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#131:  Using a reverse mortgage to pay tax on 401K Roth conversion  


After retiring in 2020, you had planned on leaving your 401(K) plan where it was in the company plan. Basically, satisfied with the investment options offered through that employer plan, you saw no reason to roll the money into an IRA. (Needless to say, your account was affected by the market downturn, but that would have been true no matter where the funds were held, you realize.)

Now, however, you have been advised by your CPA to convert the 401K into a Roth IRA.  While you would certainly take a big tax hit this year and next, she has explained, (she is advising you do the conversion in two stages), the assets will grow tax free after the conversion, with no need for you to take future distributions until and unless you choose to do so. In addition, your beneficiaries will not be paying tax when they, someday, take money out of the account. From a timing standpoint, you agree, precisely because the value of your account has fallen because of the stock market drop, the tax burden will be less now than it might be later on.

With your home in very good shape and mortgage-free, you have not needed to withdraw any money from the 401K. Your lifestyle needs have been more than satisfied through the combination of a life annuity, regular plus as-needed withdrawals from your own investment portfolio, and through fees from speaking engagements. In fact, you are hoping never to tap the 401K money, considering it a future legacy for your daughter and son. Still, should you someday need to make withdrawals from that account, the CPA points out, having made the Roth conversion could prove a blessing.

Rather than funding the tax bill out of the 401K account itself, an alternate strategy would be “tapping” your housing wealth in the form of a reverse mortgage set up as a line of credit. Since your vision of the 401K funds-turned-Roth is as a future legacy for your two children, the conversion of the account in its entirety (without diminishing its value by the amount of the conversion tax) will further that goal.

Since there will be no principal or interest payments due on a reverse mortgage, there will be no effect on any of your current or future sources of income. Any withdrawals you make out of the reverse line of credit (beginning with the cash needed to pay the tax on the Roth conversion and continuing for any draws you might take over the years) will be tax-free, with the unused portion of the credit line growing at the same rate as the interest being charged on the loan.

Through discussions with your tax advisor, you’ve come to understand the advantages of converting your 401K to a Roth IRA. Taking that a step forward, using the equity in your home to fund the conversion costs can help avoid taxation to you while enhancing your children’s potential legacy.

This is not tax advice. Please consult a tax adviser for your unique situation.