Strategy of moving taxable money to Roth IRA

[rhymenocerous]

I have mostly been maxing out my pre-tax 401k and Roth IRA each year, but I have a small taxable account of $25k invested in GTU.  My company 401k allows me to contribute after-tax money to my 401k, so I've been thinking about doing this and using my taxable account to pay for living expenses.  The after-tax money would go into a money market fund, and I can withdraw it twice a year and move it to my Roth IRA.  My problem is that gold is currently down as a % of my portfolio, so I don't want to really be exchanging gold for cash.  I'd rather be buying more gold.  Is it worth it for the benefit of building up my Roth though?  It would take me about 1 year to move all $25k.

[notsheigetz]

I have mostly been maxing out my pre-tax 401k and Roth IRA each year, but I have a small taxable account of $25k invested in GTU.  My company 401k allows me to contribute after-tax money to my 401k, so I've been thinking about doing this and using my taxable account to pay for living expenses.  The after-tax money would go into a money market fund, and I can withdraw it twice a year and move it to my Roth IRA.  My problem is that gold is currently down as a % of my portfolio, so I don't want to really be exchanging gold for cash.  I'd rather be buying more gold.  Is it worth it for the benefit of building up my Roth though?  It would take me about 1 year to move all $25k.

I was actually in a very similar situation to yours but with gold being down I used it as an opportunity to convert to physical, something I had been planning on doing for a long time.

I'm now toying with the idea of doing the same thing with the Gold ETFs I'm holding in a Roth account.

One thing I don't understand is what your reasoning is on putting after tax money into your company 401k. Of all 3 investment vehicles, taxable, Roth and traditional the one that is likely to have the highest tax liability is the traditional because it will be taxed as ordinary income and you will have mandatory distributions. Unless there is some advantage I'm missing I can't see why anyone would want to do this.

[rhymenocerous]

The 401k max is $51k per year in 2013.  Let's say you contribute $17.5k pre-tax and your employer matches $3.5k.  That means you can contribute $30k in after-tax money to your 401k.  You can then withdraw that $30k each year and move it to a Roth IRA, paying tax only on the gains on that money.  This effectively allows you to contribute $35.5k to a Roth IRA each year.  Your 401k has to allow for this; not all plans do.  So instead of putting $30k in a taxable account, you end up with $30k in a Roth where the gains can grow tax-free forever.

[notsheigetz]

The 401k max is $51k per year in 2013.  Let's say you contribute $17.5k pre-tax and your employer matches $3.5k.  That means you can contribute $30k in after-tax money to your 401k.  You can then withdraw that $30k each year and move it to a Roth IRA, paying tax only on the gains on that money.  This effectively allows you to contribute $35.5k to a Roth IRA each year.  Your 401k has to allow for this; not all plans do.  So instead of putting $30k in a taxable account, you end up with $30k in a Roth where the gains can grow tax-free forever.

First I've ever heard of this strategy. We do have both Roth and traditional at my company but I don't think they allow this.

I've kind of soured on the Roth idea lately any way.

[rhymenocerous]

I think you are thinking of the $17.5k portion of the 401k.  You can either put this money in pre-tax (ie traditional), or after-tax (ie Roth), as some companies are offering this now.  That's not what I'm talking about, however.  There is a $51k hard limit on all 401k money.  This includes $17.5k + employer match + other.  You can fill up this "other" option in the 401k until the total of all three reaches $51k.  This "other" money, which is after-tax, can be moved from your 401k to a traditional IRA throughout the year, and you can then convert that traditional IRA to a Roth.

[MachineGhost]

One thing I don't understand is what your reasoning is on putting after tax money into your company 401k. Of all 3 investment vehicles, taxable, Roth and traditional the one that is likely to have the highest tax liability is the traditional because it will be taxed as ordinary income and you will have mandatory distributions. Unless there is some advantage I'm missing I can't see why anyone would want to do this.

During my research into variable annuities, I learned that you can bypass those stupid mandatory distributions by rolling the retirement plan into one.  Good riddance.

EDIT: Until age 90.

[notsheigetz]

I think you are thinking of the $17.5k portion of the 401k.  You can either put this money in pre-tax (ie traditional), or after-tax (ie Roth), as some companies are offering this now.  That's not what I'm talking about, however.  There is a $51k hard limit on all 401k money.  This includes $17.5k + employer match + other.  You can fill up this "other" option in the 401k until the total of all three reaches $51k.  This "other" money, which is after-tax, can be moved from your 401k to a traditional IRA throughout the year, and you can then convert that traditional IRA to a Roth.

