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Sara Nunnally
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Sara is Co-Editor of Smart Investing Daily. As Senior Research Director and global correspondent, Sara Nunnally's diverse resume includes studies in art history, computer science and financial research. She has appeared on news media such as Forbes on Fox, Fox News Live, and CNBC's Squawk Box,... More
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  • Uncle Sam Wants You... To Have A Roth 401(K) 1 comment
    Jan 4, 2013 4:37 PM

    Attention, everyone holding a 401(k)! Whether you're on the verge of retirement, or just starting to contribute to your account, the U.S. government is recruiting you to join an elite squad of retirement plans...

    The Roth 401(k)s!

    Here are the terms: No signing bonus, and you have to pay your taxes up front.

    Sound like a deal? Who's ready to sign up?

    The truth is, this isn't a good deal for everyone, but for some of you, it's worth considering.

    This deal came out of the fiscal cliff talks, and is expected to generate $12.2 billion in revenue over the next 10 years. That would come from investors moving some $48 billion in assets from their 401(k)s to a Roth account.

    Previously, only certain funds and plans were allowed to switch to a Roth 401(k), but now the gates are open to all accounts, putting some $5 trillion in assets on the table. From Bloomberg:

    "This dramatically expands the number of participants who can use this provision," said Bob Holcomb, executive director of legislative and regulatory affairs for JPMorgan Chase & Co.'s (NYSE:JPM) retirement plan services. "It will allow any amount to be transferred."

    That $48 billion seems like an achievable number... but what you need to consider is if a move is right for you.

    First, you pay taxes on your contributions, not your gains. That really simplifies things for you in retirement. You know what's in your account, and what's there is yours. You may pay a higher percentage of taxes up front, especially as your wealth bumps you into a higher income bracket, but what you take out is tax-free.

    The big wrench in that system, however, is the big chunk of change you'll have to pay out if you're converting a large 401(k) account to a Roth account. If you have a million-dollar account and you're taxed at the highest income rate of 39.6%, you will have to pay $396,000 to get that money into a Roth.

    That can really deplete your investments. If you've got the cash outside of your 401(k), that's one thing, but if you don't, you're putting a big chunk of your retirement wealth right into the government's coffers.

    (Which is the whole point of opening the gates to Roth accounts for all funds and plans.)

    But for those of you not in the top tax bracket now, but expecting your tax rate to be higher in retirement, this step could save you a lot of money. Some tax experts say that if you're in the 15-25% tax brackets, and have a while before you expect to retire, it might make sense for you to take advantage of this new legislation.

    Outside of the tax situation, however, there aren't many other reasons you should consider a Roth 401(k) account.

    If anything, you should be looking to roll over your traditional 401(k) to a Roth IRA account. You'd be subject to the same taxation as if you were getting into a Roth 401(k), but here's where things get really interesting.

    Roth IRAs offer a number of different investment avenues not available in your traditional 401(k)... Things like real estate, private equity, business startups and other unconventional investments.

    These asset classes are off-limits to traditional 401(k) holders. You could buy land, or condominiums, or even tax lien certificates.

    There are differences to how much you're allowed to contribute to your 401(k)s and your IRAs, to the tune of thousands... and your employer won't be able to match your contributions.

    But for some folks looking to take their investment access off of Wall Street, and into the world of tax-free distributions, a Roth IRA is the way to go.

    Happy Investing,

    Sara


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  • azbroker
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    Comments (61) | Send Message
     
    So if I have 1 million in a 401 K and I quit my job for 1 year, so my earned income for 2013 is $0, My tax rate will also be 0%. And I roll my 401k into a Roth, will I "earn" $396K just by not working? Or would I have to report the $396K in earned income and pay the marginal rate on that?

     

    If so it seems like a great incentive for some people to pauperize themselves for a year.
    23 Jan 2013, 03:54 AM Reply Like
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