In lieu of Roth recharacterizations

[pb4uski]

As many of you know, the ability to recharacterize Roth conversions is now gone for the tax year 2018 and beyond... crimping the style of many of us that manage taxable income to a certain level... in my case to the top of the 0% LTCG bracket. (You can still recharacterize Roth contributions, but not Roth conversions).

It just struck me today that there may be a suitable workaround for those 59 1/2 or older. Make part of what you otherwise would have done as a Roth conversion as a tIRA withdrawal instead and do it as late in 2018 as possible. Then do your tax return as early in 2019 as possible and if you have an excess, then just redeposit any excess back to your tIRA using the 60 day rollover rule.

Looks like that will work.

You have a 60-day window to get that money back into an IRA. The key to the do-over option is a tax rule that people often use to roll IRA money from one financial institution to another. If you take a distribution from your IRA at Company A today and deposit those dollars in an IRA at Company B within 60 days, there’s no tax bill due.

You can also use this 60-day rule to deposit the money you withdrew back into your original IRA, says Suzanne Shier, chief wealth planning and tax strategist at Northern Trust: “You just have to put it back into an IRA. It doesn’t have to be at another institution.”

There are a few things you need to know: You can use this 60-day rule only once a year. However, there are no limits on transactions in which you direct your IRA custodian to send the dollars directly to another provider. And last year, the IRS granted a little more flexibility to IRA investors who accidentally go beyond the 60-day period for reasons such as a family death or home damage.

IRA Withdrawal Rules: When You Can Undo Without a Penalty | Money

 

[user5027]

Thanks. I am in the same boat and was planning to estimate my 2018 1040 to figure how much tIRA to convert this month.

I like your idea. Using it takes the angst out of having to get it right without all the final income figures for the year.

 

[kaneohe]

Very clever! be careful tho about the "once a yr" rule tho.........it's NOT once a calendar yr........it's once every 365 days so w/ appropriate safeguarding it probably ends up later each yr .

 

[jimbee]

Thanks for the idea, pb4uski, and the caveat kaneohe. Here are the details on the conversion limits. https://www.irs.gov/retirement-plans/ira-one-rollover-per-year-rule

It should be doable for a number of years, allowing for a "one day later each year" conversion.

 

[fh2000]

I have not done Roth conversion so there is one detail that is not clear to me how you do this 60 day rollback.

For Roth conversion, you would withdraw funds from tIRA and roll it in Roth IRA account. You used to be able to recharacterize from Roth IRA account back to tIRA account.

With this 60 day rule, the money withdrawn will also be rolled into a Roth IRA account? The key is to make sure you roll back in 60 days, and you will be allowed?

 

[pb4uski]

No... let me explain. Let's say that it is late December I calculate that I can do a $25,000 Roth conversion, but I estimate that could be up to +/-$1,000 off by the time I finalize my tax return.

Back when we could do Roth recharacterizations, I would convert $26,000 before December 31. Let's say that I'm finalizing my tax return in early Feburary and it turn out that I can really only convert $24,500 to the top of the 12% tax bracket. When recharacterizations were available, I would recharacterize $1,500... effectively reducing the $26,000 conversion to $24,500.

Now, given the same facts, I'll do a Roth conversion for $24,000 and a IRA distribution for $2,000... the same $26,000 in total. Then when I finalize my tax return I'll deposit $1,500 back in my IRA... reducing my IRA withdrawal to $500. On my tax return I'll report a $24,000 Roth conversion and $500 IRA withdrawal and still hit my target of the top of the 12% tax bracket on the button.

The other difference is rather than having $24,500 in my Roth that I'll have $24,000 in my Roth and $500 in my pocket.... but either way my IRA will be $24,500 lower.

 

[fh2000]

The other difference is rather than having $24,500 in my Roth that I'll have $24,000 in my Roth and $500 in my pocket.... but either way my IRA will be $24,500 lower.

Got it. The whole purpose is to reduce tax later in life.

 

[pb4uski]

Yup... you got it.

