Should I Convert To A Roth?

A couple of weeks ago, President Obama signed into law the Small Business Jobs Act of 2010. Buried within the Act, there is a provision whereby if you are eligible to take assets out of your company’s retirement plan, 401k or profit sharing, you can convert those assets into a designated Roth account within the same plan.

Example: Over the last ten years your account in the company’s profit sharing plan has grown to a couple hundred thousand dollars. The plan document allows you to take an “in service” withdrawal of the funds if you have been with the company for over two years. Since you’ve been there longer than two years, you are allowed to take a distribution of the $200,000. Instead of taking the distribution you convert the $200,000 to the plan’s designated Roth account. Your account is now growing completely tax free.

Why would you want to use to convert into a Roth 401k instead of a Roth IRA?

A whole slew of reasons:

1. Most IRAs are probably distributed already.
2. Better asset protection with a 401k over an IRA.
3. Higher contribution limits.
4. Ability to borrow from your 401k.
5. No need for a custodian.
6. Ability to make joint investments with family members.

Make sense? Ok, let’s go to double bonus round. 

Inside the rules regarding your Roth 401k, there is a little nugget saying that the Roth account within a 401k can swap assets with the traditional side, so long as equal value is given. So, for the sake of discussion, let’s say your traditional retirement plan has an option to purchase some land that you think is going to skyrocket in value. Right now, the option is worth $20,000, but you are positive it is going to grow to $200,000 in a couple of years. All you need to do is have your Roth move $20,000 over to the traditional side and have the traditional side move the option over to the Roth.

Voila! If the option does in fact skyrocket in value, where did the growth occur? Yep, your tax free Roth account. How much did you have to pay in taxes to “convert” the gains from traditional to Roth?

Is that pretty cool?

Let’s move out the decimal place and go to triple bonus round. 

What if the option was worth $200,000 right now and you thought it was going to jump to $2,000,000 over the next 10 years, but only had 50K inside your Roth account? Is there any law that says a Roth 401k can’t borrow money? Nope.

Could your Roth 401k find someone crazy enough to loan it $150,000, and then move the full 200K over to the traditional side? Then, as you made future contributions of 22K (assuming you are over 50) to the Roth 401k you use those contributions to pay down the debt. After 9 years the loan will be paid off. Then if in fact you sell the option in year 10, you just made one hell of a fantastic return. All tax free! All creditor protected!

Let’s see you do that with a Roth IRA conversion.

In this day and age of more shocking revelations coming from the financial services industry, I think it is pretty much a sure thing that you cannot trust some faceless behemoth to be looking out for your best interests. Chances are if some fancy-dancy investment firm is pushing an investment it is an investment in their future not yours. You owe it to yourself and your family to be aware of all the investment strategies, so you can make sure you are able to retire with some sort of financial dignity.