Another beginners questions. Converting to Roth IRA

[bclover]

Hello All,
Would someone explain the reasoning behind converting regular IRA"s into roth ira's prior to retiring for income?

Why is it a good thing?

So if I have an IRA with 440K in it, wouldn't I pay a penalty for withdrawing it before 59 1/2 to convert it to a roth?

would the money I take out of the IRA be considered ordinary income. I'm still working so I definitely don't want to bump up my tax bill.

Thanks,
BC

[hnzw_rui]

Quote:

Originally Posted by bclover Would someone explain the reasoning behind converting regular IRA"s into roth ira's prior to retiring for income? Why is it a good thing? So if I have an IRA with 440K in it, wouldn't I pay a penalty for withdrawing it before 59 1/2 to convert it to a roth? would the money I take out of the IRA be considered ordinary income. I'm still working so I definitely don't want to bump up my tax bill.

If you're taking money out of a traditional IRA pre-59 1/2 and converting the entire amount of the distribution to Roth (paying taxes with after tax money), then no, there's no penalty.

I don't quite understand the first question though. In general, I think you wouldn't want to do Roth conversions while you're still working because you're probably still in a higher tax bracket than when you retire unless it's just for a backdoor Roth (can make non-deductible traditional IRA contributions but too high income to make normal Roth contributions).

[growing_older]

There is no penalty for doing a conversion, although you do have to pay the tax as if the entire converted amount is regular income. If you have a very big IRA and anticipate RMDs will bump you into a higher tax bracket getting some of that into a Roth may be advantageous. Also if you do retire early, you may have some years with no income before SS or RMDs kick in. If so, you may be able to convert at low income tax rates during those years your income is low.

[bclover]

Quote:

Originally Posted by hnzw_rui I I don't quite understand the first question though. In general, I think you wouldn't want to do Roth conversions while you're still working because you're probably still in a higher tax bracket than when you retire unless it's just for a backdoor Roth (can make non-deductible traditional IRA contributions but too high income to make normal Roth contributions).

Actually my question was basically why do it? either now while I'm working or later when I retire.

I was watchng Ed Slott on PBS and I may have heard him incorrectly, but I thought he was advising folks to transfer their regular IRA's into roth's and I could not understand why. He's got a book called "parlay your ira into a family fortune" that I may pick up to read.


I'm 55, I have about 800K in a couple of IRAs. I basically thought I could not touch them until I'm 59 1/2 without paying a 10% penalty plus getting hit with a tax bill so I'm just trying to figure out how risking all that would be advantageous.

I plan on retiring at 56 but I do have enough savings to use until I hit 62,

I don't understand the tax savings for doing it at all.

[bclover]

Quote:

Originally Posted by growing_older There is no penalty for doing a conversion, although you do have to pay the tax as if the entire converted amount is regular income. If you have a very big IRA and anticipate RMDs will bump you into a higher tax bracket getting some of that into a Roth may be advantageous. Also if you do retire early, you may have some years with no income before SS or RMDs kick in. If so, you may be able to convert at low income tax rates during those years your income is low.

so if I convert it to a roth I won't get that 10% penalty for withdrawing prior to 59 1/2? Just the tax bill?

Thanks,

[RE2Boys]

Quote:

Originally Posted by bclover so if I convert it to a roth I won't get that 10% penalty for withdrawing prior to 59 1/2? Just the tax bill? Thanks,

Yes.

Many early retirees are concerned that RMDs starting at age 70.5, along with SS and other income streams, will push them into a higher tax bracket. Unless your working income is low, most do not due conversions while working unless their TIRA was not deductilble. One way to help avoid this is to convert TIRA to Roth before RMDs and presumably while in a lower tax bracket. I convert partial TIRA to Roth each year but only as long as I can stay in the 15% marginal tax bracket......that also insures that cap gains and Qualified dividends are taxed at 0%

I won't get all of my TIRAs converted by 70, but will have put a dent in it. Once converted, all growth based on these funds is tax free.

[aaronc879]

Quote:

Originally Posted by RE2Boys Yes. Many early retirees are concerned that RMDs starting at age 70.5, along with SS and other income streams, will push them into a higher tax bracket. Unless your working income is low, most do not due conversions while working unless their TIRA was not deductilble. One way to help avoid this is to convert TIRA to Roth before RMDs and presumably while in a lower tax bracket. I convert partial TIRA to Roth each year but only as long as I can stay in the 15% marginal tax bracket......that also insures that cap gains and Qualified dividends are taxed at 0% I won't get all of my TIRAs converted by 70, but will have put a dent in it. Once converted, all growth based on these funds is tax free.

This was a good explanation. You only do it if you can stay in the 15% tax bracket. Some people end up with well over a million in their tax deferred accounts by the time they reach 70 1/2. Say they have $1.5MM and a life expectancy of 15 years, that means the minimum they can take out of their tax deferred account is $100K. That puts them in a higher tax bracket. That is what people are trying to avoid.

