Rolling Over From 401K to (Roth?) IRA + Education


K

kramer31

I have been making contributions to both a 401K and IRA for the past
4.5 years, but recently parted ways from the company with which I had
the 401K. I have about $79K in the 401K and $14K in the IRA.

I believe that a Roth makes more sense for me long term and would like
to roll both into a Roth IRA, but now I need to consider the tax
implications.

First, if I use some of the cash from the 401K/IRA to pay the taxes,
that would be considered a disbursement for which I would pay a
penalty, correct? So I would need to pay those taxes using other
means to avoid that penalty.

Second, I will be in school in the fall. Technically, I will be in
school full time and working full time (Executive MBA). Now as I
understand it, the tuition for an Executive MBA might or might not be
deductible, but if I want to deduct it, I should prepare to be audited
and be able to make a strong argument that it is truly a business
expense, correct?

Third after I am enrolled, can I take a disbursement from the IRA and
avoid the penalty by claiming it as being for educational expenses,
but then use the money to pay the taxes on the rollover?

Thanks in advance for any help that anyone provides!
 
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J

JoeTaxpayer

I have been making contributions to both a 401K and IRA for the past
4.5 years, but recently parted ways from the company with which I had
the 401K. I have about $79K in the 401K and $14K in the IRA.

I believe that a Roth makes more sense for me long term and would like
to roll both into a Roth IRA, but now I need to consider the tax
implications.

First, if I use some of the cash from the 401K/IRA to pay the taxes,
that would be considered a disbursement for which I would pay a
penalty, correct? So I would need to pay those taxes using other
means to avoid that penalty.

Second, I will be in school in the fall. Technically, I will be in
school full time and working full time (Executive MBA). Now as I
understand it, the tuition for an Executive MBA might or might not be
deductible, but if I want to deduct it, I should prepare to be audited
and be able to make a strong argument that it is truly a business
expense, correct?

Third after I am enrolled, can I take a disbursement from the IRA and
avoid the penalty by claiming it as being for educational expenses,
but then use the money to pay the taxes on the rollover?
Timing is everything. Over 150 financial bloggers recently joined up to
all write about the Roth IRA in an effort known as Roth IRA Movement.
The mainstream press picked up on it as well.
I am currently finishing up an article I'll publish over the weekend
titled "The 401(k) to Roth IRA Fail."

Pushing 600 words, but here I'll tell you in a sentence or two why the
conversion is a bad idea. A $93K jump in income is likely to put you
into a higher bracket. You should review what your 'taxable income' is
going to be this year, and consider whether converting piecemeal makes
more sense. The 401(k) to Roth has no recharacterization option, no
do-over. Convert $80K, watch the market tank, and even with $40K left
when you do your 2012 return, you owe tax on the full $80K. First
transfer to the Traditional IRA, then if you want, convert what you
will. But if in 2013, you wish to recharacterize any of it for whatever
reason, you still have the option.

Last, converting when the tax must be paid with account funds is usually
a bad idea. The penalty is just part of it.
 
R

removeps-groups

I have been making contributions to both a 401K and IRA for the past
4.5 years, but recently parted ways from the company with which I had
the 401K. I have about $79K in the 401K and $14K in the IRA.
Do you have any non-deductible contributions in the IRA? Ie, was form 8606 filed when you made the IRA contributions. If you do have non-deductible contributions (contributions for which you did not take a deduction), then convert that portion of the IRA to Roth tax free this year, and deal with converting the 401K to traditional or Roth IRA, and the remaining money in the traditional IRA to Roth IRA next year.
First, if I use some of the cash from the 401K/IRA to pay the taxes,
that would be considered a disbursement for which I would pay a
penalty, correct? So I would need to pay those taxes using other
means to avoid that penalty.
Yes, 10% penalty, in addition to federal + state + local taxes on the amount taken out.
Second, I will be in school in the fall. Technically, I will be in
school full time and working full time (Executive MBA). Now as I
understand it, the tuition for an Executive MBA might or might not be
deductible, but if I want to deduct it, I should prepare to be audited
and be able to make a strong argument that it is truly a business
expense, correct?
If the education expense is in your current field -- ie. furthering your skills -- then it is deductible as a business or unremibursed employee expense. The latter is subject to the 2% rule and AMT. Are you working in the MBA field while doing your studies, and if so are you paid on a W-2?

Also I wonder if you can the Lifetime credit for part of the studies, and business expense for the other part.
Third after I am enrolled, can I take a disbursement from the IRA and
avoid the penalty by claiming it as being for educational expenses,
but then use the money to pay the taxes on the rollover?
I don't think so.
 
J

JoeTaxpayer

Do you have any non-deductible contributions in the IRA? Ie, was form 8606 filed when you made the IRA contributions. If you do have non-deductible contributions (contributions for which you did not take a deduction), then convert that portion of the IRA to Roth tax free this year, and deal with converting the 401K to traditional or Roth IRA, and the remaining money in the traditional IRA to Roth IRA next year.
If one has an IRA with any post-tax money, any conversion to Roth is
prorated, i.e. one cannot convert only post tax money to the Roth
leaving pretax in the IRA. They pay tax based on the percentage of pre
and post tax in their IRA. And IRA = the total of all IRA accounts,
separate accounts do nothing to segregate pre and post tax money.

Your advice to convert before flooding the IRA with 401(k) money is
sound, but my warning still applies.
 
R

Rich Carreiro

Do you have any non-deductible contributions in the IRA? Ie, was
form 8606 filed when you made the IRA contributions. If you do have
non-deductible contributions (contributions for which you did not
take a deduction), then convert that portion of the IRA to Roth tax
free this year,
You can't do that. The usual pro-rata rules for trad IRA
distributions also apply to Trad-to-Roth conversions. The OP says his
IRA is worth $14,000. If he had $5,000 in non-deductible
contributions in it and did a $5,000 conversion, only $5,000 *
($5,000/$14,000) = $1,786 would be non-taxable while the remaining
$3,214 would be taxable.
 
R

removeps-groups

You can't do that. The usual pro-rata rules for trad IRA
distributions also apply to Trad-to-Roth conversions. The OP says his
IRA is worth $14,000. If he had $5,000 in non-deductible
contributions in it and did a $5,000 conversion, only $5,000 *
($5,000/$14,000) = $1,786 would be non-taxable while the remaining
$3,214 would be taxable.
You and Joe are right. Thanks.
 
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K

Kramer314

Thanks for the detailed discussion and I appreciate the advice. I
wasn't really planning on rolling all of it into the Roth immediately
anyway, and there are no non-deductible contributions.

What I am really more interested in here is whether I can take a
disbursement to cover tuition costs and then use the money that I
would have paid in tuition to cover taxes on a rollover portion
penalty free.
From ivestopedia, it seems that yes I can. But am I missing
something?


For Qualified Higher Education Expenses
Amounts are penalty free if they are used to cover qualified higher
education expenses for the IRA owner and/or his or her dependents.
These qualified education expenses are tuition, fees, books, supplies
and equipment required for the enrollment to or attendance at an
eligible educational institution. An eligible educational institution
is any college, university, vocational school or other post-secondary
educational institution eligible to participate in the student aid
programs administered by the Department of Education. These eligible
educational institutions include virtually all accredited post-
secondary institutions, whether public, nonprofit or proprietary
(privately owned and profit making). The educational institution
should be able to indicate whether it is an eligible educational
institution.

Read more: http://www.investopedia.com/university/retirementplans/ira/ira3.asp#ixzz1rILE6AJJ


On a side note, I really wish more employers offered Roth IRAs...
 

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