That and if you eek over by $100 it costs you $27 in tax... 12% on the increase in ordinary income and 15% on the capital gains pushed from 0% to 15%... ouch

 

[Onward]

Good idea, but problematic for me because it requires you have your entire tax picture complete in late Feb or early Mar. My taxes aren't done until late Mar or Apr. One reason is just the general complexity. Another is that I don't receive some 1099s, corrected 1099s, and K-1s until late March or early Apr.

 

[Crabby Mike]

Yup... you got it.

That and if you eek over by $100 it costs you $27 in tax... 12% on the increase in ordinary income and 15% on the capital gains pushed from 0% to 15%... ouch

Are you sure about that? It seems to me that the next dollar of income is either capital gains (at 15%) or ordinary income (at 12%), not both. I forget which gets counted first (or last, since that's what matters here), but it's one or the other. Right?

 

[Cobra9777]

...Let's say that it is late December I calculate that I can do a $25,000 Roth conversion, but I estimate that could be up to +/-$1,000 off by the time I finalize my tax return...

By late December, there's rarely more than +/- $100 unknown in our tax return... typically FTC on international equity. I can estimate FTC based on prior years, but I've yet to figure out a precise calculation. So that's the only number I'm waiting to firm up with the 1099... which BTW doesn't come until late March usually, so I can't finalize the return until after that.

Also, my Roth conversions are an in-kind transfer of an ETF (VTI), which sells for $130-140 currently. So that price defines the threshold of accuracy I can get to when targeting the top of the 12% bracket. I usually undershoot by about $100-200 and that's just fine with me. Even overshooting by a hundred dollars at 27% is not the end of the world, but I still err on the low side to avoid it, as a matter of principle.

 

[fh2000]

Good idea, but problematic for me because it requires you have your entire tax picture complete in late Feb or early Mar. My taxes aren't done until late Mar or Apr. One reason is just the general complexity. Another is that I don't receive some 1099s, corrected 1099s, and K-1s until late March or early Apr.

Because of the very reason of the late reporting and oftentimes, receiving corrections, I have liquidated all K-1 assets to make tax filing easier.

 

[Sunset]

By late December, there's rarely more than +/- $100 unknown in our tax return... typically FTC on international equity. I can estimate FTC based on prior years, but I've yet to figure out a precise calculation. So that's the only number I'm waiting to firm up with the 1099... which BTW doesn't come until late March usually, so I can't finalize the return until after that.

Also, my Roth conversions are an in-kind transfer of an ETF (VTI), which sells for $130-140 currently. So that price defines the threshold of accuracy I can get to when targeting the top of the 12% bracket. I usually undershoot by about $100-200 and that's just fine with me. Even overshooting by a hundred dollars at 27% is not the end of the world, but I still err on the low side to avoid it, as a matter of principle.

My thought on in-kind transfers is that I can use the value on the day of the transfer, which is the day it shows up in the ROTH.
That is about as accurate as I get.

 

[pb4uski]

Are you sure about that? It seems to me that the next dollar of income is either capital gains (at 15%) or ordinary income (at 12%), not both. I forget which gets counted first (or last, since that's what matters here), but it's one or the other. Right?

Yes, very sure about that. If you are dead on the top of 0% LTCG and have $100 more of ordinary income then the $100 of ordinary income is taxed at ordinary rates (most likely 12%) and it pushes $100 of LTCG into the 15% rate.. so the incremental tax on the $100 is $27.

 

[pb4uski]

By late December, there's rarely more than +/- $100 unknown in our tax return... typically FTC on international equity. I can estimate FTC based on prior years, but I've yet to figure out a precise calculation. So that's the only number I'm waiting to firm up with the 1099... which BTW doesn't come until late March usually, so I can't finalize the return until after that.

Also, my Roth conversions are an in-kind transfer of an ETF (VTI), which sells for $130-140 currently. So that price defines the threshold of accuracy I can get to when targeting the top of the 12% bracket. I usually undershoot by about $100-200 and that's just fine with me. Even overshooting by a hundred dollars at 27% is not the end of the world, but I still err on the low side to avoid it, as a matter of principle.

