Rolling IRA into 401K

[drivingaround]

I posted this in YM but didn't get any responses. Neither our tax accountant or investment advisor was able to help. Thought I'd try here although recognize it is a pretty specific question.

I need help determining if this retirement investment option is a solid idea. Bit of background:

Ages - 32 & 36 (MFJ)
Gross income w/bonuses - $200k
AGI - $185k (max 401k’s but have investment income)

Our income has fluctuated the last 5 years so aren’t always able to make contributions to Roth IRA due to exceeding income limit. Typically fund current year contribution Jan – Mar then a year later, when filing taxes, recharacterize the Roth as non-deductible contribution to regular IRA. The amount recharacterized depends if allowed a partial contribution or not. With the income limit on converting IRA contributions to Roth IRA eliminated, thus enjoying tax free growth, I want to know if this would 1. Work and 2. Be smart.

DH IRA includes:

Rolled over 401k - $125,000
Non deductible contributions – $15,000
Earnings – $5,000 (this is an estimate, I need to dig up paperwork on exact amount)

DW IRA includes:

Rolled over 401k - $90,000
Non deductible contributions – $15,046
Earnings – $5,000 (this is an estimate, I need to dig up paperwork on exact amount)

Based on my research I could roll the 401K portion and related earnings into current 401k’s (Assuming our plans allow it) then convert the non deductible contributions and earnings to Roth IRAs. By rolling the 401k portion into current 401k we can avoid including any of the rollover in 2011 income. That is the only reason we’re considering it given converting the full balances to Roth doesn’t make sense with our tax bracket. Does anyone have experience doing this? Our 401k investment choices are more limited than IRA however tax free growth & distributions on our non deductible contributions is what we’re looking for. What I haven’t been able to locate information on is if rolling the earnings into the 401K plan counts towards your current year contributions.

If the above scenario isn’t a good idea should we quit making nondeductible contributions? Leaning towards yes since capital gains tax is significantly less than ordinary income tax rates but 30 years of tax free growth is enticing.

[rovo]

drivingaround, This is too complicated for me but maybe someone else on this board can help you.

[phil5185]

If the above scenario isn’t a good idea should we quit making nondeductible contributions? Leaning towards yes since capital gains tax is significantly less than ordinary income tax rates but 30 years of tax free growth is enticing.

Keep in mind - tax free growth is only enticing if you didn't have to pay an even higher tax to buy into the tax free growth. Eg, you wouldn't want to pay a $5000 tax to 'liberate' $10,000 so that it could grow to $230,000 in 30 yrs. Instead you would keep the whole $15,000 and grow it to a taxable $345,000 - and then pay a lower tax (maybe $50k or $75k) over the yrs after age 70 1/2.

As for the nondeductible contributions - as such they are a bad deal, you will pay full ordinary income tax on the earnings when you sell (rather than cap gains rates). But they have a temporary use, for a couple of yrs you are allowed to convert them to Roths.

And I would not roll the old 401k's into new 401k's - it is a near certainty that you will have more & better choices in a Rollover IRA with a no-load provider. And, at retirement, that is where your current IRAs will go.

[drivingaround]

As for the nondeductible contributions - as such they are a bad deal, you will pay full ordinary income tax on the earnings when you sell (rather than cap gains rates). But they have a temporary use, for a couple of yrs you are allowed to convert them to Roths.



Thanks, Phil. My only problem with the above is I can’t elect to just convert the non-deductible portion of my IRA to the Roth I have to take a % of the total IRA balance then that is the portion of my conversion that is taxable. Being in the 28% bracket that would be painful.

I haven’t filed the 2010 recharacterization forms so might instead see if I can have the Roth contributions withdrawn. I can’t remember if penalties are applicable or not. If there are will make them nondeductible. Sadly only recently thought out this scenario so expect 2011 to have similar outcome (exceed Roth income limit). Note to self… don’t make annual contributions until after tax return is drafted!

[phil5185]

My only problem with the above is I can’t elect to just convert the non-deductible portion of my IRA to the Roth I have to take a % of the total IRA balance then that is the portion of my conversion that is taxable. Being in the 28% bracket that would be painful.

My 401k had a non-deductible component left from a profit sharing plan of the 1970's. When I retired I had the same issue that you have - couldn't split out the non-deductible part of the 401k. So I rolled the 401k to a Trad IRA - and then split off the non-deductible portion. (I didn't want non-ded money in the IRA, it contaminates the RMD calculation at age 70 1/2)