Quit, Leave, & Roll
The common mantra of financial advice is to roll the 401(k), 403(b), or other employer sponsored retirement plan into an IRA after quitting and leaving a former employer. However, rolling a retirement plan into an IRA does have its drawbacks, especially for high-earners. Rolling a 401(k) plan into an IRA can close the door on Backdoor Roth IRA, which could substantially increase the tax liability on a Traditional IRA that is predominately funded with non-deductible contributions.
The Backdoor Roth IRA is the term used to describe the process of making a non-deductible contribution into a Traditional IRA and immediately converting to a Roth IRA. The purpose of the Backdoor Roth IRA is to avoid taxes on the growth of post-tax contributions. If an individual earns more than $72,000 (>$119,000 married filing jointly), the contribution into an IRA is non-deductible. The Backdoor Roth immediately converts these post-tax monies to a Roth IRA to avoid taxes on the growth. If the non-deductible contribution remains in a Traditional IRA, the growth on this money is subject to income tax when it is withdrawn.
Our paper, Stop, Drop, But Don't Roll: Keep The Backdoor Roth Open, covers the merits of keeping money in a 401(k) plan and not rolling into an IRA to maximize after-tax returns.
If you have questions on Backdoor Roth IRAs or on your employer retirement plan, please feel free to reach out to us.