Roth IRA vs Roth 401 (k)

[Guest Jimibo]

Need a little clarification with what appears to be a loophole in the law. One of the glaring differences between the roth IRA and the roth 401(k) is the contribution amount each year. For 2007, I believe, the limit for the roth IRA is $4,000 while the limit for the roth 401(k) is $15,000. Another difference between the two investment vehicles is that there are no required distributions for a roth IRA while the roth 401(k) will force me to start withdrawing money at a specific age (I believe 70½).

I would like to combine the best of both of these types of investment and it appears that there is a way to do this. I wish to combine the high contribution limit of the roth 401(k) with the stretching power (no minimum distribution requirement) of the roth IRA. To do this I plan on maxing out my roth 401(k) each year that I am at my current job (let’s hypothetically say 5 years). When I leave that job, I will take my roth 401(k) and roll it to my current roth IRA which I have been contributing to each year. I believe that this is done with regular 401(k)s all the time. When you leave a job, you are allowed to roll a regular 401(k) (from a previous job) into a traditional IRA. Therefore, are you allowed to roll a Roth 401(k) into a Roth IRA? If I can do this rollover, would the government make me set up separate roth IRAs stipulating which I contributed money to as a roth IRA and which I contributed to as a Roth 401(k). I have not seen any published information on this loophole (if it does exist!) that could generate millions of dollars for investors. I am 27 now and am maxing out my contributions to my Roth 401(k). Can I be exempt from the Required Minimum Distribution of the Roth 401(k) through conversion to a Roth IRA as I leave each place of employment? Apologize if I wasn’t able to explain my question clearly. Comments welcome.

[Belgarath]

You explained it quite clearly. Yes, as the law stands now, you can do exactly what you propose - do a direct rollover of your Roth(k) accounts to your Roth IRA, with no RMD's from the Roth IRA. Whether the tax law will continue to allow this until such time as it matters to you, (40+ years) is obviously unknowable, but you can only plan based upon current law.

Incidentally, the limit for 2007 is $15,500.

[Guest Jimibo]

If that is then true, I could basically boost my roth IRA to hundreds of thousands of dollars within a very short period of time and never have to pay any further tax on the investment. I again am shocked that i have never seen any IRA experts address this because it is probably the most significant investment move that young people could ever make. Far more important than the other typical discussions and requires no financial savvy whatsoever.

[Guest mjb]

Most experts ignore this option because few 401k plans offer the Roth 401k and most taxpayers will be in a lower tax bracket when they retire which make a tax deductible contribution the better option. In order to boost your Roth contributions you have to boost the amount of taxes that are paid and lose the invest income on those taxes. The taxable income contributed to a Roth is subject to the 26-28% AMT tax while tax deductible contributions are not taxed.

[John Feldt ERPA CPC QPA]

Of course, depending on future tax schemes, if in 20+ years when a consumption tax is enacted, then you can just pay those taxes again as the funds are spent. Hopefully that won't happen, right?!

[Guest mjb]

It aint going to happen because (1) the rates imposed under a VAT tax to the conusmer to raise the same amount of revenue raised by the income tax would be as much as 50% of every item or service sold and (2) a consumption tax or VAT tax is too regressive for legislators to adopt. The top 50% of taxpayers pay over 90% of the fed income tax and the top 1% of taxpayers alone pay 35% of all income tax. The political advantage of the income tax is that it relieves lower income taxpayers of having to pay any income tax whereas a national sales tax, vat tax or flat tax would reduce the tax burden for wealthy taxpayers while raising taxes for everyone else.

Every politician who advocates a sales, Vat or Flat tax disappears quickly from the political radarscope. Remember Al Ullman the Chairman of ways and means who was voted out of office by oregon voters in 1980 because he made statements favoring a VAT tax and Steve Forbes, the presidential candidate who advocated a flat tax that could be filed on a post card because it taxed all income at the same rate with no deductions or exemptions.

[J Simmons]

I agree with mjb's comments on policies underlying alternate tax schemes. Additionally, the only consumption tax that I think could possibly be taken seriously would be one where the current income tax is determined, but the taxpayer would get a tax deduction for the net amount he or she saved during the year. If more is drawn out of savings during the year than added, the difference is treated as additional taxable income. With this kind of a consumption tax scheme, the progressive rates may yet apply--to higher spenders rather than higher earners. The problem is that this could cause a slow down in spending and thus a slowdown in economic growth. However, with the Social Security and Medicare future longterm as bleak as it is, this might make sense if coupled with means testing benefits under those two programs about 15 years down line from when this type of consumption tax scheme is implemented.

[John Feldt ERPA CPC QPA]

Great! I know that over 90% of the taxes are paid by only 50% of the taxpayers and that the top 1% pay 35% of all income taxes. As far as what will truly be legislated 20+ years from now, I hope you're both right, my crystal ball is broken!