With the arrival of tax season, if you are thinking of rolling your 401(k) into a Roth account, financial guru and money expert Suze Orman says you might want to think twice — especially if you’re considering a massive conversion.
When Gina, a 56-year-old retiree, phoned into the Women & Money podcast, Orman didn’t mince words.
After Gina laid out her strategy — moving her $1.6 million pretax 401(k) into a Roth 401(k) and eventually rolling it into a Roth IRA — Orman dismissed the idea, calling it “crazy.” She then explained why this strategy could lead to huge tax consequences.
Here’s what Orman recommends instead and what you need to know before making a big retirement rollover decision.
Why It’s a ‘Crazy’ Move
Gina explained that she had recently retired at 56 with a pension and a nest egg of about $1.6 million in a pretax 401(k). Her idea was to shift that balance into Roth accounts over time. The plan included moving $1.6 million into her Roth 401(k), rolling it into a Roth IRA and then covering the hefty tax bill by pulling money directly from her 401(k).
She asked Orman if it makes sense to roll over funds from the 401(k) into the Roth IRA over the next 10 years, and then do an immediate withdrawal from her 401(k) for the amount owed in taxes, about $40,000, and then ask her company to withhold 100% of this amount.
“Are you crazy? Really? I don’t know how else to say it,” Orman said.
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She pointed out that money in a 401(k) is pre-tax, and if you do a rollover to a Roth 401(k), it’s not actually a rollover. It’s called a conversion, which involves moving money from a pre-tax account to an after-tax account.
“So guess what? My dear Gina, you owe income taxes at that point in time for that year’s income tax,” Orman said. “So that’s absolutely crazy.”
What Orman Recommends Instead
Instead of following this “crazy” move, which was suggested to Gina by her employer’s benefits person, Orman recommended that she take $100,000 out of her pre-tax 401(k), converting it into her Roth IRA and paying taxes on it.
Orman pointed out that rolling money from a Roth 401(k) into a Roth IRA doesn’t automatically make all future withdrawals tax-free. According to the IRS, a Roth IRA must be open for at least five tax years before any earnings can be withdrawn without tax, in addition to meeting an age or other qualifying condition.
If your Roth IRA is newer than five years, money you roll over from a Roth 401(k) still counts as a Roth IRA contribution, but the earnings on those amounts could be taxable, and possibly subject to a 10% penalty, if withdrawn early.
“There is no way for you to get around the taxes,” Orman said. “If you wanna do it, you’re gonna have to pay taxes on it in the year that you convert. So start converting now and just pay taxes from your savings, or don’t do it at all.”
Caitlyn Moorhead contributed to the reporting for this article.
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This article originally appeared on GOBankingRates.com: Suze Orman Calls This $1.6 Million 401(k) Rollover Move ‘Crazy’
