We’ve stashed over $2 million in our 401(k) accounts – should we switch to a Roth to hedge our bets?

Getting caught up in a financial Reddit thread is surprisingly easy. After all, where else can you learn the financial secrets of total strangers and respond to them as though you’ve met? A recent post caught my attention, primarily due to the incredible position one 48-year-old finds themselves in.

The situation

A man wrote into a subreddit called r/fatFIRE. Here’s how he laid out his situation: The man is 48, and his partner is 47. They have two children under the age of 10. They currently own these assets:

• 401(k): $2.5 million
• Roth IRA: $900,000
• Brokerage accounts: $1.65 million
• High-yield savings account/cash: $500,000
• 529 Plan: $225,000
• Rental property: $1 million

The poster mentions he plans to work between seven and fifteen more years and wonders if he should slowly convert the money in his 401(k) into a Roth IRA. Since funds deposited into a Roth IRA are taxed before the deposit is made, this couple won’t have to pay taxes on them again when they begin making mandatory withdrawals in retirement.

Over a cup of coffee

If I were sipping coffee across a table from this couple, I would – first and foremost – tell them what a great job they’ve done saving money. I would also suggest they:

Speak with a financial advisor

I suspect a couple with this much money tucked away probably has a talented financial advisor available. However, the poster’s decision to ask thousands of random strangers for their opinions threw me off. The pair should ask for an advisor’s opinion, particularly a professional familiar with their financial situation.

The original poster doesn’t mention how much money his household brings in annually, but I ran a quick calculation to get a rough idea of how much they’ll have available in retirement. Based on what they have today in a 401(k), Roth IRA, and brokerage accounts alone, taking a required minimum distribution (RMD) of 3% annually gives them a foundational income of $151,500. Add to that Social Security, pension(s), income from rental property, and any other investments they make between now and retirement, and they may be in a high tax bracket.

Only they (and their financial planner) know if they currently bring in more money than they will in retirement. If they’re going to make as much (or nearly as much) in retirement, transferring money to a Roth IRA makes no sense. 

Don’t do anything before 59 1/2 

The original poster is 48, and taking money from his 401(k) before he hits age 59 1/2 would be expensive. If he were to begin transferring funds before 59 1/2, he’d not only have to pay taxes on the 401(k) money (at his current tax rate), but he’d also be hit with a 10% penalty. 

Weigh the pros and cons

Finally, if I were sitting across from this couple, I’d advise them to weigh the pros and cons of transferring money from a 401(k) to a Roth IRA. Here’s how I see it: 

Pros

• Once they reach retirement age, money withdrawn from a Roth IRA’s principal will be tax-free. After holding the Roth IRA for at least five years, they can withdraw earnings on the account tax-free.
• The couple will find that Roth IRAs often offer more investment options than their 401(k) plans. 
• Unlike traditional IRAs and 401(k)s, a Roth IRA will not require them to take minimum distributions beginning at age 73. 
• The couple can pass their Roth IRA on to their heirs without the heirs having to pay taxes on the money. 

Cons

• Taxes are due on funds transferred from a 401(k) in the year they are converted to a Roth IRA. 
• Transferring funds can be complex and may require professional advice. 
• The couple may find that their Roth IRA has higher fees than the 401(k).

Not to put too fine a point on it, but this family is in great financial shape. Their best bet is to head directly to their financial advisor to determine their next best move.