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Lev
Lev, Tax Advisor
Category: Tax
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Experience:  Taxes, Immigration, Labor Relations
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converting a 401k account to IRA

Customer Question

Hello, I have a few questions about converting a 401k account to a Traditional vs a Roth IRA. In the event that I would choose to rollover to a Roth, I would pay the income taxes due using money outside my 401k. I was a regular W2 employee for the beginning of 2013 until end of April, when my employment was terminated. I moved to Japan and am now an employee of a Japanese company. It's safe to assume I will remain here until the end of 2014 at least. My questions are: (1) If I rollover to a Roth this year--when I have both W2 income and employee income in Japan--what will the tax rate be on the 401k account? How about next year, when I will be exclusively an employee of a Japanese company? (2) If I rollover to an existing Roth account, will I get all the benefits of a Roth with that "401k money", or will those benefits be limited? (3) If instead I rollover to a Traditional IRA now and decide to rollover a Roth later, how long must I wait after rolling over to the Traditional IRA? Thanks!

Submitted: 1 year ago.
Category: Tax
Expert:  Lev replied 1 year ago.

LEV :

Hi and welcome to Just Answer!
You are correct - if you convert funds to Roth IRA - the full amount will be added to your taxable income. However there are some advantages of having funds in Roth IRA - earnings potentially will never be taxed and there will not be RMD (required minimum distribution) after you turn 70 1/2.

LEV :

(1) If I rollover to a Roth this year--when I have both W2 income and employee income in Japan--what will the tax rate be on the 401k account?
The tax rate will be based on your total income and filing status. You may review tax rate schedule on the last page of this publication - www.irs.gov/pub/irs-pdf/i1040tt.pdf‎
How about next year, when I will be exclusively an employee of a Japanese company?
If you will qualify - you will be able to exclude foreign earned income from taxable income - however that exclusion would not affect your effective tax rate. Your remaining taxable income will be taxed at highest rate.

LEV :

(2) If I rollover to an existing Roth account, will I get all the benefits of a Roth with that "401k money", or will those benefits be limited?
You will have all Roth IRA benefits. However the immediate distribution from Roth IRA of these funds will be subject of 10% penalty if you are below 59 1/2. Otherwise - there is no difference.
(3) If instead I rollover to a Traditional IRA now and decide to rollover a Roth later, how long must I wait after rolling over to the Traditional IRA?
It is advisable that you avoid large taxable income because you might be pushed into higher tax bracket. So you may spread Roth IRA conversions over several years. You may convert some funds this year and some in following years.

Customer :

Thank you for the response! Just to be clear, it appears that if I have the same total gross income this year (from W2 employment + Japanese employment) and next year (Japanese employment only), that most likely the effect tax rate on the converted 401k account will be about the same.

Customer :

Is this correct? All other answers are understood--thanks.

LEV :

That is correct - unfortunately the way how foreign earned income is excluded was changed several years ago. Now - if you qualify for exclude - for instance $90,000 in foreign earned income and have another $10,000 taxable income that is not excluded - $10,000 is taxed at the same rate as if foreign earned income were not excluded.

Expert:  Lev replied 1 year ago.
Just in case you were not able to use the chat - I am switching to Q&A mode and porting the answer below.
Please feel free to communicate if you need any clarification or have other tax related issues.

That is correct - unfortunately the way how foreign earned income is excluded was changed several years ago. Now - if you qualify for exclude - for instance $90,000 in foreign earned income and have another $10,000 taxable income that is not excluded - $10,000 is taxed at the same rate as if foreign earned income were not excluded.

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Lev
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Taxes, Immigration, Labor Relations