401K rollover to Traditional IRA or Roth IRA? Which is better?

Question

I have 10K in my 401K. I tend to roll it over to Roth, taxed once and never again, since only 4000 per year contribution is allowed, I can only rollover 10K this year 4000 and then next year 5000 and the rest, bit by bit? is that right? And I have to rolloever to a rollover IRA first right? Sincce I can only contribute 4000 or 5000 per year, the growth is not as large as if I have a larger lump sum compare to traditional. Unless I know by the time I retire, I am in a lower tax bracket... then traditional is good? I am confused, or maybe either turns out to be the same? I know traditional is tax deductable, Roth you can take the contributions out penalty free after 5 years. I read motley fool example and they said Roth is a bit better, but now I'm not sure. let's just say, I can pay the tax now if I move it to Roth, but still, I can't roll it all at once, correct?

Answer 1

you do not have to rollover to a traditional from a 401k... your can lump-sum it ALL out.

Check with your brokerage, but I do believe the initial funding is not limited to 4k$ a year.

Remember that you are paying $1000 in penalties for early disbursal.. and whatever your income tax rate is on $10K. If you do it all at one time, you are paying a high hit on the penalty and potentially a high hit on the taxes.

Were I you... I'd follow the path you are suggesting. Take it out in small bites and eat the penalties / pay the taxes that way.

If you are young, and absent a matching 401k, the Roth IS your wisest move....If you have a MATCHING 401k you should fund it first and keep the money where it is... as the "match" is an INSTANT ROI that cost you NOTHING...

Answer 2

Since the money you rollover won’t receive the 25% 401k match, you basically receive the same benefits from a Traditional IRA as you do from a 401k. Both accounts will allow your money to compound tax-free until retirement, when any withdrawals will be subject to income tax. So really, the basic question comes down to your satisfaction with the company plan and its options. If you’re happy with what the company 401k offers, you might go that route. Otherwise, the Traditional IRA is your best bet. Why? Because you maintain control over your own investment decisions. Also, what happens if the company 401k plan satisfies you now, but doesn’t at some point in the future? You might as well make the move to the Traditional IRA and take control now while the opportunity is available. A Traditional IRA will provide you with the same retirement savings benefits, but give you the added bonus of flexibility now and down the road… Also, in regard to the Traditional IRA annual fee… Do some research. Most of the online discount brokers I’ve researched waive annual IRA fees if you maintain a certain balance, usually a low threshold. You also state, “I cannot rollover to a Roth IRA.” Do a little research here as well… While you might not have a direct rollover option available through your company, if you rollover to a Traditional IRA, there’s no reason you should be barred from converting your Traditional IRA to a Roth IRA once the initial conversion is completed. In fact, if your income level is what prevents you from a Roth IRA rollover now, you’re in luck. Starting in the 2010, the IRS income limit on Roth IRA rollovers disappears. So, in 2010, regardless of how much you earn, you’ll be able to convert your Traditional IRA to a Roth IRA. While a Roth rollover will result in a taxable event in the current year, you benefit down the road from tax-free withdrawals from a Roth IRA. In other words, with a Roth, you never pay taxes again. That might be a nice complementary retirement account to have alongside your 401k, which triggers income taxes upon withdrawal. After all, who knows how high future income tax rates will be? Probably a lot higher than your rate today… But, with a Roth, who cares? It’s tax-free anyway! I hope this helps answer your questions, and best of luck to you.

Answer 3

first...compare tax rates now versus historical tax rates...they are lower now so there is no guarantee that tax rates will be higher when you retire as the first poster is hinting at. And if they do end up lower or the same then the tax deferred account is better.

If you have 10k in your account you won't be rolling in 10k. You'll be converting 8k. You will be paying the taxes on it now so you'll have less to move in.

You should be looking at the Roth as a different investment option just like you should be investing in tax free municipal bonds OUTSIDE of your 401k...so that you have additional tax free income when you retire. If you do the math using the thought that the tax rates are/will be equivalent for the two accounts then the Roth versus the tax deferred accounts come out exactly the same.

That's why the advice is out there to invest in your 401k AND your ROTH so that you have OPTIONS when you retire. That being said...I'd roll your 401k to a traditional IRA and contribute to a ROTH IRA on my own. That way you have both accounts and stay in a lower tax bracket as you won't have the 8k income to account for.

Answer 4

The annual contribution limits do not include Roll Overs. You can roll it over all at once.

I thought that there was a new rule this year that you roll directly to a Roth from a 401k. It didn't make a lot of sense to roll to a tradional first and then convert to a Roth. The net effect is the same.

With only $10k, it would probably make sense to do the Roth and pay the taxes.

Answer 5

If you were a farmer, would you rather be taxed on your seed now and not taxed on your harvest, or not taxed on your seed but be taxed on your harvest? Go with the Roth, and don't be fooled by thinking that you will be in a lower tax bracket when you are older.