Vanguard Rollover IRA vs Roth IRA?

Hello!

I just rolledover my old 401k into Vanguard. I don’t know what happened but they seemed to have created 2 accounts for me: a Rollover IRA Brokerage Account and a Roth IRA Brokerage Account. The full amount of my old 401k is currently in the Rollover IRA account, the Roth IRA says $0. Based on the PFC Building Wealth Course (chapter 6), shouldn’t my full amount be in the Roth IRA account (and delete the rollover IRA)?
I just want to make sure my money is in the right account before I invest it into a Target Date Index Fund. (Also, sorry in advance because I accidentally put this same question in the discussion section of the course!)

Stella, you should call your brokerage and/or your employer to find out what happened.

Yes I definitely plan to, but figured I should know in advance which account I want to keep before I tell them to remove/delete the other one!

Stella,

If you contributed as Roth or after-tax into your 401k, you could have rolled over that balance into a Roth IRA. If you have a pre-tax balance in your 401k (e.g., company match, gains, your pre-tax contributions), you could have rolled over that balance into a Rollover/Traditional IRA. Splitting the rollover balance according to its contributed type is more tax advantageous.

If your entire 401k is pre-tax money, you can roll it over to a traditional/rollover IRA with no tax consequences. If your entire 401k is pre-tax money, you can roll it over to a Roth IRA but be prepare to pay tax on that entire balance at year-end.

It all depends on what you want to do.

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Thanks Mindi! Okay so from what I remember, that old 401k had employer match and gains (which is probably why it’s sitting in the rollover account), but what I don’t remember is if my contributions were taxed already or not. Where can I find that information, on an old statement from that previous brokerage? Or is that something Vanguard can magically look up? Im guessing once I figure that out, then I can decide if I should split the balance or not.
Just to check my understanding: because my old 401k had employer match and gains, it cannot be allowed in the Roth IRA account, right? Secondly, if i discover that my contributions were traditional (so I guess pre-tax), then is it okay to keep it in that Rollover account and still invest all that money to a Target Date Index Fund? Or do I have to have vanguard make another account called Traditional in order to invest in a TDIF?

I’m not sure if I’m getting caught up in the legalese of things, but I’m such a noob when it comes to the world of finance, so every bit of info helps me!

You would need to ask your old employer what type of contribution you had made. Vanguard will not know.

However, since it’s already rolled over to the Rollover IRA, it is too late to ask your employer to split the balance for Traditional IRA and Roth IRA. This could only be done prior to the ex-employer distributing your 401k balance.

Right now, since all of the 401k is in a Rollover IRA, which is a Traditional IRA, you can start buying Target Date Index Funds if you want.

The entire 401k balance (your contribution, match, gains, etc), that is now in the Traditional IRA, can always be converted into a Roth IRA whenever you want. However, any amount you convert into a Roth IRA will be added to your annual income and you will be taxed on that amount.

Hope that helps.

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That makes so much sense, thanks so much for explaining all that! Truly appreciate it. Okay then TDIFs here I come :))

Ah one more question related to above! Right now I’m unemployed and have been collecting unemployment payment from government. Do these payments count as income? Wondering if I should switch it over to Roth IRA now since my “income” is low.

Unemployment benefits are generally taxed as ordinary income (wages). Though for 2020, the government passed a law that you can exclude up to $10,200 of unemployment benefit from being taxed. Don’t know if that law will be extended for 2021 - but for planning purposes, I would recommend not to count on that law being extended.

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If you choose to convert to Roth, be careful when deciding if you want the brokerage to withhold your tax liability. If you choose to have the brokerage withhold your tax liability for the conversion, and you are below age 59.5, your withheld amount will be counted as an early distribution and you will be subject to a 10% penalty in addition to paying the ordinary tax.

I’m trying to convert mine Traditional to Roth right now, and these are things I’m learning along the way.

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Thanks again Mindi, I’ll make sure to keep these things in mind!

Edit:

  • 03/25/21 @0000hrs PST added second bullet point!
  • 03/24/21 @2355hrs PST added bullet point!

Hey Stella Kim

To expand on @Mindi , always two-steps behind you, killer! Unemployment benefits do not count as “earned income” (wages, tips, etc.,) as of 03/24/21. But they do count as taxable income, isn’t that a “shut your mouth.” I recently just helped a close friend with this predicament.

