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RMD converting to Roth, 5-year rule operation?
Old 06-25-2014, 11:54 PM   #1
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RMD converting to Roth, 5-year rule operation?

I have started to do some thinking about the future when we get to RMD age. For myself, I am predicting that the first required distribution at 3.65% will yield more than our predicted expenses. And the predicted expenses (always subject to change and disaster!) would anyway already be met by my SS + DW on my SS with her GPO offset + some dividends from taxable accounts. So I would probably put most/all $ from RMDs into a Roth (do a Roth conversion), and pay the taxes, and then never pay taxes on gains in the Roth over the forthcoming years.

The question: Let's assume that every year I do this RMD to Roth Conversion. Let's call the first year "A", the second "B", etc. So the "A" year conversion to Roth I need to leave alone for 5 years, right? And so on with years B, C, D, etc. leaving each alone for its respective 5 years due to the conversions.

Does this mean I would create a separate Roth account for each year, to keep the 5 year visible for each? Or can they be all put into the same Roth account, and basis or something that is tracked by mutual fund companies keeps it all straight, so if I later decide to cash in some shares, the shares greater than 5 years old are used, and not some newer shares which would incur a penalty?
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Old 06-26-2014, 12:06 AM   #2
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Uh-oh, just found this in PUB 590:

Quote:
Required distributions. You cannot convert amounts that must be distributed from your traditional IRA for a particular year (including the calendar year in which you reach age 70) under the required distribution rules (discussed later in this chapter).
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Old 06-26-2014, 02:48 AM   #3
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As you found out, you cannot convert RMDs to Roths. What you can do is to start converting now, thus lessening your RMDs later. Of course, you should analyze your tax situation to determine how much to convert each year. Once you reach 70.5, you can convert any withdrawals above your RMDs to a Roth.


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Old 06-26-2014, 05:54 AM   #4
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Anyone know if you can convert 457$ to a Roth?
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Old 06-26-2014, 07:22 PM   #5
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You can take your RMD, then for that same year make a voluntary/additional withdrawal for the amount you want to convert to a ROTH and use the RMD to pay the taxes on the amount you convert to a ROTH -as akck suggested above.
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Old 06-28-2014, 12:01 AM   #6
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Once I start taking RMDs, it will effectively double my income, so I don't think I will want to make it even worse for taxes by withdrawing more than that required by RMD.

I understand the reason for RMD, the gov wants the piper to be paid for that tax-deductible $$ and its gains over the years. But it seems they want to keep on being able to tax it every year if you are hanging onto the RMD rather than spending it (by not allowing the RMD to conversion to Roth and paying the taxes ONCE).

So it seems my only course of action to try to minimize RMD-driven taxation in the future is to pay them in the present by IRA to Roth conversions. I don't think I can make a significant dent in the IRA without really boosting my current income (by adding conversion $) by a large amount in the years remaining before 70 1/2, thereby greatly increasing my current taxes.

I had this idea that taxation would be lower in retirement. I now realize that that can be an over-simplification that may not be applicable to many E-R folks.

Maybe this is more accurate summation for many of us:

Working --> Taxes High
E-R, not on SS yet, not to RMD age yet --> Taxes Low
Retired, older, on SS & RMD --> Taxes High
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Old 06-28-2014, 05:16 AM   #7
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Quote:
Originally Posted by Telly View Post
...

So it seems my only course of action to try to minimize RMD-driven taxation in the future is to pay them in the present by IRA to Roth conversions. I don't think I can make a significant dent in the IRA without really boosting my current income (by adding conversion $) by a large amount in the years remaining before 70 1/2, thereby greatly increasing my current taxes.

I had this idea that taxation would be lower in retirement. I now realize that that can be an over-simplification that may not be applicable to many E-R folks.

Maybe this is more accurate summation for many of us:

Working --> Taxes High
E-R, not on SS yet, not to RMD age yet --> Taxes Low
Retired, older, on SS & RMD --> Taxes High
One should almost certainly do partial conversions during that middle period to smooth out taxes, so they are low-to-medium from ER onward. The exception might to be qualify for Obamacare subsidies.
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Old 06-28-2014, 08:21 AM   #8
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Quote:
Originally Posted by Telly View Post
I have started to do some thinking about the future when we get to RMD age. For myself, I am predicting that the first required distribution at 3.65% will yield more than our predicted expenses. And the predicted expenses (always subject to change and disaster!) would anyway already be met by my SS + DW on my SS with her GPO offset + some dividends from taxable accounts. So I would probably put most/all $ from RMDs into a Roth (do a Roth conversion), and pay the taxes, and then never pay taxes on gains in the Roth over the forthcoming years.

