Converting t-IRA dollars into Roth IRA dollars

[Al18]

So all this talk has me considering a small conversion this year to start the 5 year clock. I'm 54 now. The clock will be expired at 59 1/2.

I've resisted doing my first conversion since I'm in the high tax bracket. However, just for simplicity, I may start it now with the smallest conversion I can do to open the account at Vanguard. I think $1k? BTW, I have a very high post-tax basis in my IRA so the taxable amount would probably be less than $500.

You should look into opening a Roth IRA and contributing to it this year. You can contribute up to $6500 this year, since you're over 50. If you already have an online retirement account, you can probably open a Roth IRA in a couple of minutes. I opened one at Fidelity about 5 years ago and it took about 3 minutes.

 

[kaneohe]

You turned me on to this chart years ago at Fairmark. I've printed it out and given it to numerous people over the years. Very helpful. Your commission check is in the mail and will be taxable.

Holding my breath The one weakness is that it's like a crutch so that I can never remember all the details. That's also its strength cuz I have to look it up. I've always been to search on fairmark.com to find the table. This AM for some reason it failed. But google to the rescue.......search the topic and site:
Roth withdrawal table site:fairmark.com in case you need it again .

 

[kaneohe]

To clarify, I believe it means as long as "any" Roth account is 5 years old. You could have an old Roth (over 5 years) and a new Roth. You can still take money from the new Roth since the IRS considers all Roth IRAs as one big Roth IRA and you met the 5 year period with the old one.

I only have a couple of months until I'm 59 1/2 at which time I can forget about all of these rules!

To further clarify, note the words in the table: "Since opening first Roth IRA"....it doesn't say oldest Roth so if your original Roth acct (opened > 5yrs
ago) was closed and your current "oldest" Roth is 1 yr. old, you would still qualify.

OVER AGE 59.5
FIVE YEARS OR MORE SINCE OPENING FIRST ROTH IRA

All Distributions Are Qualified

No Taxes
No Penalties

 

[Lawrencewendall]

For those with TSP
From
https://www.tsp.gov/LifeEvents/career/enteringRetirement.html

Early Retirement
If you receive a TSP withdrawal payment before you reach age 59½, in addition to the regular income tax, you may have to pay an early withdrawal penalty tax equal to 10% of any taxable portion of the payment that is not transferred or rolled over. However, if you separate from service during or after the year you reach age 55 (or the year you reach age 50 if you are a public safety employee as defined by section 72(t)(10)(B)(ii) of the Internal Revenue Code), then the 10% early withdrawal penalty tax does not apply.

 

[pb4uski]

To clarify, I believe it means as long as "any" Roth account is 5 years old. You could have an old Roth (over 5 years) and a new Roth. You can still take money from the new Roth since the IRS considers all Roth IRAs as one big Roth IRA and you met the 5 year period with the old one.

I only have a couple of months until I'm 59 1/2 at which time I can forget about all of these rules!

Yes, as long as one of your Roth accounts is over 5 years old.

 

[HadEnuff]

What if you are over 59 1/2, but your oldest Roth is not 5 years old. Can you take out the transfer amount and leave earnings in, without penalty or tax?

 

[JoeWras]

What if you are over 59 1/2, but your oldest Roth is not 5 years old. Can you take out the transfer amount and leave earnings in, without penalty or tax?

Yes. Transfer amount is OK. Earnings, wait 5 years. Even if you are 106 y.o.

Note however, the tax-ability of the conversion process still applies. These rules concern the Roth post conversion.

 

[Sunset]

You should look into opening a Roth IRA and contributing to it this year. You can contribute up to $6500 this year, since you're over 50. If you already have an online retirement account, you can probably open a Roth IRA in a couple of minutes. I opened one at Fidelity about 5 years ago and it took about 3 minutes.

He is probably looking to do the least amount, just to get the clock started. He could probably open a ROTH with $100.

Everyone should tell their children to open a ROTH with $100, just to get the clock started.

For Canadians, tell your children to open a TFSA, so the clock starts on the $5,000 annual contribution clock which builds up per year. (it's like a ROTH, sort of).

 

[Scuba]

T-IRA to Roth conversions are more beneficial if you pay the tax owed using Non-IRA (taxable account) funds.

Why is this? Either way, funds are coming out of your portfolio to pay the taxes so what difference does it make?

 

[bingybear]

Why is this? Either way, funds are coming out of your portfolio to pay the taxes so what difference does it make?

when you do a conversion you get taxed on all the $ removed from the IRA. If you use after tax $ to pay the taxed, then the $ to pay the tax are not taxed. If you withdraw $ from the IRA to pay the tax, you have to pay tax on the $ to pay the conversion tax. You actually need to pull even more as you as you now need to pay the tax on the tax... and so on.

This really is just looking at the conversion and taxes at that time of the conversion.

 

[vtd0918]

Posting to follow

 

[Accidental Retiree]

Why is this? Either way, funds are coming out of your portfolio to pay the taxes so what difference does it make?

If you convert $10,000 and owe $2,000 in taxes, paid from the converted funds, you end up with $8,000 in your new Roth.

If you pay taxes with external funds, you end up with the entire $10,000 in your Roth.

We prefer to direct the whole amount to the Roth, so we pay with external funds.

 

[pb4uski]

Why is this? Either way, funds are coming out of your portfolio to pay the taxes so what difference does it make?

Here's the difference based on converting $100 and incur a 20% tax.

If you pay the tax from taxable funds, you then have $100 invested that will generate tax free income for the rest of your life.

If you pay the tax from the conversion, you only have $80 that will generate tax free income for the rest of your life and $20 that will generate taxable income for the rest of your life.

The difference is the taxes on future earnings of the $20 of taxable funds that are retained.

