Converting t-IRA dollars into Roth IRA dollars

[HadEnuff]

I've been reading on the FIRE threads about this strategy.

If I understand it correctly, the idea is to take more out of my t-IRA than I need to, prior to my RMD age (I am currently 64), to bump my Federal Tax Bracket to the brink of the 15% to 25% threshold (around 75K), and convert what I don't need from that to live on into a Roth IRA.

Do I have that right?

Is there a limit on how much one can convert in a year, this way?

 

[SecondCor521]

The limit on how much you can convert each year is the smaller of:

1. How much money you have in your traditional IRA(s).
2. How much taxable income you are willing to pay taxes on.

In theory, if you withdraw or convert and pay 15% federal taxes on the money now, that may reduce the amount of RMD's you will face starting in six years or so. I think most people advise trying to project what your RMD's will be, plus the taxable part of Social Security, plus any other income you'll have at that point, and see what bracket it puts you in. If it's much higher than where you are now, and you're willing to take the risk of the tax landscape changing, then it could be a good idea.

 

[RunningBum]

Yes. There are other factors, like limiting MAGI for an ACA subsidy, and what your tax bracket will be after RMDs, but I'd guess for most ER people this is a good strategy.

Make sure you include dividends and cap gains in that limit. Otherwise, every $1 you convert gets taxed at 15% for that income, plus 15% for the qualified dividend or LTCG that you pushed into being taxed, for an effective 30% rate on the overage.

What some have done is to make sure you convert enough, and then when you do your taxes, figure out the exact amount and recharacterize the overage. That ability may go away with the new tax law proposals, so you'll have to try to estimate what you want to convert before the end of the year. It's not the end of the world if you go a bit over since it's not a cliff like losing the ACA subsidy, but you probably don't want too much taxed at 30%.

No limit on conversion. You could convert your entire tIRA if you wanted to.

 

[bingybear]

I've been reading on the FIRE threads about this strategy.

If I understand it correctly, the idea is to take more out of my t-IRA than I need to, prior to my RMD age (I am currently 64), to bump my Federal Tax Bracket to the brink of the 15% to 25% threshold (around 75K), and convert what I don't need from that to live on into a Roth IRA.

Do I have that right?

yes, I guess that is one way to say it. But you can do it at RMD time also just by taking more than you RMD.

You may or may not want to go above the 15% bracket at this time depending upon your situation. However, you are usually better off if you pay the taxes on your conversions with existing after tax dollars.

Doing Roth conversions at lower tax rates than your marginal rate RMD time likely will benefit you. If you have to get a larger distribution to pay the taxes too, look at the total effective tax on the conversion.

 

[Sunset]

You don't take it out of your IRA, you call up the brokerage and tell them you want to do a "Conversion" from your IRA to ROTH.

You do not touch the money.
You don't take it out of the IRA as you cannot put it into a ROTH if you touch it.

There is no limit, but depending upon how much you have in the IRA (a number here would get better advice) most feel going to the top of the 15% bracket is great.

Sounds like you are married since you referenced 75K, so remember that 75k is after the deductions are taken off, so its about $98K of total income.

 

[ERD50]

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

 

[JoeWras]

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

-ERD50

Good idea. But it is also a difficult calculus, because you are increasing your Roth basis, which ultimately (hopefully) will have future untaxed gains. The gains you harvest in the taxable sphere will be reinvested as taxable, with future taxable gains.

 

[pb4uski]

I've been reading on the FIRE threads about this strategy.

If I understand it correctly, the idea is to take more out of my t-IRA than I need to, prior to my RMD age (I am currently 64), to bump my Federal Tax Bracket to the brink of the 15% to 25% threshold (around 75K), and convert what I don't need from that to live on into a Roth IRA.

Do I have that right?

Is there a limit on how much one can convert in a year, this way?

As Sunset said, you don't take it out of your tIRA and put it into you Roth.... you transfer (aka convert) it from your tIRA to your Roth. You never touch the money. If you are also taking money out to live on then that is a separate process.... a withdrawal rather than a conversion.

I actually overconvert by a little because anytime before you file your tax return you can "recharacterize" any excess above the top of the 15% tax bracket... essentially reverse a part of your conversion and reflect it on your tax return.

So for example, each of the last two years I have finalized my tax return, determined how much above the top of the 15% tax bracket I was, recharacterized that excess, reduced the conversion amount on my tax return by the amount rechracterized and finally, filed a tax return with taxable income exactly equal to the top of the 15% tax bracket.

The reason for recharacterizing is because if you have some capital gains or qualified dividends and go over by a little, the effective tax rate on any excess is 30%.

There is no limit on the amount that can be conveted in any one year.... if you're willing to pay the tax you could convert the entire tRA balance... in fact there are some reasonable arguments that woudl be the best thing to do economically in the long run since all future income would be tax free... but many (including me) are loathe to write the government a big check for taxes.

 

[Koolau]

One should read up on this process before executing. As many have pointed out, there are quite a few pros and cons, pitfalls and strategies. A good place to start is "Fairmark Guide to the Roth IRA" You should be able to find Fairmark on the NET or buy the book at Amazon, etc.

I wasn't too smart about doing my conversions and I'm sure I cost myself some money along the way. Still, my RMDs are "manageable" at least for now and that was a big part of what I wanted to accomplish. By manageable, I mean that they do not (currently) force me into any of the "gotchas" of higher AGI/MAGI, etc. Wether I ultimately "win" will only be known in the future (probably after I'm dead, heh, heh.) Still I think the concept is one everyone should at least look into - with great care, of course. YMMV

 

[43210]

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

"Don't forget basis step-up for heirs if that's a factor."
http://www.early-retirement.org/forums/f28/roth-conversion-vs-gap-gain-89167.html#post1959829

 

[kaneohe]

You don't take it out of your IRA, you call up the brokerage and tell them you want to do a "Conversion" from your IRA to ROTH.