[bclover]

Quote:

Originally Posted by RE2Boys Yes. Many early retirees are concerned that RMDs starting at age 70.5, along with SS and other income streams, will push them into a higher tax bracket. Unless your working income is low, most do not due conversions while working unless their TIRA was not deductilble. One way to help avoid this is to convert TIRA to Roth before RMDs and presumably while in a lower tax bracket. I convert partial TIRA to Roth each year but only as long as I can stay in the 15% marginal tax bracket......that also insures that cap gains and Qualified dividends are taxed at 0% I won't get all of my TIRAs converted by 70, but will have put a dent in it. Once converted, all growth based on these funds is tax free.

Ok, I think I got it, so last question.

So now you are retired. you take let's say 100K (because I work well with round numbers. ) now while you are in a 15% tax bracket and stick it in a roth. You pay taxes on the 100K now as ordinary income.

Do I have that right? and you can convert part of your IRA, you don't have to churn over the entire thing?

[aaronc879]

When you transfer money from tax deferred to Roth it needs to be a direct transfer if you're under 59.5. You can't make a withdrawal and put it in your checking then a couple months later put it in a Roth. As long as you transfer directly from one account to another then it can be any amount, does not need to be the entire account.

[pb4uski]

BC, the ideal time for Roth conversions is after you stop working and before pensions, SS and other forms of retirement income come online. During that period, many of us are living off of savings (taxable accounts) and our income is very low, so there is plenty of headroom within the 15% tax bracket to do Roth conversions. IIRC, I paid about 7% in taxes on my Roth conversions tha last two years, vs saving 28% or more when I deferred that income.

There is not early penalty on Roth conversions and any converted amount is ordinary income, so you would NOT want to do this while you are still working.

Finally, Roth conversions are best where your current tax rate is low and you expect your tax rate to be the same or higher once SS, pensions, RMDs, etc are online.

[bclover]

I got it.

darn it, I spent 11.00 bucks on that book.

[aaronc879]

Quote:

Originally Posted by bclover Ok, I think I got it, so last question. So now you are retired. you take let's say 100K (because I work well with round numbers. ) now while you are in a 15% tax bracket and stick it in a roth. You pay taxes on the 100K now as ordinary income. Do I have that right? and you can convert part of your IRA, you don't have to churn over the entire thing?

If you're in the 15% tax bracket then take out the $100K that will put you in a higher tax bracket. You will have to pay most of that 100K at a higher rate. You'll probably take closer to 10K per year rather than 100K per year because your income can't be that high and still be in the 15% tax bracket.

[pb4uski]

Quote:

Originally Posted by bclover ...Do I have that right? and you can convert part of your IRA, you don't have to churn over the entire thing?

Yes, you can do it a little at a time. And best of all, if you overconvert you can recharacterize (undo) any excess before you file your tax return.

[pb4uski]

Quote:

Originally Posted by aaronc879 If you're in the 15% tax bracket then take out the $100K that will put you in a higher tax bracket. You will have to pay most of that 100K at a higher rate. You'll probably take closer to 10K per year rather than 100K per year because your income can't be that high and still be in the 15% tax bracket.

For MFJ, under 65 with standard deduction it works out like this:

Standard deduction...............$12,600
Personal exemptions.................8,000
Top of 15% tax bracket...........73,800

Total income..........................94,400

Now subtract any income you have before any Roth conversions and that is the amount you can convert. If you itemize deductions, it might be even more.

[Jimmer25]

What about converting aftertax money in a TIRA to a Roth IRA? Is there a limit and are there tax or penalty implications?

[48Fire]

Quote:

Originally Posted by bclover Actually my question was basically why do it? either now while I'm working or later when I retire. I was watchng Ed Slott on PBS and I may have heard him incorrectly, but I thought he was advising folks to transfer their regular IRA's into roth's and I could not understand why. He's got a book called "parlay your ira into a family fortune" that I may pick up to read. I'm 55, I have about 800K in a couple of IRAs. I basically thought I could not touch them until I'm 59 1/2 without paying a 10% penalty plus getting hit with a tax bill so I'm just trying to figure out how risking all that would be advantageous. I plan on retiring at 56 but I do have enough savings to use until I hit 62, I don't understand the tax savings for doing it at all.

Have you looked at a 72t?

[kaneohe]

Quote:

Originally Posted by Jimmer25 What about converting aftertax money in a TIRA to a Roth IRA? Is there a limit and are there tax or penalty implications?

You can't just convert the aftertax money alone; it has to be converted in the same proportion as exists in all the TIRAs combined. See Form 8606. No limits.

Possible workaround: if you have an accepting 401K that will take your pretax money, you can isolate the basis and then convert that separately.

[bclover]

Quote:

Originally Posted by 48Fire Have you looked at a 72t?

See just when I was beginning to understand. What is a 72t?

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[48Fire]

You can withdraw from your IRA before 59 1/2, as long as you take out the same amount each year. Go to 72t.net for more details. I am in my third year of withdraws.

[harley]

Quote:

Originally Posted by bclover See just when I was beginning to understand. What is a 72t?

Don't worry about the 72t, since you've already stated that you have plenty of money to tide you over until 59 1/2. It's just a way to draw from your IRA early and without penalty, but it doesn't sound like you need it.

Quote:

Originally Posted by bclover I got it. darn it, I spent 11.00 bucks on that book.

It's a pretty good book and also has information in it about passing on the Roth to your heirs (if you have any). You'll still get your money's worth out of it. But next time check your library first.