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0% Cap gains or Roth IRA rollover
Old 08-01-2009, 07:57 PM   #1
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0% Cap gains or Roth IRA rollover

I'm trying to decide whether to take advantage of the 0% capital gains tax rate or do a Rollover into a Roth IRA.

I've been thinking about converting some or all of my approx $100k Traditional IRA into a Roth IRA, to take advantage of the down market and pay less ordinary income tax on the conversion due to low share prices compared with the past few years.

Obviously I should have done this at the bottom of the market months ago, but I don't have future vision. What's been causing me to hesitate to pull the trigger on the conversion is that I would be giving up the possibility to use the 0% cap gains tax rate for income levels below about $34k that's good only for 2009 and 2010, but which will rise to 10% or so thereafter.

I'm currently FIREd, so the only taxable income I have is about $20k of dividends per year. Therefore I could theoretically sell to realize approx $34k-20k=$14k of my approx $100k unrealized LTCGs and not pay any tax on that. Assuming future CG tax rate is 10%, that would save me $1400.

On the other hand, I could convert say $14k worth of IRA to Roth IRA, which would keep that conversion in the 15% tax bracket rather than the 25% tax bracket, also saving 10% or $1400. And assuming we are close to a market bottom as seems to be conventional wisdom, this might be a good timing move as well, although I don't want to do it just for that reason because I'm not a timer by nature.

Writing all this out, I suppose I really need to do sample tax returns for the different scenarios, for several years out, to get a sense of which would be best, because there are lots of subtle effects left out of my simplified calculations above, and the possibility of filling up some or all of the $34k-$82k tax bracket.

Since I have approx $100k in IRA to convert and $100k in LTCGs to soak up, I want to use this time when I'm in low tax brackets for those purposes; it's possible I could go back to work if the economy tanks and I want to take advantage of my low tax bracket while I have it (and while Obama allows it).

I think I'm leaning towards taking the 0% CG now before that expires, given that it seems like the future holds higher CG tax. And it seems that the IRS is loosening things up around roth IRA conversions (e.g. allowing them for people with over $100k income), so it may be best to hold off on that.

Any input is welcome. What are others in low brackets doing, CG or Roth conversion?
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Old 08-01-2009, 08:29 PM   #2
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Don't you have another 9.3K (=3.6K of exemption and 5.7K of std deduction)
worth of income you could realize and still stay in the 15% bracket?
I haven't given your ?? much thought but my initial guess would be the same
as yours......take advantage of the 0% CG before it disappears. The lower
brackets for conversion hopefully will still be there in the future.
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Old 08-01-2009, 09:04 PM   #3
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Originally Posted by kaneohe View Post
Don't you have another 9.3K (=3.6K of exemption and 5.7K of std deduction)
worth of income you could realize and still stay in the 15% bracket?
Sounds about right. I was just doing a first approxmation above. Thanks for the input.
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Old 08-01-2009, 11:28 PM   #4
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Originally Posted by free4now View Post
And assuming we are close to a market bottom as seems to be conventional wisdom...
IMO this would be an odd assumption to make, as we are 49.5 % above a "bottom" just last March.

I guess it depends on your definition of close.

Ha
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Old 08-02-2009, 10:25 AM   #5
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Quote:
Originally Posted by haha View Post
IMO this would be an odd assumption to make, as we are 49.5 % above a "bottom" just last March.

I guess it depends on your definition of close.

Ha
Yes, that struck me as odd also.

I would say that if the "conventional wisdom" was we were near a market bottom, then we would not be. Because they all would have bought up the market at this near bottom, and that would drive it higher.

It is a difference in views that makes markets.


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Old 08-02-2009, 11:23 AM   #6
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Morningstar has an IRA rollover calculator for helping to determine if a rollover from a traditional IRA to a Roth makes sense. You may want to take a look at that.
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Old 08-03-2009, 02:41 PM   #7
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Quote:
Originally Posted by ERD50 View Post
I would say that if the "conventional wisdom" was we were near a market bottom, then we would not be.
Not to turn this into a market timing discussion but...

I should clarify that my statement about conventional wisdom indicating we're near a market bottom was mostly based upon the the recent signs the recession is easing (e.g. GDP not falling much). I don't put much stock in market timing predictions, but when I have to make decisions for other reasons (e.g. now where I have to decide whether to sell for CG or convert to Roth) I will try and take account of the long term market direction. The word "bottom" was clearly a bad choice of words on my part, but I think there is general sentiment that the recession is not going to last forever and that 5, 10, or more years from now a long position today is likely to pay off. I would only make my decision based on that market prediction if everything else were equal.

I think I'm leaning towards doing the 0% CG realization sale; the main disadvantage I see with that strategy is that it precludes doing anything this year that generates taxable income above $34k, like taking advantage of the 15% CG rate for income levels above $34k that will rise to 18-20% in 2010 (or doing more Roth conversion to fill the $34k-82k bracket). So it comes down to question of whether I think I'll stay FIREd long enough to have space in those lower brackets for more CG and Roth conversion in future years. I'm optimistic enough about not having to go back to work that seems like a good route.
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