Yes, I'm usually much closer than that, typically the biggest unknown is FTC... I was just making an example.

What is the reasoning or benefit of doing in-kind Roth conversions? I designate an amount.. and I think they sell VTSAX in the IRA and buy VTSAX in the Roth, though I could buy something different if I wanted to.

 

[Cobra9777]

Yes, I'm usually much closer than that, typically the biggest unknown is FTC... I was just making an example...

I understand. But what's the point of your proposed process if, with a little effort, most people can nail down their taxable income to within a couple hundred dollars before year-end?

...What is the reasoning or benefit of doing in-kind Roth conversions? I designate an amount.. and I think they sell VTSAX in the IRA and buy VTSAX in the Roth, though I could buy something different if I wanted to.

We don't own any mutual funds, only ETFs. The in-kind transfer is a single transaction, so it's a bit simpler than two separate sell/buy transactions separated by several days. Plus it locks in the conversion amount at the closing price on the day of the conversion. It also avoids two $4.95 commissions at Fidelity. And it avoids being out of the market for a few days while the transactions clear and cash is moved.

 

[pb4uski]

Ah, got it. On the first part my TI each of the last 4-5 years was the top of the 15% tax bracket on the button, so I'm thinking of extending the streak, but to the top of the 0% LTCG bracket of $77,200.

 

[Crabby Mike]

Yes, very sure about that. If you are dead on the top of 0% LTCG and have $100 more of ordinary income then the $100 of ordinary income is taxed at ordinary rates (most likely 12%) and it pushes $100 of LTCG into the 15% rate.. so the incremental tax on the $100 is $27.

Well, Turbo Tax disagrees. I just set up a sample return with a mix of ordinary income and cap gains/dividends, right at the 0 cap gains tax threshold ($77,400 MFJ). I added $1,000 IRA withdrawal (ordinary income), and the tax was $150. That means that the ordinary income was effectively taxed first, so the tax hit the capital gains at 15%.

 

[pb4uski]

Well, Turbo Tax disagrees. I just set up a sample return with a mix of ordinary income and cap gains/dividends, right at the 0 cap gains tax threshold ($77,400 MFJ). I added $1,000 IRA withdrawal (ordinary income), and the tax was $150. That means that the ordinary income was effectively taxed first, so the tax hit the capital gains at 15%.

Wanna bet on that?

Well you must have a bad version of TurboTax... I'm using the What-If worksheet in TurboTax 2017 but using 2018 rates... MFJ with $50,000 of LTCG and $51,200 of Roth conversions... total income is $101,200 and taxable income is $77,200 (top of 0% LTCG bracket)... tax is $2,886.

The 0% LTCG threshold is $77,200, not $77,400... $77,400 is the top of the 12% tax bracket.... but that error shouldn't make a difference in the analysis.

Now add $100 to Roth conversions... total income is $101,300 and taxable income is $77,300 and tax is $2,913... $27 more... just like I said.

I'm guessing that you added $1,000 of capital gains rather than $1,000 of Roth conversions... if that is what you did then you would get an additional $150 in tax... no increased ordinary tax and 15% on the increased LTCG.

 

[kaneohe]

Wanna bet on that?

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.........................................................................................
I'm guessing that you added $1,000 of capital gains rather than $1,000 of Roth conversions... if that is what you did then you would get an additional $150 in tax... no increased ordinary tax and 15% on the increased LTCG.

Don't bet against pb4uski...............and he figured out what you did too.
If might help to have a visual concept of how this stuff works...
https://www.bogleheads.org/forum/viewtopic.php?t=86849 see tfb chart
12/11/11

 

[zinger1457]

Being just $100 over could cost some a lot more than just the extra $27 in taxes. I do ROTH conversions but try and take it as close as possible to the ACA MAGI limit without going over so that I get a subsidy. I've cut it real close the last couple years but could always recharacterized if needed, if I go $100 over this year it will cost me $10.5K.

