Should We Convert Our 401(k) to a Roth?

Summary

Ramsey Everyday Millionaires: Should We Convert Our 401(k) to a Roth?

Episode Release Date: January 15, 2025
Hosts: Dave Ramsey, Ken Coleman, Rachel Cruze, George Kamel, Jade Warshaw, Dr. John Delony
Guest: Connor Huckell

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Introduction

In this insightful episode of Ramsey Everyday Millionaires, host Ken Coleman welcomes Connor Huckell from Boston, who seeks guidance on managing his and his wife's retirement savings. The discussion centers around the strategic decision of whether to convert traditional 401(k) accounts to Roth 401(k)s, especially in the context of their current financial situation and long-term goals.

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Listener's Financial Situation

• Financial Stage: Connor and his wife are navigating Baby Step 3B. They are currently renting and plan to continue renting for the next few years due to potential relocation.

• Retirement Savings: Together, they have accumulated approximately $220,000 in their traditional 401(k) accounts.

• Household Income: Both partners have roughly equivalent incomes, allowing them to collaboratively plan their financial future.

Connor Huckell [00:31]:
"Should we convert the money that we have in our traditional 401ks into Roth, or should we just, from this point forward, put money into the Roth 401k option?"

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Hosts' Recommendations

Jade Warshaw provides a strategic overview, emphasizing the importance of aligning retirement strategies with their current financial priorities.

• Delay Conversion:
  Jade Warshaw [00:55]:
  "Typically, we would wait until baby step six to make a rollover like that, because the truth is, you're going to be on the hook for some taxes associated with that, obviously."
  She advises postponing the conversion to avoid immediate tax burdens that could impede their goal of saving for a down payment on a home.

• Future Contributions:
  Jade Warshaw [01:30]:
  "From this point on, I would do Roth style. That's what I would invest in."
  She suggests that while they continue contributing to a Roth 401(k) moving forward, they should hold off on converting existing traditional 401(k) funds until they reach Baby Step 6, ensuring they are better positioned to handle the associated taxes without compromising other financial objectives.

Ken Coleman reinforces the importance of understanding the tax implications and maintaining focus on their immediate goals.

• Understanding Tax Implications:
  Ken Coleman [02:06]:
  "Cause somebody might be like, why do they want to do that? What's the purpose?"
  He highlights the necessity of comprehending why one might choose to convert, ensuring that decisions are made with clear intentions and long-term benefits in mind.

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Roth vs. Traditional 401(k) Conversion Explained

Jade Warshaw delves deeper into the mechanics and rationale behind the conversion choice:

• Taxation Timing:
  Jade Warshaw [02:01]:
  "Their 401k that they have now, they have not paid taxes on that money. Right. And what they're trying to set themselves up for is a situation that when they get into retirement, they can pull money and not have to pay taxes on it."
  She explains that traditional 401(k)s are funded with pre-tax dollars, meaning taxes are deferred until withdrawal. Converting to a Roth 401(k) entails paying taxes upfront, allowing tax-free withdrawals in retirement.

• Strategic Burden Shift:
  Jade Warshaw [02:02]:
  "So if you do a Roth account, you're paying the taxes upfront so that when you're 59 and a half and older, you can pull money from that and you're not taxed on it."
  This strategy is advantageous for individuals who anticipate being in a higher tax bracket during retirement or prefer the certainty of tax-free income streams post-retirement.

• Tax Payment Considerations:
  Jade Warshaw [02:02]:
  "Whenever you attempt to move that money that you have not yet paid taxes on it, well, then you will have to pay taxes on it."
  She cautions that converting traditional 401(k) funds to Roth accounts triggers a taxable event, which can significantly impact their current financial standing if not timed appropriately.

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Key Insights and Takeaways

1. Assess Current Financial Goals:
   Before making retirement account conversions, evaluate how immediate financial objectives, such as saving for a home down payment, might be affected by increased tax liabilities.

2. Strategic Timing is Crucial:
   Converting to a Roth 401(k) is generally more advantageous once other financial milestones (e.g., debt elimination, emergency fund completion) are achieved, aligning with Baby Step 6 in the Ramsey plan.

