I just read a news article about the various options available when rolling over a 401(k) from a previous employer. (I like to call that an ”Orphaned 401(k)”) The article talked about the normal options of cashing it out (a bad idea unless you’re over 59 1/2 or you’re losing your house for some reason), rolling it over from the previous employer’s 401(k) to the new employer’s 401(k), or actually rolling it over to an IRA.
At the end of the article it talks about also converting the 401(k) to a Roth IRA and having to pay the taxes on the amount converted. That could be “a big shock at tax time”, because the amount converted is added to ordinary income. In some cases, that could push the taxpayer into a higher tax bracket, and create an unexpected burden.
The one thing the author failed to mention – which is a very interesting oversight because we are so close to 2010 — is the fact that during 2010, and only during 2010, the government has set up a much more favorable environment for converting from a traditional IRA or a 401(k) to a Roth IRA. Here are the rules in a nutshell for 2010:
- There are no income limits for converting to a Roth in 2010. Usually, only those who make under $100,000 are allowed this conversion.
- If you convert in 2010, you can spread the tax burden over two years, by reporting only half the converted amount in each year.
- If you convert in 2010, you can delay reporting the conversion until 2011. That’s right. You can pay the taxes over two years, but those two years are 2011 and 2012, not 2010.
Adding this information to the article, a clear strategy emerges for those wishing to convert their orphaned 401(k)s to Roth IRAs.
Wait until 2010. Heck, it’s only three months away.
The tax burden, while still there, will be delayed and then spread out over a longer time, giving the taxpayer a decent amount of time to set aside a little each month for the eventual payments needed, making it, in my opinion, significantly more manageable.
This is definitely one strategy to consider and may not fit for everyone. As always, and as the article said, sit down with your tax advisor to determine the best scenario for your situation.
{ 1 comment… read it below or add one }
Paul,
This is an excellent and timely article. Being newly separated from GM, I am desperately trying to find the best way to get most out of my pension fund, my 401K, my conventional IRA and a small Roth IRA. Gayle and I have many investment / business goals, but paying the least possible taxes is right at the top!