You do not touch the money.
You don't take it out of the IRA as you cannot put it into a ROTH if you touch it.

.............................................

Certainly converting directly is better and simpler but why can't you touch the money similar to an indirect rollover of IRA?

 

[pb4uski]

I think that you can... you just have the 60-day window to keep in mind.

I certainly would not recommend that anyone do it that way because things can go wrong... also, if there is federal and state income tax withholding on the withdrawal then the taxpayer would have to front that money up when they do the conversion and then wait to get it back as a refund when they file their taxes.

 

[Scuba]

This is one area I'm not comfortable with DIY. Seems like there are many potential options with varying short & long-term impacts. I'll be asking our tax CPA to help us with this planning.

 

[walkinwood]

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

 

[Sunset]

Certainly converting directly is better and simpler but why can't you touch the money similar to an indirect rollover of IRA?

I was being fairly simple as OP has said he would take it out, and while a person might be able to touch the money in doing a conversion, there are plenty of opportunities to screw it up.
So not touching the money is simpler and easier, just tell the brokerage how much from the IRA you want to convert to the ROTH, sign the form and watch your accounts.

I've only done it a few years, and I always have the brokerage move the $$$ or the stocks which as a note you can move the stocks in kind if you really want to keep them and are in essence simply changing where they reside.

OP will need to figure out if the money in the Traditional IRA is post-tax money, as no tax will be due on the percentage of that compared to the total IRA balances, but that is done at tax time.

 

[braumeister]

Here's a good discussion on the subject from FIDO:
Answers to Roth conversion questions

 

[HadEnuff]

Wow, lots of good information. Thanks everyone.

 

[HadEnuff]

From what I've read, if I understand correctly, you have to wait 5 years before you can make a withdrawal of converted funds, without a penalty?

 

[bingybear]

From what I've read, if I understand correctly, you have to wait 5 years before you can make a withdrawal of converted funds, without a penalty?

and each conversion has it's own 5 year waiting period.

 

[braumeister]

From what I've read, if I understand correctly, you have to wait 5 years before you can make a withdrawal of converted funds, without a penalty?

It could be as little as four years and a day, since the five year clock starts on Jan 1 of the conversion year.

 

[kaneohe]

From what I've read, if I understand correctly, you have to wait 5 years before you can make a withdrawal of converted funds, without a penalty?

Here's a somewhat more complex set of rules by kawill of the fairmark.com site. Withdrawals are considered to be in the order listed:
contributions first, then conversions oldest first (within each conversion the taxable portion of conversion first), and then earnings come out last.
The decision depends on your age at withdrawal and there is either a 5 yr clock on conversions for the spring chickens or for the older wiser folks there is a 5 yr clock on your oldest Roth (even if not in existence anymore). If you are over 59.5 y.o. and opened your first Roth over 5 yrs. ago, there is no waiting.......
And if over 59.5 y.o. but first Roth is less 5 yrs old, you can still take out your contributions/conversions. Just the earnings are an issue.

Re: Roth IRA Rules - Table Approach
Posted by: KAWill (IP Logged)
Date: October 14, 2010 11:57PM


Roth IRA Distribution Table

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD NOT MET

Contributions: Tax-No; Penalty-No
Conversions: Tax-No; Penalty-Yes (Taxable Portion)
Conversions: Tax-No ;Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-Yes

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD MET

Contributions: Tax-No; Penalty-No
Conversions: Tax-No; Penalty-No (Taxable Portion)
Conversions: Tax-No; Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-Yes

OVER AGE 59.5
LESS THAN FIVE YEARS SINCE OPENING FIRST ROTH IRA

Contributions: Tax-No ;Penalty-No
Conversions: Tax-No; Penalty-No (Taxable Portion)
Conversions: Tax-No; Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-No

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

All Distributions Are Qualified

No Taxes
No Penalties

Note: The table is not applicable to timely distributions of excess contributions or return of regular contributions.

 

[MrLoco]

and each conversion has it's own 5 year waiting period.

I have heard this before.

My questions are:

1) Can anyone confirm the 5 year waiting period ( as it pertains to each new conversion made)?

2) Who keeps track of this rule? The investor? The brokerage house? Will the IRS know if a withdrawal has satisfied the 5 year rule?

 

[kaneohe]

I have heard this before.

My questions are:

.................................

2) Who keeps track of this rule? The investor? The brokerage house? Will the IRS know if a withdrawal has satisfied the 5 year rule?

You do ............on lines 22 (for contributions) and line 24 (for conversions) of F8606
.
There is gruesome detail on how to do this in the instructions for this form.....
I suspect that IRS could know from your prior history but more likely if interested, they will make YOU prove it. Keep good records of contributions,conversions, and withdrawals.

 

[bingybear]

You do ............on lines 22 (for contributions) and line 24 (for conversions) of F8606
.
There is gruesome detail on how to do this in the instructions for this form.....
I suspect that IRS could know from your prior history but more likely if interested, they will make YOU prove it. Keep good records of contributions,conversions, and withdrawals.

+1

The brokerage could not do this. The investor could have multiple RIRA and multiple brokers. All Roths of a individual investor are treated as one from an IRS viewpoint.

Keep a good record of all contributions, type and date as well as withdraws.

 

[VanWinkle]

and each conversion has it's own 5 year waiting period.

My understanding is that if you convert it into a roth account that has already met the 5 year test, and you are over 59 1/2, you do not have a waiting period on the conversion. Vanguard has indicated the same when answering my specific question about conversions. If this is not correct, it may affect the timing of conversions.

VW