3. Understand Tax Implications:
   Conversions result in taxable income in the year of the change. Proper planning ensures that this tax burden does not hinder other financial goals.

4. Future Contributions Matter:
   While considering past conversions, it's beneficial to start contributing to Roth accounts moving forward to maximize tax-free growth and withdrawals.

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Conclusion

Connor Huckell's inquiry underscores a common dilemma faced by many striving to balance immediate financial goals with long-term retirement planning. The hosts collectively advocate for a measured approach—prioritizing current financial stability and goals before undertaking significant changes to retirement accounts. By waiting until a later baby step, Connor and his wife can optimize their financial strategy, ensuring that retirement savings work effectively without compromising their present aspirations.

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Notable Quotes:

• "Typically, we would wait until baby step six to make a rollover like that, because the truth is, you're going to be on the hook for some taxes associated with that, obviously."
  — Jade Warshaw [00:55]

• "So if you do a Roth account, you're paying the taxes upfront so that when you're 59 and a half and older, you can pull money from that and you're not taxed on it."
  — Jade Warshaw [02:02]

• "Whenever you attempt to move that money that you have not yet paid taxes on it, well, then you will have to pay taxes on it."
  — Jade Warshaw [02:02]

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This episode provides invaluable guidance for individuals contemplating the conversion of traditional retirement accounts to Roth options, emphasizing the importance of strategic planning and alignment with broader financial goals.

Transcript

[Ken Coleman]

This episode is sponsored by SmartVestor. Connect with an investing pro for free at RamseySolutions.com invest. You're listening to Ramsey Everyday Millionaires, where we talk investing, retirement, building wealth, and outrageous generosity. Connor's up next. In Boston, Connor Huckell.

[Connor Huckell]

Hi, Ken. Hi, Jade. Love you guys. Thanks so much for taking my call.

[Ken Coleman]

You bet. What's going on?

[Connor Huckell]

All right, so my wife and I just got married. We're in the process of combining our finances, and I basically have a retirement question. My question is, should we convert the money that we have in our traditional 401ks into Roth, or should we just, from this point forward, put money into the Roth 401k option?

[Jade Warne]

Okay, what baby step are you in?

[Connor Huckell]

We're in baby step 3B. We're currently renting, and we're going to be renting for the next couple of years because we're not going to be in the city that we're in long term.

[Jade Warne]

Yeah. I mean, how much do you have?

[Ken Coleman]

Can I ask how much do you have in your 401k?

[Connor Huckell]

Yeah. So across my wife and my accounts, we have about 220,000 in there. Our household income is about the same.

[Ken Coleman]

Okay, good.

[Jade Warne]

Very good. Typically, we would wait until baby step six to make a rollover like that, because the truth is, you're going to be on the hook for some taxes associated with that, obviously.

[Connor Huckell]

Right.

[Jade Warne]

And with the goals that you have up until this point. In this case, it's saving for a down payment. It could really eat into that goal that you have. So for this matter, you may, you know. Yeah. From this point on, I would do Roth style. That's what I would invest in. But I probably would wait to roll it over until you're ready to fit the tax bill. And. And that it's. It's not going to put a dent in your other very important goals. So, yeah, you could wait till baby step six to do that.

[Connor Huckell]

Okay, great. Thank you very much.

[Ken Coleman]

Absolutely. My question, Love that call. They're rocking.

[Jade Warne]

Yeah.

[Ken Coleman]

Love hearing that.

[Jade Warne]

Let me go back to that. Cause somebody might be like, why do they want to do that? What's the purpose?

[Ken Coleman]

Oh, okay.

[Jade Warne]

So their 401k that they have now, they have not paid taxes on that money. Right. And what they're trying to set themselves up for is a situation that when they get into retirement, they can pull money and not have to pay taxes on it. So if you do a Roth account, you're paying the taxes upfront so that when you're 59 and a half and older, you can pull money from that and you're not taxed on it. So most people would like to carry that burden now instead of waiting for later. So that's the purpose of that. And whenever you attempt to move that money that you have not yet paid taxes on it, well, then you will have to pay taxes on it. Okay.

[Ken Coleman]

No, good. Good explanation. I'm glad you did that.