Scenarios:

  1. You have no earned income (wages, tips, etc.) in the year you want to contribute - You do not qualify to contribute to your IRA accounts within that year!

  2. You have some earned income (wages, tips, etc.) in the year you want to contribute - You qualify up to the amount of (wages, tips, etc.) claimed on that year’s tax forms. Example: Your earned income is $4,000, which is less than the $6,000 (current contribution limit). You may only contribute up to your earned income—($4,000) for the current tax year you’re contributing to.

  3. You already contributed to your IRA with no “earned income.” You should consult with your financial advisor, tax professional, and broker as you will need to withdraw the newly contributed basis and earnings from the IRA and into a Taxable, Checking, or Savings Account. This, If I recall correctly, will come with Tax penalties.

  • I believe I see what you’re attempting to accomplish, If I am correct, you’re trying to convert your traditional 401k → Roth IRA during your unemployment year because your marginal tax rate is low. If so, extremely smart :fist:t5: .

  • Just for educational purposes: You can technically contribute $6,000 to your 2021 Contribution Year now with no earned income. Just make sure you have up to $6,000 of earned income by December 31st, 2021.

Hopefully, that helps, and I wish you the best in your future employment opportunities!

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Ohhh my lanta! Why don’t they teach you this in school or college? It should be a requirement before adulting. Thanks so much for your post @Rick. Great to know all the scenarios. And yes you’re correct, I’m trying to convert my traditional to Roth this year.
I just called Vanguard to confirm and clear up the process of me converting from Rollover to Roth, but I walked away with more questions (even though the process is somewhat easy). So additional questions: 1) in the conversion process, its asking if I want to convert part of my money or all of the account. Full disclosure it’s about $30k. They’re saying if I do the full amount I may be bumped up in a tax bracket, but I don’t have any income so does that matter?
2) I don’t remember if I did Roth or Traditional with my old 401k. If I convert into Roth IRA, will the system/IRS automatically know what’s taxable or not? For example, if my old 401k was Roth and I already paid taxes on it, and I do the conversion now, will the IRS tax me on that amount again? Or will it know that it already taxed me.

Why don’t they teach you this in school or college?

  • That’s another time for another day; I wouldn’t want to de-rail this topic with my lengthy posts on my beliefs and resources to back my statements :grinning:

In the conversion process, it’s asking if I want to convert part of my money or all of the account. Full disclosure it’s about $30k. They’re saying if I do the full amount, I may be bumped up in a tax bracket, but I don’t have any income, so does that matter?

  • Well, above, we discussed you’re on unemployment so then you have taxable income. That $30,000 “could” very well push you into another marginal tax bracket and impact your current year’s tax liability. This is where I would consult with a licensed tax professional or financial advisor for your specific tax scenario. Thinking outside the box, you could even consult with FreeTaxUSA or TurboTax live experts (cost money but available) for more accurate advice on your specific tax liabilities.

I don’t remember if I did Roth or Traditional with my old 401k. If I convert into Roth IRA, will the system/IRS automatically know what’s taxable or not?

  • I assume it was a Traditional 401k; I can infer this because (a) Vanguard didn’t roll the 401k straight into the Roth IRA (b) It’s becoming more common now, but it’s still rather rare to have a Roth 401k option with your employer, and you the employee know about it and choose to contribute to it. I will happily stand corrected, but I do believe your 401k was traditional. Your broker (Vanguard) will provide you with tax documentation that you will use to file your taxes and provided the IRS with what you owe on basis + earnings.

For example, if my old 401k was Roth and I already paid taxes on it, and I do the conversion now, will the IRS tax me on that amount again?

  • In the above hypothetical scenario, no. But, your broker will provide you with all the necessary documentation/tax forms needed to accurately and successfully file your taxes.
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@Rick again thanks so much! Appreciate the specific trains of thoughts and explanations. I was able to reach out to my old 401ks (there were two that I rolled over) and it turns out the big chunk was traditional! But the second one was Roth. So I’ve been talking with Vanguard to try and move that smaller check to the Roth IRA without any penalties. Once that’s squared away, I’ll be able to convert the traditional one (finally). And then ultimately into a target date index fund.

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