converting IRA to Roth IRA based on new Roth Rules vs. 72t

[mbmmccoy]

I need help determining an retirement/investment strategy.

Should I convert my IRA ($700,000) to a Roth IRA based on the new Roth rules that allow one to pay the taxes on the conversion to Roth over 3 years from 2010-2012 :?
This would mean I would have a tax liability that I could pay out over 3 years; if it's $700,000 or a smaller $$ amount.

This move allows me to have tax free assets moving forward no matter what Obama does.

It also doesn't restrict the amount of $$ I can remove from my Roth, I think??

OR should I leave my monies in my IRA and pull out $50,000 over the next 5 years based on the IRA 72t rule?

Any insight's would be appreciated.

 

[Animorph]

Watch out for the Roth 5-year holding rule for withdrawals if you are planning to use some of this money in the next 5 years.

You might want to convert only upto the amount that will keep you in a lower tax bracket. No sense in driving your income way up just for the conversion. If you are starting to draw from $700k already it sounds like this big money for you and would really increase your taxes.

You need to be able to pay the taxes without touching the conversion money to make it worthwhile. That sounds like it could be a problem for you.

You might consider a partial conversion so that you are tax-diversified and can optimize your near-term taxes as well.

 

[mbmmccoy]

Animorph,

Thank you for your response.

I am not familiar with the Roth IRA rules, but your response is indicating there is a 5-year holding rule for withdrawals once you have started or converted to a Roth; Is that correct?

I like your advice about converting an amount that will keep me in a lower tax bracket. I could do this on a yearly basis, correct?

Thanks again

 

[Animorph]

Yes, that is my understanding. You can Google it and find out the details. Each conversion starts a new 5 year clock for the amount converted, and when you turn 59 1/2 also makes a difference. Conversions are slightly different than contributions, so make sure you're looking at conversion rules.

I'm not sure how long the 2010 no-income-limit for conversions lasts, or if it matters for you. That's the only thing that I can think of that might affect yearly conversions. Normally your income must be less than $100k to convert.

If you can convert just enough to top-out on the lowest tax bracket each year that's usually a good move.

Try www.fairmark.com for detailed answers. They are usually concise and understandable.

 

[Koolau]

This move allows me to have tax free assets moving forward no matter what Obama does.

I don't mean to be a party pooper (as I am also converting traditional IRA money to Roth to avoid future taxation at potentially higher tax rates) but I am concerned about the various forms of "national sales tax" that have been proposed. Imagine that you have converted to a Roth, paid the taxes and then eventually spend your Roth money, only to be taxed yet again. Will it happen? Who knows, but there is a fair amount of support for such a taxing system. One thing seems certain. Those who have prepared for retirement will be a target for wealth transfer to those who have not. It is very politically expedient to take from the "rich" (anyone who has saved money) and give it to the poor (those who didn't save). But I'm not bitter.

Just something to think about. Not offering advice.

 

[bizlady]

I need help determining an retirement/investment strategy.

Should I convert my IRA ($700,000) to a Roth IRA based on the new Roth rules that allow one to pay the taxes on the conversion to Roth over 3 years from 2010-2012 :?
QUOTE]

Regarding the tax payments, I believe your choice is to pay your taxes at once for 2010, OR spread them equally and pay them in 2011 and 2012. In other words, a two year spread not a three year spread.

 

[LOL!]

No, you should not convert $700K and owe 35% or more in taxes on it. That would be ridiculous. It looks like the mbmmccoy tax plan is worse than any plan that Obama could come up with. Why pay taxes when you don't need to?

If you withdraw/convert only the minimum you need, you could probably pay less than $70K in taxes on the entire amount spread out over several years. That would save you more than $170K.

Did you somehow miss that conversion to a Roth costs you a lot in taxes?

 

[bobbee25]

I am planning on moving as much as possible to stay stay at the 15% tax rate. It is my understanding that the tax can be spread over 2 years.
Convert in 2010 pay in tax year 2011 and 2012.
i.e. pay by 4/2012 and 4/2013.

 

[kaneohe]

Regarding the tax payments, I believe your choice is to pay your taxes at once for 2010, OR spread them equally and pay them in 2011 and 2012. In other words, a two year spread not a three year spread.

I believe that you spread the income (not the tax) equally for the 2011 and 2012 tax years (which, as another has said, you pay in Apr of he following yrs). Depending on your personal situation and if/how tax rates change, that might amount to the same thing or maybe not.

 

[Animorph]

I think you should be able to do a pure 2010 conversion and also a 2010 conversion with taxes split into 2011/2012. That would give you the three year tax spread. But I haven't looked into doing that.

I'll probably be converting a substantial amount in 2010, so we'll all be experts then.

 

[Koolau]

Did you somehow miss that conversion to a Roth costs you a lot in taxes?

LOL, I assume everyone knows that conversion is a taxable event. In my case, since most of my retirement savings are in trad. IRAs or 401(k), I will face a large (and largely uncontrolled) set of taxable events when I turn 70 1/2 and am forced to take RMD. I'm just trying to head that off and pay some now to avoid paying even more later. The wild card(s) are future tax law changes. None of us can see into the future, but with multi trillion dollar deficits, we will either face higher taxes, higher natl. debt, higher inflation or some combination of all 3. With that in mind, I guess I'm trying to hedge my bets by converting SOME IRA money to Roth now. Am I right?? We'll see.

 

[LOL!]

I will certainly be converting IRAs assets to Roth piecemeal over many years. There is nothing wrong with converting.

