The Roth 401(k) Conversion: Pros and Cons

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The Roth 401(k) Conversion: Pros and Cons

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May 13, 2014

Since the Pension Protection Act, Roth 401(k)’s are becoming more popular amongst investors through their employer sponsored retirement plan.   If you have been investing in a 401(k) for some period of time, it’s likely you’ve chosen the pre-tax option and maybe it is time to consider whether or not a Roth 401(k) conversion makes sense for your individual situation.

PROS:

  • If you believe you’ll be in a higher tax bracket in the future when you distribute these funds, then converting your existing 401(k) to a Roth 401(k) could make sense.
  • Roth 401(k)’s are subject to Required Minimum Distributions, but you can easily roll your Roth 401(k) into a Roth IRA and this can continue to allow you to defer dollars within your retirement accounts if you don’t need to distribute the money.
  • If the market has another depressed year like it has twice in the past fifteen years, that particular year could be a really good time to convert your existing 401(k) over to Roth 401(k) especially if you still have a long time horizon until retirement.

CONS:

  • Make sure you work with your accountant or CPA to really look at the tax implications.  Whatever you convert will be taxable income, so consider carefully what tax bracket the conversion may push you into in that tax year.
  • You will want to pay for the taxes with cash outside of your 401(k) plan.  This could chew up a good bunch of your existing cash reserve or liquid brokerage accounts.
  • Age works against you.  Typically, older participants that get into their 50’s or 60’s will have a more challenging time making this conversion.  The Roth conversion is more favorable for younger 401(k) participants due to the time frame they have before they will access the money.

This isn’t intended as an end all be all list, but a Roth 401(k) could also work if you have a year where your income is way down due to a job change or lighter results in your business.   In the next several years, it may be time for you to turn the 401(k) light switch to the ON position!

Written by: Ted Jenkin

Request a FREE consultation: www.oxygenfinancial.net

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