No, I did get what you were talking about after doing some Googling. Interestingly enough I found our very own MediumTex weighing in on it in the Bogleheads forum at the top of my search.

I had never heard of this strategy before. My own company offers both Roth and Traditional but not the after-tax traditional. I did encounter this in my wife's previous employer's plan and I remember thinking why would anyone want to contribute to a Traditional 401k "after-tax" for the reasons I stated. Now I get it.

It's a moot point now because I don't think the option is available to either me or my wife and like I said I've kind of soured on the Roth idea. This is mainly because I'm not that far away from retirement and have a fairly good handle on what my tax situation is likely to be and I don't think the Roth IRA is going to improve it very much, if at all.

What I really find weird about this although I probably shouldn't, given the nature of government, is if they are going to allow some people to contribute $35k/year into a Roth IRA through little-known procedures like this which only some people can take advantage of why in the hell not just let everyone contribute up to $35k and be done with it.

But like I say, I shouldn't be surprised.

[notsheigetz]

One thing I don't understand is what your reasoning is on putting after tax money into your company 401k. Of all 3 investment vehicles, taxable, Roth and traditional the one that is likely to have the highest tax liability is the traditional because it will be taxed as ordinary income and you will have mandatory distributions. Unless there is some advantage I'm missing I can't see why anyone would want to do this.

During my research into variable annuities, I learned that you can bypass those stupid mandatory distributions by rolling the retirement plan into one.  Good riddance.

I have heard of this too but haven't fully investigated. My own MRD situation won't be so bad initially, because my wife is 17 years younger and I don't have to take out as big a percentage. Further down the road however it does get more worrisome as they calculate the remaining years of your dwindling life expectancy. If your portfolio does really well you could really get punished for it in the last years of your life.

(So maybe I should rethink the Roth I've been questioning after all?).

[Libertarian666]

I think it is very naive, surprisingly so for such a generally well-informed group, to believe that the government will honor its promise not to tax the gains in a Roth.

[moda0306]

I think it is very naive, surprisingly so for such a generally well-informed group, to believe that the government will honor its promise not to tax the gains in a Roth.

Well, first, our government controls its own currency, so the need to overtly tax isn't what it is at the state level or Euro participants.  Otherwise I might have a similar fear.

Further, though, retired people vote and are the holy grail of political pandering.  Try telling people that money that they've specifically allocated to a tax-free scenario is now going to be taxed and they'll write their representatives in droves.  If the government really gets to a point where they desperately need to tax us more, which seems really unlikely when you understand our monetary system, it's likely that the Roth IRA will be one of the last things to be hit, behind higher ordinary rates, fewer deductions, higher corporate and/or estate tax, or taxing investment income more.  Those things are palatable and understandable to most of the electorate.  Taxing a Roth would piss even my biggest hippy friends off.

And in the end, we can only work with the tools we have available to us.  Most of us are attempting to achieve some sort of balance in our tax hedging strategy, knowing anything's possible.  If the government is going to tax us, between using the tax of inflation, and all the tax moves that would make strategic sense to employ, I'd be surprised if they'd tax Roth earnings, but even if they do, what are we supposed to do in the mean-time to prepare for such an event?  Invest 100% pre-tax into our 401(k)?  Attempt to commit tax fraud with investments that don't send us 1099's? 

I've gotten to the point where when my ability to accurately predict an outcome, and my ability to properly hedge against that outcome even if it did happen, have been exhausted, that I just keep it filed in the back of my mind as something to get creative on someday when I can either predict or prepare with more certainty.  Until then, I'll spend my time trying to predict what I can, and controlling what I can, and the Roth IRA will be one of my favorite tools to increase the certainty that I'm prepared for higher taxes in the future.

[rocketdog]

If the gov't decides to tax Roth IRAs, it will be a long time coming for sure.  And it won't be an all-or-nothing proposition; gov't doesn't normally work that way for precisely the reasons you state.  Instead, they gradually bring it in little by little so that no ones really notices or complains.  Just the way they did with the income tax. 

So they might tax only the amount over a certain theshold, or they might start instituting RMDs (to prevent passing the account on to your heirs), or they might tax what's left at your death, and so on. 

I'm erring on the side of caution and fully funding both my 401K and Roth IRA, so that I have more options at retirement (assuming the laws haven't changed substantially by then).  To not contribute to a Roth on the assumption that the gov't won't keep its promise seems foolhardy, especially if you forego the Roth in favor of a regular taxable account. 

