer Roll Over Funds From an IRA Into an HSA? (The Nest)
(see "Considerations" section)
Funding HSA with IRA Assets (League of Financial and Insurance Services)
(see "Essentially individuals are trading one tax-favored account, the IRA, for another, the HSA")
IRA Transfer to HSA: Does This Make Sense? (FinancialDucksInARow.com)
Rules for IRA to HSA Rollovers (Kiplinger)
"it's usually better to contribute new money directly to the HSA"
I even believe an HSA should be maxed out even before deciding what you can contribute to your IRA. Untaxed in, untaxed out. Better deal than an traditional IRA, Roth IRA or 401k. How do you beat that?
If you don't, you can follow a suggestion from one of the articles - take the money out of the IRA (assuming you're over 59.5) and use that to contribute to the HSA. That way, you get around the "one time only" restriction.
I agree that there are special situations where the conversion makes sense. I also agree that the HSA looks better than a Roth, assuming one keeps good medical expense records (so that one has the expenses to back up the withdrawal years down the road).
One qualification - HSAs are taxed by some states, making the decision less obvious.
http://www.optumhealthfinancial.com/individualsfamilies/hsataxresourcecenter/statetaxinformation.html
(curious that NH, which has no state income tax, nevertheless taxes HSA earnings)