by Lewis A. Weinstein
Founder of GenerationTax
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Determine if Your MBA Expenses Are Deductible on Your State Tax Return Consider Withdrawing Funds From Your IRA–Penalty Free Consider Recognizing Long- Term Capital Gains in Low Income Years |
While you’re in school, this is a great time to consider converting your 401(k) or traditional IRA to a Roth IRA. This is especially true for MBAs who’ll likely be in their lowest tax bracket for decades to come. By converting your assets to a Roth, you’ll pay the tax on the conversion now, when you’re presumably in a lower tax bracket while in school – in exchange for tax free growth and tax free distributions in the future. This strategy could be worth hundreds of thousands of dollars when you reach retirement age.
Let’s take a hypothetical (but not uncommon) example. Let’s say in 2023 you’re single and you have $40,000 in a 401(k) which you want to convert to a Roth IRA before the end of the year. Let’s further assume you worked for part of the year in 2023 and earned $45,000. The $40,000 conversion would be taxable but it would not subject to the 10% early distribution penalty. You would owe approximately $8,800 (22% federal tax rate) in federal income taxes on the amount converted. Now let’s assume an annual rate of return of 8% and that you’ll be in the top federal tax bracket (37%) when you retire at age 68. By the time you reach age 68, the $50,000 would grow to approximately $1,013,000. The after tax net federal return from the Roth IRA conversion would be approximately $240,389* more than if you left the assets in your 401(k) and you invested the $8,800 in taxes you paid on the Roth conversion at 8% in a taxable investment account. You can calculate your own future values using different rates of returns but in any scenario you’ll likely find the savings to be significant.
If you’re considering converting your 401(k) or traditional IRA to a Roth IRA you should probably get some help soon (before year-end) to plan for the impact on your federal and state taxes. For the past 30 years, Lewis Weinstein has given a talk on this issue at HBS, Sloan & Tuck that has helped thousands of students make the right decision. If you need help with deciding on weather to make a Roth conversion, calculating the federal and state taxes you would owe on the conversion, making pre-payments of estimated taxes on the conversion to avoid underpayment penalties or discussing how and when to convert your retirement funds, please contact Lewis Weinstein. You’ll be glad you did!