The question: Let's assume that every year I do this RMD to Roth Conversion. Let's call the first year "A", the second "B", etc. So the "A" year conversion to Roth I need to leave alone for 5 years, right? And so on with years B, C, D, etc. leaving each alone for its respective 5 years due to the conversions.

Does this mean I would create a separate Roth account for each year, to keep the 5 year visible for each? Or can they be all put into the same Roth account, and basis or something that is tracked by mutual fund companies keeps it all straight, so if I later decide to cash in some shares, the shares greater than 5 years old are used, and not some newer shares which would incur a penalty?
Telly, you could use the surplus RMD funds to pay the resulting taxes to convert a portion of your remaining Traditional IRA balance. However, be careful to make sure doing so doesn't jump you into a higher tax bracket.
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Old 06-28-2014, 09:06 AM   #9
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Originally Posted by Telly View Post
Maybe this is more accurate summation for many of us:

Working --> Taxes High
E-R, not on SS yet, not to RMD age yet --> Taxes Low
Retired, older, on SS & RMD --> Taxes High
That's pretty much my situation. I am going to try and start roth conversions up to the limits of current tax bracket but being single doesn't give much room to work with.
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Old 06-28-2014, 09:09 AM   #10
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Originally Posted by Telly View Post
I understand the reason for RMD, the gov wants the piper to be paid for that tax-deductible $$ and its gains over the years. But it seems they want to keep on being able to tax it every year if you are hanging onto the RMD rather than spending it (by not allowing the RMD to conversion to Roth and paying the taxes ONCE).
Actually your RMD withdrawal is only taxed once. After that, only future earnings on that money are taxed. The actual withdrawal itself, no additional taxes.

I know it's painful to pay taxes on RMD's. I'm getting ready to do so myself in just a few years. But I've also run some numbers regarding the benefit of decades of tax-deferred compounding I've received and it looks like a positive situation.

Like the kid who eats dessert first, enjoying IRA tax deferral while we're young is nice. Eventually paying the taxes when we're geezers, not so much!
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Old 06-29-2014, 11:12 AM   #11
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We too are staring down the barrel of RMDs. We've been Roth converting (paying the taxes) and/or spending the 401(k) or IRA money. We have been helping the kids with down payments on houses, etc. and doubling up on charity to spend down the "excess" in the qualified plans.

Telly, look at it this way. It's a "good" problem to have. You have "too much" money (if that's possible.) One thing I have suggested on this forum in the past (to those much younger than we are) consider putting less in qualified plans and more in taxable (and Roths if you qualify) to avoid the future RMD "trap". It's especially "bad" for us since I am holding off on SS until 70. Suddenly, I really will be paying the piper (unless I "gift" more to charity - a reasonable approach if you already are happy with your spend level.)

Some folks on this forum are completely comfortable figuring their own taxes (using Turbo, etc.) I have gotten professional help to figure the best moves as I slip into decrepitude (er., I mean RMD land). Good luck and remember YMMV.
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Old 06-29-2014, 10:40 PM   #12
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... if I later decide to cash in some shares, the shares greater than 5 years old are used, and not some newer shares which would incur a penalty?
Money going in/out of TIRA or Roth IRA is counted on the basis of cash values, not by share basis.

Suppose you transfer 100 shares of XYZ mutual fund worth $10 each from TIRA to Roth, and these 100 shares later become 110 shares due to reinvested dividends, and now worth $11 each.

Five years later, for no penalty you can only withdraw the original $1000, which is now the value of 90.9 shares. You cannot claim the entire original 100 shares that were converted.
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Old 07-02-2014, 11:42 PM   #13
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DW is the Turbo tax guru, so I asked her to do an experimental run, using 2013 with: No wages, same Int and Divs as 2013, my little existing pension as in 2013, used future SS FRA values for us both, with GPO for her future pension, faked our birthdates to make me 71 in 2013 so RMD would apply, I calculated first RMD using present T-IRA total.
DW gasped at the taxable income... no, she really gasped at the taxes due! Well over 6x what we paid for 2013 tax year.

I will need to be getting my brain around this, more trial runs, look at tax brackets, try to come up with a Roth-conversion plan that will take some of the sting out of RMDs when we get there, without stinging too much for the next x years until we do. It will take some thought and some math. And will have to be flexible on implementation, as taxable income dependent on market returns via Divs, so can't really implement until near the end of each year, to fine-tune actual conversion amount.

