Tips For Converting Your 401K
To view our videos, you need to
enable JavaScript. Learn how.
install Adobe Flash 9 or above. Install now.
Then come back here and refresh the page.
A recently passed bill is allowing for more options when it comes to managing your retirement savings. NY1's Tara Lynn Wagner filed the following Money Matters report.
Tucked into the Small Business Jobs Act is a big change regarding how you can save for retirement; namely converting traditional 401ks into Roth 401ks. The difference comes down to taxes. Certified Public Accountant Michael Goodman explains that with a traditional 401k, money is deposited pre-tax. So let's say you earn a thousand dollars."You can put that whole thousand in a 401k now and that's great. You get the whole thousand and you save," says Goodman.
With a Roth 401K, you have to pay taxes on that money first. If you're in the 30 percent tax bracket, that means Uncle Sam gets his cut -- $300 -- before you can set aside anything for the future.
"So you're only going to put in $700 instead of $1,000 in that scenario," explains Goodman.
The other difference comes later, when you start to tap into that account. With a traditional 401k, you have to pay taxes when you start to make withdrawals -- both on the amount you've invested and any interest it's earned. With a Roth, you already paid taxes on the initial investment and the money it earns grows tax-free. That means you won't pay Uncle Sam a dime when it's time to retire.
Greg McBride, a senior financial analyst with Bankrate.com, says this is particularly advantageous to people who start saving early.
"Think of it like a snowball. Do you want to pay taxes on a little tiny snowball on the top of the hill or do you want to pay taxes on a much bigger snowball on the bottom of a hill? If you've got enough years for that money to grow on a tax free basis, your tax obligation would be much bigger on a much higher account balance later in life," explains McBride.
Of course, conversion itself will cost you since you have to pay taxes on the amount you're converting. Again, you're in the 30 percent tax bracket. Convert $10,000 from a traditional 401k to a Roth and Uncle Sam's gonna take $3,000. That's good news for the government which gets to collect taxes on your money now rather than when you retire. Just be sure you have enough cash on hand to cover that tax bill.
"The tax obligation on conversion can in some cases be very significant. We're talking well into the thousands of dollars and for some people thats a hindrance to them wanting to the do the conversation," says McBride.
Another hinderance: in order to convert, you're company has to offer a Roth 401k and experts say, at the moment, not many of them do.
"Perhaps this legislation will precipitate more companies offering that to the menu of choices," says Goodman.