[moda0306]

To not contribute to a Roth on the assumption that the gov't won't keep its promise seems foolhardy, especially if you forego the Roth in favor of a regular taxable account. 

Exactly.  In reality, I think having a good mix of pre-tax, Roth, physical gold and cash, and a paid-off (if you're old... if you're young I think holding a mortgage and building Roth basis is smarter) home with a line of credit approved are the best ways to be able to pivot should things change.

I'm assuming everyone has a threshhold where they're not going to claim physical gold gains, or report it as an asset if required.  I don't disagree with positioning ourselves.

And let's be honest... governments "taxing" is more likely to be in the form of inflation... or more specifically, inflation in excess of the rate of return on safe assets.  I think, in this world, putting ourselves in a position to take advantage of negative real rates when they present themselves in the form of some leveraged strategies is going to be the best way to avoid this "tax."  However, this is against HB's rules and for good reasons.  I just think that we may want to realize where the "new" form of tax is coming from and consider amending our opinions on low-interest, tax-deductible debt accordingly.

[cnh]

I share the sentiments of Libertarian666, moda0306 and rocketdog on this one. There are compelling arguments for "tax diversification," and I wouldn't go "all in" on Roth IRAs or Roth 401Ks.  I prefer to diversify assets across Roth IRAs, 401Ks and taxable brokerage accounts.

[notsheigetz]

I think it is very naive, surprisingly so for such a generally well-informed group, to believe that the government will honor its promise not to tax the gains in a Roth.

I don't think we are as naive as you believe. Not only do I think the government could go back on its promise to tax Roth IRA's I believe they could seize them altogether as well as all of your other IRA's. I get a kick out of people who ask if the same thing that is happening in Cyprus could happen here. I say just look at your paycheck - they already took what they wanted before you even saw it didn't they? If it comes down to the government paying its bills versus private citizens paying their bills, guess who is always going to win that battle?

What our well-informed group doesn't have however, is a crystal ball that tells us if or when the economic conditions will be ripe for this. So that's why we can only go with the information we have and play all the angles.

[rocketdog]

I think it is very naive, surprisingly so for such a generally well-informed group, to believe that the government will honor its promise not to tax the gains in a Roth.

I don't think we are as naive as you believe. Not only do I think the government could go back on its promise to tax Roth IRA's I believe they could seize them altogether as well as all of your other IRA's.

This is the stuff revolutions are made of.

[Libertarian666]

Here are just three broken government promises about financial matters that come to mind immediately. I'm sure there are many more.

1. Social Security payments would never be taxed.
2. The SS "trust fund" was inviolable.
3. The dollar was redeemable for gold at will.

Anyone who counted on any of those was disappointed. I'm sure many others will be disappointed in the future.

And I haven't noticed any revolutions for those reasons, or any other reason, for that matter. So far, anyway.

[rocketdog]

Here are just three broken government promises about financial matters that come to mind immediately. I'm sure there are many more.

1. Social Security payments would never be taxed.
2. The SS "trust fund" was inviolable.
3. The dollar was redeemable for gold at will.

Anyone who counted on any of those was disappointed. I'm sure many others will be disappointed in the future.

And I haven't noticed any revolutions for those reasons, or any other reason, for that matter. So far, anyway.

It's like the allegory about how to boil a live frog:  You don't toss him into a pot of hot water because he'll jump right out.  You put him in a pot of cold water and very slowly turn up the heat so that he doesn't realize he's slowly being cooked alive.  I don't know if that's true or not, but the analogy is useful here (hint: we're the frogs). 

[notsheigetz]

It's like the allegory about how to boil a live frog:  You don't toss him into a pot of hot water because he'll jump right out.  You put him in a pot of cold water and very slowly turn up the heat so that he doesn't realize he's slowly being cooked alive.  I don't know if that's true or not, but the analogy is useful here (hint: we're the frogs).

I read somewhere not long ago that the frog allegory isn't actually true and the frog really will have enough sense to get the hell out of the water before boiling to death.

Nice to know for frogs but I still suspect it might be a true allegory for humans.

[AgAuMoney]

I read somewhere not long ago that the frog allegory isn't actually true and the frog really will have enough sense to get the hell out of the water before boiling to death.

Nice to know for frogs but I still suspect it might be a true allegory for humans.

I have the same recollection.

It just took decades for someone mean enough to do that to a frog came along to try it.

Meanwhile, no problem heating up the pot of humans.