People have written in to Scott Burns about suddenly and unexpectedly being burned by RMDs (no pun intended), but his "answer" has usually been "well that's a nice problem to have". Thanks Scott, that's not very helpful. Us boomers born in the 1950s will probably be the first really big group to get RMD'd, as IRAs have been around long enough for us to build a majority of our assets there.
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Old 07-03-2014, 06:01 AM   #14
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Same situation here and I am converting to the top of the 15% bracket each year from now until I turn 70.

I don't share your resentment about it. These are tax-deferred accounts, not tax-free accounts. You didn't pay taxes on that income when you earned it so you are paying taxes on it when RMDs kick in. In my case, there is no doubt that my marginal tax rate on the contributions was higher than the marginal tax rate on my withdrawals, so I have come out ahead.

While I'm not keen on paying taxes or on seeing my marginal tax rate go from next to nothing in ER to 25% once SS and RMDs arrive, I can do Roth conversions to reduce taxes even more (7% in 2013 vs 25-28% when I made the contributions and an estimated 25% in my 70s).
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Old 07-03-2014, 10:56 AM   #15
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While I haven't worked all the numbers yet, I've come to the conclusion that my RMDs will be in the 25% tax bracket. So, I plan to convert as much as possible prior to taking them. At minimum, I'll save taxes on the income and gains in the Roth. Best case is that we avoid the 25% bracket entirely.




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Old 07-03-2014, 02:14 PM   #16
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Quote:
Originally Posted by Telly View Post
DW is the Turbo tax guru, so I asked her to do an experimental run, using 2013 with: No wages, same Int and Divs as 2013, my little existing pension as in 2013, used future SS FRA values for us both, with GPO for her future pension, faked our birthdates to make me 71 in 2013 so RMD would apply, I calculated first RMD using present T-IRA total.
DW gasped at the taxable income... no, she really gasped at the taxes due! Well over 6x what we paid for 2013 tax year.

I will need to be getting my brain around this, more trial runs, look at tax brackets, try to come up with a Roth-conversion plan that will take some of the sting out of RMDs when we get there, without stinging too much for the next x years until we do. It will take some thought and some math. And will have to be flexible on implementation, as taxable income dependent on market returns via Divs, so can't really implement until near the end of each year, to fine-tune actual conversion amount.

People have written in to Scott Burns about suddenly and unexpectedly being burned by RMDs (no pun intended), but his "answer" has usually been "well that's a nice problem to have". Thanks Scott, that's not very helpful. Us boomers born in the 1950s will probably be the first really big group to get RMD'd, as IRAs have been around long enough for us to build a majority of our assets there.
I've been Roth converting the last two years. I do partial conversions, maybe 2x more than I expect to need, into multiple Roth accounts, including 3 or 4 accounts with cash down to $1k or $2K. Each account holds just shares from one mutual fund. I do some conversions at the start of the year. If the market dips during the year I might add more conversions at the lower prices. At the end of the year I might do more conversions if prices are low, and add the cash conversions.

Then at tax time I select the conversion accounts that have performed the best and fit within the amount I want to convert. The rest I recharacterize, which transfers them to a traditional IRA as if they were never Roth converted in the first place. I can get pretty close to the exact amount I want by using the cash Roth conversion accounts. Although a little plus or minus won't hurt anything (unless you're targeting an ACA income limit and can't go over). It is also possible to partially recharacterize an account, so I could probably use just one cash Roth conversion and recharacterize the exact amount that I don't want in it.

I recharacterized 12 accounts in 2013. It wasn't too bad, 12 forms, and Fidelity said I could have just called. But make sure you start early enough to finish before you file your taxes.

The nice thing about this is that you get to look forward in time, see how it all looks at tax time, and then pick your best conversions. I have Roth conversions for 2014 that have 17% (tax free!) gains since I converted, and 4% gains. If they stay that way until March 2015, I can keep the big gainers and try again with the rest.

Ideally you are trying to Roth convert shares at their lowest value, so taxes are minimized.
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Old 07-03-2014, 03:27 PM   #17
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As others have above have said I consider us to have benefited well from tax deferred investments, the bulk of which were contributed during the highest earning years of our lives at the highest marginal tax rates of our lives. Doing ROTH conversions between retiring and having to take RMD's is a feature that is also a great tax saving tool.
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