Question for the Money Doctors

Question submitted on Apr 21, 2021.

Question

Hello, I am divorcing and a QRDO plans to transfer around $50K from my exspouse 401k to me. I have a public pension retirement and I wish to open a Roth IRA to transfer the money I'll get, not my retirement pension account. I have to pay income taxes on the amount I transfer on the Roth IRA but I cannot fund the payment of these due taxes with any other money that the amount I get from the QRDO. I need advice. Thanks. Helene

Answer

Helene,

First of all, you should be commended for recognizing the value of having a Roth account even though you have to pay increased tax up-front in order to obtain it.  The question of whether absorbing the cost of paying some tax up-front is worth it in your case might be worth discussing with an accountant or financial planner.  In performing their analysis, he/she will take into account your retirement income plans, whether you are able to pay the income tax from a source other than the IRA funds (almost always a good idea), what your marginal tax rate might be in the future, whether you might be subject to required minimum distributions which exceed your income needs, and other factors.

Budgeting for the additional income tax expense need to create a Roth can be a challenge.  Ideally, you will want to use non-IRA funds to pay for the income tax.  If you use IRA funds to pay for the tax, not only will you have to pay income tax on the amount not converted to your Roth account, but if you're under 59 1/2, you will have to pay a 10% penalty on the amount not converted.  One possible solution to this might be to develop a multi-year plan to convert the $50K to a Roth account.  For example, you could plan to convert $10K each year for the next 5 years and spread this cost out a bit.  You could have the $50K deposited in a traditional IRA and then make Roth conversions each year.  Remember that a Roth conversion will be taxed at whatever bracket you're in for that year, so you'll probably want to be sure that making the conversion, especially if you do it all at once, doesn't push you into the next higher bracket.

All of this may sound complicated because it is tricky even for professionals.  It is probably a worthwhile investment for you to engage a professional to assist you with the decision making and mechanics of executing this transfer.  Mistakes in this area can be costly and normally cannot be undone.  However, the benefits offered by having a Roth account are frequently more than worth the cost for competent advice or the headaches of trying to get this done on your own.  Thanks for asking a great question.

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