Beginning med school: roll over 401k to Roth IRA?

[Transmogrifier]

I'm starting med school next month. I've had a job in my gap year and I've got about $7000 in a 401(k).

One of the disadvantages to converting the 401k to a Roth IRA would be having to pay taxes. However, if I wait until 2010 to do the conversion when I have no other income, would I be able to avoid paying taxes on it due to having such a low income?

If I do have to pay taxes, I have some savings I could use to do so.

Also, it seems converting it to a Roth IRA would be the best solution since I'd be in such a low tax bracket that'd it'd be far better than delaying taxes until I'm an attending making however much in 40 years. No?

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[southerndoc]

I would talk to a tax adviser. If I'm not mistaken, I believe you must have income greater than your rollover amount in order to roll the amount over for that particular year.

You can do the rollover in 2010 and split the tax burden over 2 years if I remember correctly.

 

[Transmogrifier]

I'll check with someone I suppose.

I did find the stipulation that I must have earned compensation during the tax year to contribute to a Roth IRA, but I couldn't determine if that applied to rolling over a 401k into a Roth IRA. I did find in other places that rollovers do not count as contributions that would count towards limits, but again I don't know if this applies when I have no income.

 

[Transmogrifier]

I just got some professional advice on the matter and I was told I should be able to execute the 401k to Roth IRA rollover in 2010 without any problems and take advantage of my lack of income.

 

[southerndoc]

Good to hear. Sorry I couldn't offer you definitive advice, but with the tax code being so complicated, it's best to seek professional advice.

 

[nontrdgsbuiucmd]

Another option, if you will be taking out med school loans, is to roll the 401K into a regular IRA. Per my read of the relevant IRS document, you are able to withdraw funds from an IRA to pay for education without an early withdrawal penalty, i.e. med school, regardless of the amounts of loans that you have -- if med school costs 7K, you can withdraw 7K from the IRA even if you also get 7K in federal loans. The benefit is that you can roll $$ into a 401K when you're earning more money pre-med school, roll it into a regular IRA, withdraw it while a med student and earning very little, and at that point it would be considered taxable income, but there'd be no 10% early withdrawal penalty. You'd then use the $$ to pay for med school, thereby taking out fewer loans at 8% or so, particularly beneficial if you'll need to pull out grad + loans which I believe accrue interest from when first taken out.

My thinking on this is if you can withdraw IRA funds to pay part of med school costs and thereby avoid taking a loan for 7K at an 8% "guaranteed interest rate", you'd likely do better than putting $$ into a Roth, which will never be able to deliver a guaranteed 8% annual return -- there are no financial intruments that will guarantee 8%, (although I think Madoff guaranteed 10%). The stock market may "on average" return more than 8%, but there's a lot more risk in investing in the market than in following this path of using retirement funds to pay for part of med school.

 

[Transmogrifier]

Another option, if you will be taking out med school loans, is to roll the 401K into a regular IRA. Per my read of the relevant IRS document, you are able to withdraw funds from an IRA to pay for education without an early withdrawal penalty, i.e. med school, regardless of the amounts of loans that you have -- if med school costs 7K, you can withdraw 7K from the IRA even if you also get 7K in federal loans. The benefit is that you can roll $$ into a 401K when you're earning more money pre-med school, roll it into a regular IRA, withdraw it while a med student and earning very little, and at that point it would be considered taxable income, but there'd be no 10% early withdrawal penalty. You'd then use the $$ to pay for med school, thereby taking out fewer loans at 8% or so, particularly beneficial if you'll need to pull out grad + loans which I believe accrue interest from when first taken out.

My thinking on this is if you can withdraw IRA funds to pay part of med school costs and thereby avoid taking a loan for 7K at an 8% "guaranteed interest rate", you'd likely do better than putting $$ into a Roth, which will never be able to deliver a guaranteed 8% annual return -- there are no financial intruments that will guarantee 8%, (although I think Madoff guaranteed 10%). The stock market may "on average" return more than 8%, but there's a lot more risk in investing in the market than in following this path of using retirement funds to pay for part of med school.

I will be taking out GradPlus loans for medical school. I'd thought of doing using the 401k money to offset loan costs but decided against it.

- Doing so (right now anyway) would lock in the big losses the account has seen with the recession over the past year.
- Having less debt but no available money was less appealing than having a little more debt and some money available in the future.

I may decide to use the money later on, but this seems best for now.

 

[Bobblehead]

One side note is that 401ks are better protected from creditors (and litigation) than IRAs.