 

[Crabby Mike]

Wanna bet on that?

Well you must have a bad version of TurboTax... I'm using the What-If worksheet in TurboTax 2017 but using 2018 rates... MFJ with $50,000 of LTCG and $51,200 of Roth conversions... total income is $101,200 and taxable income is $77,200 (top of 0% LTCG bracket)... tax is $2,886.

The 0% LTCG threshold is $77,200, not $77,400... $77,400 is the top of the 12% tax bracket.... but that error shouldn't make a difference in the analysis.

Now add $100 to Roth conversions... total income is $101,300 and taxable income is $77,300 and tax is $2,913... $27 more... just like I said.

I'm guessing that you added $1,000 of capital gains rather than $1,000 of Roth conversions... if that is what you did then you would get an additional $150 in tax... no increased ordinary tax and 15% on the increased LTCG.

Hmm, so if I don't get the answer you think, my TurboTax (current 2018 Premier, not a What-if on last year's version like you used) must be wrong.


OK, you're right about the $77,200 vs. $77,400 -- mea culpa. Though interestingly, TT showed no tax due at $77,400. And I didn't add $1,000 of capital gains, but rather a $1,000 tIRA withdrawal, as I said.



So ... I reran the sample return with your exact parameters (though I characterized as tIRA withdrawals, not Roth conversions, though that shouldn't make a difference). And the answer I got was ... $12. My guess (without sleuthing the calculations in the Qualified Dividend and Capital Gains worksheet) is that that the incremental amount ends up being taxed at either the LTCG or ordinary income rate, whichever is lower.


Congrats, you appear to have uncovered an error in last year's TurboTax what-if worksheet. Be sure to let them know.


All snarkiness aside, can't you see my point? Each dollar of taxable income is taxed at one rate or the other, never both (except when you get into NIIT, etc.).

 

[cathy63]

OK, you're right about the $77,200 vs. $77,400 -- mea culpa. Though interestingly, TT showed no tax due at $77,400. And I didn't add $1,000 of capital gains, but rather a $1,000 tIRA withdrawal, as I said.

If you have $77.2K of LTCGs and $1K tIRA withdrawal, then it's correct that you owe no tax. If you file MFJ, you can go all the way up to $24K tIRA withdrawal in that scenario because you are just offsetting the standard deduction. Try putting in $24,100 of tIRA withdrawal and I think you'll see that you owe something like $27 in tax on that extra $100. (It might be off by a few cents because that amount will come from the tax tables instead of a calculation.)

 

[Cobra9777]

Crabby, it's time to punt.

 

[RE2Boys]

Hmm, so if I don't get the answer you think, my TurboTax (current 2018 Premier, not a What-if on last year's version like you used) must be wrong.


OK, you're right about the $77,200 vs. $77,400 -- mea culpa. Though interestingly, TT showed no tax due at $77,400. And I didn't add $1,000 of capital gains, but rather a $1,000 tIRA withdrawal, as I said.



So ... I reran the sample return with your exact parameters (though I characterized as tIRA withdrawals, not Roth conversions, though that shouldn't make a difference). And the answer I got was ... $12. My guess (without sleuthing the calculations in the Qualified Dividend and Capital Gains worksheet) is that that the incremental amount ends up being taxed at either the LTCG or ordinary income rate, whichever is lower.


Congrats, you appear to have uncovered an error in last year's TurboTax what-if worksheet. Be sure to let them know.


All snarkiness aside, can't you see my point? Each dollar of taxable income is taxed at one rate or the other, never both (except when you get into NIIT, etc.).

Well, I don't know what your doing wrong with your test scenario, but I happened to just complete my 2018 tax year estimate with TurboTax, fully updated. So went in and added $1000 in interest income, and my tax liability went up exactly $270, just as I expected. It will increase at a 27% rate until such time as all CG/QDI is converted to the 15% rate and then any further increases will be at the 22% rate.