New legislation will allow workers to convert money in a 401(k) into a Roth 401(k). If I had different financial circumstances, I would jump on the chance so I could make tax-free withdrawals from my retirement account when I'm old. However, there is a price to pay for converting to a Roth 401(k). According to a recent article by The Wall Street Journal, some experts are calling the new provision in the tax law a bonanza for investors, while others see it as a trap. For me, the conversion would not help me meet my financial goals.
Having better options
I have the unique opportunity to roll over my 401(k) money into a regular IRA since I work for a company that changed ownership. After doing the rollover into a regular IRA, I could then convert to a Roth IRA. Although it may sound as though I'm taking extra steps to accomplish the same goal, I'm really not. For me, it's much more advantageous to have my money in a Roth IRA rather than a Roth 401(k). Once my retirement money is in a Roth, I can invest in virtually anything. I can pick from thousands of individuals stocks and exchange traded funds (ETFS). However, there are no ETFS available in my company-sponsored 401(k) plan. I only have a limited choice of mutual funds and target-date funds, which I personally despise.
Paying the big tax bill
Whether I convert to a Roth 401(k) or eventually to a Roth IRA, I'd have to pay the ordinary income taxes. That's because people don't have to pay taxes upfront on money they put into a 401(k) or regular IRA account. It's almost as if that money is invisible to the IRS until a person retires. Of course, I don't want to pay as much taxes when I'm old. However, the problem is we already have such a high tax bill. I can't afford to pay a higher one now. Moreover, our paychecks are shrinking this year since the government decided to end the tax holiday and start putting more of our earned income into Social Security.
Taking a gradual approach
While some experts say a person can lighten their tax load now by converting smaller amounts over time, I rather than make sure my future contributions are to the Roth 401(k) rather than the regular 401(k). The article pointed out that a person who wants to move a half a million into a Roth 401(k) might have pay as much as $165,000 in taxes. I don't have a half a million in my retirement accounts, but I know even converting $5,000 a year could create a tax burden. I plan to simply take any new money I earn and let it be invested in a Roth 401(k). Although investing in a regular IRA or a regular 401(k) is supposed to lighten the tax bill now, I've never noticed it make a dent in my tax bill every year.
If I didn't have the opportunity to roll my 401(k) money over to a regular IRA account, I think I'd roll over a little money at a time into a Roth 401(k). I'm fortunate that the company I work for had a Roth 401(k). According to the article, less than half of companies even allow Roth 401(k) contributions. It's a shame more employers don't offer the option. The greatest advantage of having my money in a Roth 401(k) is being able to one day roll that money over into a Roth IRA without having to pay taxes. Sometimes I wish retirement investing wasn't quite as complicated, but I'm hoping staying on top of things will pay off.
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