Overall, the benefits of having any type of Roth account (e.g., IRA, 401k) is something for one to consider, especially when investing in non-traditional assets that have true “growth” opportunity. As an example, purchasing a property for $100,000 with the potential of selling the property later at, let’s say $150,000, provides an awesome opportunity to have tax-free growth within your self-directed ROTH IRA.
However, I receive many calls a year from individuals who, after the fact, wish they may not have established a ROTH IRA. You see, you may have met with your CPA and they advised you that you should make ROTH contributions to an IRA OR do a ROTH conversion on a previous pre-tax or traditional IRA or 401K account. They may have advised that paying the tax with the conversion (specifically) is in your better interests….so, what could possibly be a down side to doing this, especially after receiving CPA advice on this matter?
Current IRS rules do NOT allow ROTH IRA funds to be rolled over into a 401K (self-directed or not) plan EVEN IF the 401K plan allows ROTH contributions to the 401K plan. While this rule may change in the future, it is currently not allowed to rollover ROTH IRA funds into a qualified plan such as a 401K. Therefore, when I have an individual who meets the qualifications to establish and maintain a 401K and wants to partake in the much greater benefits associated with a 401K over an IRA, we have no current option other than establishing a self-directed ROTH IRA. Now, is a self-directed ROTH IRA bad? No, it is just that the benefits of the 401K plan far outweigh those of an IRA….again, if the individual qualifies for the 401K plan.
So, in some instances, by transferring, rolling over or converting their funds to a ROTH IRA, an individual who now wishes to self-direct those ROTH funds by rolling over these funds into a self-directed 401K may have shot themselves in the foot as they will not be able to do so. To greater clarify this situation, let’s say that “Joe” (who is self-employed and meets the qualifications to establish a self-directed 401K) has a $100,000 Roth IRA and $100,000 in a previous employer’s 401K plan (that can be rolled over). What are his options in self-directing these funds?
Joe could establish a self-directed 401K and roll over the previous employer’s 401K funds into the newly-established, self-directed 401K. However, in contrast, Joe could not rollover his ROTH IRA funds into the 401K plan as this currently is not permitted. Now, for those of you that are wondering, if Joe’s funds were Traditional IRA funds, those funds could rollover into the 401K plan…we are ONLY speaking of the ROTH funds.
Is this a bummer for Joe? Yes, because now if he wishes to self-direct the ROTH funds, we will have to establish a self-directed ROTH IRA. And, if he wants the benefits associated with the self-directed 401K as well to rollover the previous employer’s funds, we would have to set up a separate self-directed 401K plan. This leads to two accounts, possibly two different fee structures and a required annual fee for the ROTH IRA.
One can see that IF Joe had not done the ROTH conversion, he could rollover all the IRA funds ($100,000) and old employer 401K funds ($100,000) into one, self-directed 401K account. By the fact that he executed a ROTH conversion for his IRA funds, he can no longer bring those funds into the 401K. Is this bad? No. But, had Joe known this, he may have elected to not do the ROTH conversion so that he could move all of his funds ($200,000) into the newly-established, self-directed 401K.
Now, Joe’s situation leads to what your next question should be (and what we will address in our next post)….okay, if Joe has $100,000 in a self-directed ROTH IRA and $100,000 in his self-directed 401K, can those funds be possibly brought together, for investment purposes, into one investment account? The answer may surprise you.
Remember, as always, PGI does not dispense tax or legal advice, so this information is educational in nature. You should always review such situations with your tax or legal professional.