If you convert $100 and pay the $20 in tax from taxable funds and earn 7% per year in 30 years you'll have $761 in your Roth. If you pay the tax from the proceeds, you'll only have $686 ($609 in the Roth and the $20 will have grown to $77).

 

[bingybear]

If you convert $10,000 and owe $2,000 in taxes, paid from the converted funds, you end up with $8,000 in your new Roth.

If you pay taxes with external funds, you end up with the entire $10,000 in your Roth.

The example looks incomplete. In the first one "convert $10,000 and owe 2,000 in taxes paid with the conversion, you end up with $8k conversion NOTE - this cost 10k
In your second case you end up with a conversion of 10k but a cost of 12k

If you look at 10k conversions

using after tax $

10k from IRA is converted to roth. Using 20% taxes as above example we will pay taxes using after tax $ is $2k
so our cost is $10k+$2k=$12k

If we use all IRA money for the conversion
$10k for conversion
$ 2K for the conversion tax
$ 400 for tax on the $2k tax
$ 80 for tax on the $400
$ 16 tax on the 80
and so on
_________________
approx $12500

So pulling all the $ from the IRA costs about $500 more

 

[Sunset]

Where you pay the tax on conversion from is often thought of when a person has employment income or savings just lying around.

If you have a pile of after tax $$ lying around then paying the tax for a conversion with the after tax $$ is best.

However if you have no after tax money from a job for instance, and need to withdraw say $10,000 from an IRA to meet living expenses, then if you do a conversion on top of that, you will need to withdraw more from the IRA for the taxes or pay it out of the conversion funds.

 

[bingybear]

Where you pay the tax on conversion from is often thought of when a person has employment income or savings just lying around.

If you have a pile of after tax $$ lying around then paying the tax for a conversion with the after tax $$ is best.

However if you have no after tax money from a job for instance, and need to withdraw say $10,000 from an IRA to meet living expenses, then if you do a conversion on top of that, you will need to withdraw more from the IRA for the taxes or pay it out of the conversion funds.

Many of posted that Roth conversion aren't worth it if you have to pull the tax out of the IRA. I've never run the numbers to convince myself. I'm not sure people have after tax money just lying around anymore than IRA money just lying around. I would think it would be invested for the most part. But the point that some have more after tax $ is understood.

 

[pb4uski]

I wouldn't say that is isn't worth doing Roth conversions if you pay the tax from the proceeds, more that it is better if you pay the tax from taxable accounts since you then get to have more money invested tax-free... that's all. See post #63 for details.

 

[43210]

Here's the difference based on converting $100 and incur a 20% tax.

If you pay the tax from taxable funds, you then have $100 invested that will generate tax free income for the rest of your life.

If you pay the tax from the conversion, you only have $80 that will generate tax free income for the rest of your life and $20 that will generate taxable income for the rest of your life.

The difference is the taxes on future earnings of the $20 of taxable funds that are retained.

If you convert $100 and pay the $20 in tax from taxable funds and earn 7% per year in 30 years you'll have $761 in your Roth. If you pay the tax from the proceeds, you'll only have $686 ($609 in the Roth and the $20 will have grown to $77).

In addition, if 10% early withdrawal penalty is applicable, then that penalty applies to the 20% withheld (but not to the 80% converted), so you also lose 10%*20%=2%.

 

[pb4uski]

In addition, if 10% early withdrawal penalty is applicable, then that penalty applies to the 20% withheld (but not to the 80% converted), so you also lose 10%*20%=2%.

No, because early withdrawal penalties do not apply to Roth conversions.

 

[RunningBum]

No, because early withdrawal penalties do not apply to Roth conversions.

I think the part used to pay the taxes are subject to early withdrawal penalties since they are not actually converted.

 

[VanWinkle]

when you do a conversion you get taxed on all the $ removed from the IRA. If you use after tax $ to pay the taxed, then the $ to pay the tax are not taxed. If you withdraw $ from the IRA to pay the tax, you have to pay tax on the $ to pay the conversion tax. You actually need to pull even more as you as you now need to pay the tax on the tax... and so on.

This really is just looking at the conversion and taxes at that time of the conversion.

The idea is to move as much money from the TIRA to the Roth IRA. Using money from the TIRA to pay taxes on the conversions just means that much less you can convert next time.

VW

 

[43210]

I think the part used to pay the taxes are subject to early withdrawal penalties since they are not actually converted.

Exactly.

 

[VanWinkle]

Exactly.

Over 59 1/2, no penalty. Just the loss of ability to convert next time.

 

[Palmtree]

Also consider 'harvesting' any Long Term Capital Gains, which are taxed at 0% in the 15% bracket.

I haven't quite worked out the pros/cons of LTCG harvest versus Roth conversions, but it looks to be a moot point to me as I will need to sell some ETFs/funds for living expenses, and they all have some gains (some are about 50% unrealized gains). Not sure if I should harvest all the gains over the years, and then buy back what I don't need for living expenses, or do Roth Conversions. Maybe a topic for a different thread, and probably different moving puzzle pieces for different people.

-ERD50

I had this discussion/debate over on the Boglehead forum. There was not a clear answer but many people weighted heavy on the side of Roth conversions on the assumption that your tax bracket will likely go up beyond 15% once you start taking social security.

 

[ERD50]

I had this discussion/debate over on the Boglehead forum. There was not a clear answer but many people weighted heavy on the side of Roth conversions on the assumption that your tax bracket will likely go up beyond 15% once you start taking social security.

Right, but if I assume 15% bracket now and 25% later, that makes the delta on the ROTH conversions = 10%: 25% (rate on future t-IRA WD as income) minus the 15% (rate on conversion now) . And the delta on LTGC would be 15% (15% LTGC future and 0% now).

But I haven't factored time and ROTH tax-free growth into that (yet).

-ERD50