Is there any reasons I should not convert my IRA to a Roth IRA?

Question

I recently rolled a 401K into a SDIRA. At the time, I did not convert it to a ROTH SDIRA. I have purchased approx $25,000 in notes with the money but they have not been worked out yet thus they are still non-performing. I am considering converting the assets and the remaining money in the account to a ROTH. Aside from the having to pay taxes on the money and assets, is there any reason that I should NOT convert the account to a ROTH? I know I should consult with my accountant but I am considering switching to an accountant that is more real-estate investor saavy/strategic so I would rather not consult with them.

Is it best to do this BEFORE these notes get worked out? Are their downsides to this that I am not considering?

Steven Hamilton II · Answer

YES!!!! You will not be able to remove the money from your ROTH IRA to a 401k EVER.  Consider finding a way to roll it to a 401k

Kevin Yeats · Answer

Sandy,

You have a great idea .... but to answer your question, you really need to construct a spreadsheet with a lot of "what if" questions.

The two chief factors in the decision to convert are your current tax rate vs. what tax rate you will pay later.  With the winds of politics (make that a hurricane), future tax rates are very uncertain.  Will you be able to control your future income in a way to drop you into a lower tax bracket?

Second, what is the expected growth (rate of return) on the money in your IRA?  What are possible high rates of return and low rates of return?

Keep in mind that you don't have to convert ALL of your IRA into a Roth in one year.  You could partially convert over several years.

I suggest talking with several people, including accountants and perhaps a financial planner (not a product pusher), on this decision.

I knew a woman who had a sizable balance in her IRA and converted ALL of it to a Roth in one year so she could spread the tax payments over 5 years (the rules back then).  This on the advice of her accountant.  She was a single with no dependents and in the highest tax bracket.  She got hammered in taxes.  Kicker in this situation is that she had NO PLANS to continue working and remaining in that high tax bracket for more than another 3 years.  If she would have waited, she could have paid nearly 0 taxes on a partial conversion .... or at least paid taxes at only the lowest rate.  Moral: double and triple check the advice you receive.

Good Luck

Steven Hamilton II · Answer

You want to ideally be in a Roth 401k As for real estate transactions there is no UBIT (Unrelated Business Income Tax on leveraged transactions)  meaning she can finance a rental or such in the account.It can be a simple self employment situation or home party business that can support your 401k opening, You can then have a ROTH component.

Once money is put into a ROTH IRA it can NEVER be rolled out except to another ROTH IRA. Meaning the advantage of avoiding UBIT is lost.

Brian Eastman · Answer

@Sandy Uhlmann

There are a lot of factors that go into making such a decision, such as your age, the expected return on investment, current income & tax rates, expected tax rates in retirement, etc.

Generally speaking, the longer you will have the account and the higher the rate of return, the more likely you will achieve the desired result, which is access to more after-tax cash in retirement.

There are many good calculators out there on the web that can help you get a rough idea of the concept, but a conversation with a licensed professional who will help you look at all of the short term and long term variables is the right way to go.

A basic consideration is that the distributable amount in the converted Roth needs to equal or exceed the after-tax distributable amount of the traditional IRA + the personal cash you use to perform the conversion.

Converting before the account starts producing higher returns can be to your advantage.  Because you are considering converting "hard to value" assets, be sure to have a solid method of appraisal for the existing notes.

Mark Nolan · Answer

@Sandy Uhlmann

An advantage of a ROth IRA over a Roth 401k is that Roth IRA conversion can be reconverted back to a Traditional IRA by October 15 following the year of the Roth IRA conversion which is not the case for a Roth 401k conversion. Also, while there are workarounds, Roth 401k funds are subject to RMDs whereas Roth IRAs are not. Also, unless you take qualified distributions, it is more advantageous to take distributions from a Roth IRA than a Roth 401k because Roth 401k distributions consist of both basis and earnings whereas Roth IRAs have distribution ordering rules (for example, the basis can be withdrawn first  tax and penalty free without touching the earnings).

The following IRS websites shed more light on the above.

Differences Between Roth IRAs and Designated Roth Accounts

https://www.irs.gov/Retirement-Plans/Retirement-Pl...

Justin Windham · Answer

Sandy most likely rolled funds out of a very restrictive 401k with a previous employer into a self directed IRA that allows for investment into real estate. What Steven is most likely advising is rolling the funds into a self directed 401k that allows for Roth funds and comes with even more benefits than a self-directed IRA.

In general, from most restrictive/least powerful to least restrictive/most powerful:Regular IRA < Regular 401k < SD IRA < SD 401k

Justin Windham · Answer

I have to agree with @Steven Hamilton II (he is the tax expert, by the way). If you can avoid the Roth IRA and opt for a self directed 401k (a Roth 401k if you'd like Roth funds), it's going to offer you more advantages. A 401k can be transferred to a Roth IRA, but a Roth IRA can only go to another Roth IRA, so you get stuck with it.

Greg Kimura · Answer

Hi Sandy,

I've read the responses and there are some really good posts here.  I am not a financial planner, however I have set up my (our) retirement account, so I have a good grasp of what you should be considering.  I'm also in your age group, so I made plans for working another 15 years or so.

1.  I am in a high tax bracket right now.  I am pretty sure that I'll be in a much lower tax bracket when I retire.  If I convert to a Roth IRA, then the amount I transfer is taxed at today's tax rate (high).  If I leave it in a regular IRA, then when I start taking distributions, they are taxed at the tax rate when I take the money out (low tax rate).

2.  I did not do a SIDRA for the following reason: I wanted to use the money for investing in rental property or doing loans.  I chose a Solo 401k plan and I was able to purchase a rental house with my retirement money.  I also bought some high return D credit loans (with a lot of equity).  In about three years, I should be able to close out the loans (they'll be paid off) and use the money to buy another property.  I couldn't do this with a SIDRA.

3.  I read Steve Hamilton's posts and he has some great advice about converting to a Roth IRA and not being able to move it to a Solo 401k plan.  If you change to a Roth IRA, then you lose the flexibility to convert to a Solo 401k.

Make sure you have a good plan set up, but also keep in mind that the landscape will change in the next 10-15 years.  Make sure you keep up with the changes in retirement taxes and keep things as flexible as possible.

Bill Gulley · Answer

No, the "value" of an asset is not taxed nor does it increase, taxes are paid when assets are sold. Buying any note its value is the cost of acquisition or its market value, whichever is less. Payment attributed to a discount is taxed as principal. There is no tax recognition of the discount except as it is paid and upon a payoff. :)

Kevin Yeats · Answer

She just rolled the money FROM a 401k INTO a SDIRA.  Why would she want to roll money back into a 401k?

Is there any reasons I should not convert my IRA to a Roth IRA?

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