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Potential Roth stumbling blocks
Old 12-29-2009, 07:54 PM   #1
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Potential Roth stumbling blocks

OK, I've decided to convert my existing tIRAs to Roths over the years. I'll convert as much as I'm able to each year without jumping into the next tax bracket. I've made up my mind, I've thought out my reasons, and I've started the process for this year. No need to try to talk me out of it.

However, I'd like to know what potential problems I might be facing in the future. I hope to never need the money from the Roths, but maybe I will need to withdraw at some point. If not I'll pass it on to my heirs sometime in the (hopefully far) future. This and the increased tax rates I foresee are my main reasons for doing the conversions.

When discussing this with my financially minded buddy, he suggested that I might end up losing if the US implements a VAT. I could see that as being a method of taxing income from a Roth, but it seem to me you'd still be ahead of a tIRA, where the income would be taxed, then the VAT added to any purchases. I guess if they do away with income tax and replace it with a VAT it could be a problem.

However, are there any other possibilities y'all can think of? Other than removing the Roth tax-free option? Even if they do, I can't see them getting away without grandfathering in the existing ones. Feel free to be creative. I like to worry.
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Old 12-29-2009, 10:57 PM   #2
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Well a VAT tax would be a big one but only if the taxes are reduced on 401ks and previously taxable funds. If the VAT is in addition to current taxes then the Roth is still a good idea.

Could be a specific tax levied on Roths, munis and other previously tax free sources but I don't think that is likely.
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Old 12-30-2009, 12:03 AM   #3
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only if the taxes are reduced on 401ks and previously taxable funds.
Taxes reduced?
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Old 12-30-2009, 08:40 AM   #4
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The main thing I guess I worry about is means-testing the tax free nature of the Roth. I could see that happening, as can my boss.
My personal plan is that I'll split funds between tIRA, Roth IRA and taxable accounts as best I can without doing any conversions.
Feel free to worry about all kinds of things...I do!
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Old 12-30-2009, 09:25 AM   #5
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The only problem I see is if we replaced the income tax with a VAT tax. Like you, I think that simply adding a VAT doesn't change the relative value.

I can see means testing on SS (we already do some of that with the sliding scale taxes). If the "means" are taxable income, the Roth is better. If it's the simple sum of the account values, Roth is better (since you've reduced your total assets by the taxes you paid at conversion). It would take a "means" calculation that explictly overweights Roth assets or withdrawals before it becomes a problem, and I see that as unlikely.

I like the idea of having both Roth and Traditional because that gives me flexibility to deal with the uncertain future.
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Old 12-30-2009, 09:26 AM   #6
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Quote:
Originally Posted by Sarah in SC View Post
The main thing I guess I worry about is means-testing the tax free nature of the Roth. I could see that happening, as can my boss.
My personal plan is that I'll split funds between tIRA, Roth IRA and taxable accounts as best I can without doing any conversions.
Feel free to worry about all kinds of things...I do!
Non-taxable income is already used for means testing Medicare Part B I think. Doubt direct re-taxation of Roths, but can really see taking them into account for federal goodies so "the wealthy" pay their fair share; e.g., rebates for low earners along with VAT to avoid it being regressive.
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Old 12-30-2009, 09:39 AM   #7
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Like others, I doubt that they will put an additional tax on Roths that already exist, and that VAT, if introduced, would not replace income tax. 2010 is the first ever year available to me to have a Roth available, and all my tIRA money was after-tax contributions so I plan on converting it to Roth immediately (I won't roll over my 401(k) money until 2011).

After that I will probably convert some IRA money each year to get the balances down so that the minimum distributions at age 70.5 won't kick me into higher tax brackets. (half of my nest egg money is in tax-deferred IRA's / 401(k)'s)

Of course this plan can easily change as the tax code changes but this is my present thinking.
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Old 12-30-2009, 10:13 AM   #8
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After tax contributions, like Alan has, changes the discussion a bit. I'd definitely go in that direction in your situation.
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Old 12-30-2009, 10:20 AM   #9
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I could see them weaseling out of the tax-free status for the heirs of the unused Roth balances.

Not that we'll be around to gripe about it
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Old 12-30-2009, 10:23 AM   #10
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The bottom line for me is that I am "diversifying" my retirement income sources just as I am diversifying the retirement portfolios themselves. The better I can diversify between taxable, Roth and traditional tax-deferred investing, the easier it will be to roll with whatever punches Congress throws at me in the next 20+ years.

The last thing I want to do is go "all in" with one type of investment for the purposes of tax treatment, because I'd be totally screwed if I'm wrong. Diversifying in this way can help me minimize my tax bite and possibly reduce reportable taxable income for the purposes of future means testing.
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IRA Excess Distribution Tax
Old 12-30-2009, 10:25 AM   #11
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IRA Excess Distribution Tax

Until 1996 if your income exceeded 155k then an additional 15% "Excess Distribution" was levied on your (normal IRA) withdrawals. That was on top of any income taxes and penalties. Note that income tax rates were pretty steep back then, considerably higher than now. The governments claim on larger IRA withdrawals was on the verge of confiscatory. So if you needed some of your IRA cash to buy a retirement house or other large need for cash the penalties could kick in.

I could see something like that coming back again considering those who runs the show these days.
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Old 12-30-2009, 10:26 AM   #12
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Quote:
Originally Posted by Sarah in SC View Post
The main thing I guess I worry about is means-testing the tax free nature of the Roth. I could see that happening, as can my boss.
My personal plan is that I'll split funds between tIRA, Roth IRA and taxable accounts as best I can without doing any conversions.
Feel free to worry about all kinds of things...I do!
Well, as a youngster you actually have time to develop some value in your Roth. I was only eligible to contribute to them one year of my w*rking life, due to AGI limitations and the fact that they haven't been around that long. I doubt I'll ever get completely converted, but I'm going to go as far in that direction as I can. I just can't imagine that tax rates aren't going to go much higher in the future.

I agree with all of you about the VAT/Income tax dilemma. But if that's all they have to throw at me I fell pretty good about it. I was thinking that they might have some other tricks coming down the road that I haven't foreseen. Just because I'm paranoid doesn't mean...
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Old 12-30-2009, 02:15 PM   #13
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Feel free to be creative. I like to worry.
Well, as I mentioned in another recent thread, Roth might be limiting your choices down the road as to moving to another country / getting second residency or citizenship. Roth withdrawals might be taxed again by another country depending on the tax treaties. The other country may not care that this happens to be some special kind of retirement account where you had already paid taxes... With tIRA, you are likely to at least get some credits for paying taxes to US but with Roth, they won't be trying to figure out how much taxes you had paid many years ago to give you any credit...
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Old 12-30-2009, 02:57 PM   #14
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Here, Harley, add this one to your list o' worries
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