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I understand that doing a conversion from a 401(k) into a Roth IRA is a taxable event. I'm trying to understand the details of how this is taxed.

Many resources, including this answer and this blog post mention the fact that long-term capital gains are not taxed when you're in the 15% income bracket.

My first question is: the entire 401(k) is not considered long-term capital gains, right? Presumably, your contributions will always be taxed as regular income, and any gains made in the last year would be taxed as short-term capital gains, correct?

To give a more elaborate scenario, consider the following:

  • An individual contributes $1k to their 401(k) in January, 2016
  • Between January and June of that same year, it gains +$1k
  • The individual contributes another $1k to the 401(k) in July 2016
  • Between July and December of that same year, the 401(k) grows another $1k

If they do the conversion in the following March while in the 15% tax bracket, and no other change occurs to their balance, would it be taxed like so:

  • First $1k conversion taxed as ordinary income, due to it representing the January contribution
  • Second $1k conversion tax-free due to long-term gains
  • Third $1k conversion taxed as ordinary income, due to it representing the July contribution
  • Fourth $1k taxed as short-term gains

Or would the entire thing be taxed at 0%? Or something else entirely?

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Pre-tax 401(k) to Roth IRA conversions are always taxed as regular income. Remember contributions to a pre-tax 401(k) come from income that has never been taxed, so they're taxed when you withdraw or convert. There are no capital gains (short- or long-term) in a 401(k) or any other type of retirement account; it's all treated the same.

  • Thanks for the answer, Craig! Follow up question: your first sentence states that a pre-tax 401(k) to Roth IRA conversion is always taxed as regular income. Alright, makes sense. But then your second sentence says that the contributions you make to the 401(k) are taxed when you withdraw. Does this second sentence refer to a situation that doesn't involve a conversion? If your contributions were taxed upon withdrawal after a conversion, then that would be double-taxing the amount, right? – jamesplease Nov 19 '17 at 23:06
  • @jmeas The second sentence refers to any situation where pre-tax 401(k) money becomes post-tax, which would include both direct withdrawals or conversions. I clarified that in my answer. After conversion, that money has been taxed once and won't be taxed again. – Craig W Nov 19 '17 at 23:09
  • Awesome. Thank you for the clarification, and also for the great answer! – jamesplease Nov 20 '17 at 1:03

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