There is a huge difference between paying taxes on a $700,000 fully taxable one-time conversion and paying taxes on partial conversions and on RMDs.

Also some folks think that the special 2010 rule is that you won't pay taxes. This is not true, but I think it stems from the following trick:

High income people are not eligible for a Roth IRA, so they are instructed to put money into a non-deductible traditional IRA. In 2010 they can convert. Only the gains in that non-deductible traditional IRA are taxed. If the non-deductible traditional IRA was invested in a money market fund, there would be little gains and thus virtually no tax on the conversion. This also supposes no deductible traditional IRA assets are available which changes the rules and taxes somewhat.

So would anybody here advise mbmmccoy to convert $700,000 in one year? Or even in two years? I think not.

 

[Koolau]

So would anybody here advise mbmmccoy to convert $700,000 in one year? Or even in two years? I think not.

Point well taken, LOL!

 

[bobbee25]

It is my understanding that you can convert in 2010 and pay the taxes in the taxable years 2011, 2012 or you can pay it all in taxable year 2010. But not both. In other words you can add the conversion as income for taxable year:
1. 2010
or
2. split it for 2011 and 2012

but not both.

 

[bizlady]

For 2010 ONLY you may convert to a Roth and the converted amount does not have to be declared as income for 2010. You may report half as income for tax year 2011 and the rest in 2012. Or all in 2010.

 

[jdw_fire]

I don't mean to be a party pooper (as I am also converting traditional IRA money to Roth to avoid future taxation at potentially higher tax rates) but I am concerned about the various forms of "national sales tax" that have been proposed. Imagine that you have converted to a Roth, paid the taxes and then eventually spend your Roth money, only to be taxed yet again.

even if we do get a national sales tax, i think it will be in ADDITION to income tax, not a replacement for.

 

[Koolau]

even if we do get a national sales tax, i think it will be in ADDITION to income tax, not a replacement for.

I absolutely agree. However, I've been hoping to have NO or LOW income by NOT having any (or at least less) IRA money being taken as MRD at 70 1/2 yrs. My point (and it was my point) was that I could end up double (or maybe it's triple) taxed on all Trad. IRA money. I still think it's worth the chance to convert some level of Trad to Roth - hope for the best, I always say (how that squares with my Murphy tag line, I don't know)

 

[haha]

even if we do get a national sales tax, i think it will be in ADDITION to income tax, not a replacement for.

Absolutely. For one thing, there are a lot of reasons the government wants to know what your income is besides income tax. Lots of social welfare programs like Earned Income Credit, or even to figure your Medicare premium.

Many of you may not know that not everyone pays the same Medicare premium. Our leaders have determined that above a certain "Adjusted AGI" our healthcare must be worth more, so we must pay more.

One of my future goals is to try very hard to avoid that Medicare surcharge from now on. Not only is it a fair amount of money, but it really annoys me.

Ha

 

[harley]

So let me see if I've got this Catch-22 figured out correctly.

I want to convert my IRA to a Roth. I make it in below the $100K limit, fitting somewhere in the mid 25% bracket. I want to convert as much as I can without going into the 28% or higher bracket. But I caan't know what my true AGI is until I get all my 1099s, probably late Jan. or early Feb. Of course, by then it's too late to do the conversion for that year. Rinse and repeat for the next year.

My only options are to underestimate and underconvert, or take a chance on a higher tax bracket. And even if I guess right, it will probably take me 10 years or more to convert my entire (fairly healthy) IRA balance to a Roth. So the only people who really benefit from the 2010 option are the people already in the 35% bracket. Is this correct?

 

[Koolau]

Harley,

Don't take this to the bank, but I think you can "unconvert" whatever you need to up to Apr. 15 of the following year - might even be longer. Check Fairmark site - I bet they have the poop on this.

And, yeah, it's a real PITA trying to beat the taxman at his own silly game. Even worse, he can change the rules whenever it suits him. What a country!

 

[harley]

I guess a question worth considering is whether it is worth it to bump up to the next bracket (25% - 28%) and convert more, based on what the RMDs will do to you in the future. I just ran a pseudo RMD calculation based on a $2M IRA when I'm 70, and I'd be looking at ~$80K/year. I suspect that would bump me up a notch or two on our probably higher than current brackets. I'm assuming I won't need to be withdrawing from my existing IRA meanwhile, and I've got 18 years before RMDs kick in. The balance should have hopefully quadrupled by then (rule of 72 at 7%).

I also wasn't able to find out whether this no AGI limitation thing is a one time deal in 2010, or if it will continue on forward until somebody changes it again. This could also make a difference since even though a huge conversion now will cost me a ton at 35%, it might be chump change compared to bumping brackets in the 45% future. No way to tell what will happen, but I like to plan for the worst.

 

[walkinwood]

There is a detailed thread over at bogleheads that cover all the details. It also includes a link to an WSJ article that you must read if you're planning to convert.

Bogleheads :: View topic - Roth IRA conversion

 

[bobbee25]

Another big plus with the Roth is the inheritance factor for a beneficiary.

 

[kaneohe]

I also wasn't able to find out whether this no AGI limitation thing is a one time deal in 2010, or if it will continue on forward until somebody changes it again. .

It's the latter, but who knows when it will be changed again.

 

[kaneohe]

For 2010 ONLY you may convert to a Roth and the converted amount does not have to be declared as income for 2010. You may report half as income for tax year 2011 and the rest in 2012. Or all in 2010.

I saw something today on fairmark.com (for married folks only) that each spouse has an election to either declare as 2010 income or split into 2011/2012 and the elections can be different so possible to split into 3 yrs.