Should I stop contributing to my 401(k)?
I am 55 years old. I have $502K in my 401(k). I have nothing in any other retirement program (except SS). Is it valuable or even worth it to stop contributing to my 401(k) and diving into a Roth? Should I take the tax hit on the 401(k) and roll some of it over into a Roth? I currently put the annual max into my 401(k).
This is a great question and congrats on hitting the annual maximum contribution limit! Does your 401(k) provide matching contributions? If so, the short answer is “no,” you should not stop contributing to your 401(k). Matching contributions from your employer is free money. I wrote an article called Don’t Neglect Your 401(k) Retirement Plan that goes into more detail on the benefits.
I highly recommend contributing to a Roth IRA, but generally, when it’s with new contributions as opposed to converting. Does your 401(k) allow for Roth contributions? If so, then your problem is solved. If not, start pestering your benefits department so they will make Roth contributions available. If you’re not familiar with Roth 401(k) plans, read my article Roth 401(k) Plans: 5 Things You Need To Know.
Depending on your income, you might be eligible to make Roth IRA contributions in addition to maxing out the 401(k). The ideal situation would be to max out both the Roth IRA and 401(k) so if you can, do it. Assuming you work for another 10 years, contributing to a Roth IRA each year will allow the opportunity for growth and provide a source of tax free withdrawals to supplement your retirement income. I wrote about the importance of this in my article called Tax Diversification. I hope you find it helpful.
Please note that this should not be considered investment advice and is only educational in nature. Please be sure to consult with your own legal, tax, or investment advisor regarding your specific situation.
Best of luck!
David N. Waldrop, CFP®
I personally would not convert, especially while still working. I would always take a current tax deduction or deferral rather than an immediate tax liability. The conversion will be added to all the other income you have and may push you into a higher tax bracket. And If your company matches, I would put at least up to the match in the 401(k) as that is "free money" and either a 50% or 100% return depending on the match.
Also, you are not phased out of a Roth if your income is less than $133,000 for an individual or $186,000 filing jointly. This means you could do both, max out your 401(k) and do a Roth IRA contribution or some combination thereof. So they may not be mutually exclusive. Now I am talking about contributions not conversions.
Again, I am not a big fan of conversions unless you are young and are in a low tax bracket. This is because with the conversion, you lose the compounding effect on the assets used in paying the taxes. And the income "distributions" you take from your 401(k)/regular IRA rollover will be spread out over your lifetime while the corpus will still be invested and compounding.
Hope this helps, Dan Stewart CFA®
If you max out your 401(k) contribution every year ($18,000), you'll end up putting away more for retirement, especially if your employer matches a portion, than you could by maxing out a Roth ($6,500). If you are married, file jointly and have Adjusted Gross Income of less than $184,000, you should do both.
The older you get, the less attractive a Roth conversion becomes because even though conversions aren't subject to the 10% early withdrawal penalty, you'll still pay ordinary income tax when you convert an IRA or other tax-deferred retirement plan to a Roth. The average American is in a blended 18% tax bracket so even if you get a healthy return on the investments in the Roth, it will be several years before you break even.
Your 401(k) likely has a match, and that is FREE MONEY! You should do whatever it takes to get all the free money you can. Above that amount, you could defer some of those dollars into a Roth IRA, but you can also do both, max out your 401(k) AND contribute to a Roth IRA (assuming you are under the earnings threshold).
Two important questions for you in order give advice:
1) When do you expect to retire?
2) Whether or not your plan will allow you to roll over some of the account value in your 401(k). Some plans allow for rollovers to IRAs once you reach age 55. Most plans do not. They either require you reach the attained age of 60 or 62 for example, or physically retire from the job. Let's be clear, if you are able to roll over part of your 401(k) account value to a self-directed IRA, it could be a real plus if you are seeking to lock in secure income with an IRA annuity. If you have no pension or would like to add to your pension, you could grow a lifetime income benefit at 6% to 9% a year in the right annuity inside your new IRA. That annuity would provide income of 6% to 10% yield to cost when you retire, payable for life, and you can include your spouse on the annuity. You would keep your current 401(k) plan intact and if you are getting a match from your employer, it may make the most sense to simply continue to do that rather than the Roth. Once again, this is a tax question more than an investment question.
If your top priority is to save taxes over your entire retirement, the Roth is a good choice. However, you must put it in perspective. How much money will you actually accumulate in the Roth? If you start the Roth idea and then quit, like so many people do, you will have a whopping $10,000 to $20,000 in a Roth IRA one day. I see it all the time. That money will not "feed the bulldog" for very long and may become bucket list vacation money. If you start the Roth and stay committed to it, it can be a beautiful thing.
Ultimately, the Roth idea is fine if taxes are the priority and you wouldn't care about missing the deduction on your current tax returns. If that is no worry, the way is clear. The Roth is always best when taxes in the long run, rather than the short run, are the focus.