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Roth Conversion
Old 05-23-2019, 12:01 PM   #1
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Roth Conversion

Hello All
Attended mtg and topic was Roth Conversion. The argument that taxes will have to go up cause of the ever increasing deficit makes sense to me. If that's true, doing Roth conversion for our TSP and regular IRAs seems to make sense. A little painful but makes sense

Am I missing something?

Kannon
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Old 05-23-2019, 12:14 PM   #2
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Future tax rates (future anything, really) is anyone's guess.

It is true the US has both a deficit (annual) and a debt (cumulative). If, how, and when that addressed in the future is, again, anyone's guess.

Roth conversions create taxable unearned ordinary income in the year in which you do the conversion. If you think your rates are going to be higher in the future AND you expect to live for a while AND EITHER your TSP/IRA beneficiaries are also in a similar or higher bracket OR you're more focused on your own situation rather than your combined (you plus beneficiaries) situation AND you are confident that the government won't change the rules on Roths being entirely after tax - there are rumblings of taxing Roths from time to time (*) - THEN it probably makes sense to some degree.

Several people do Roth conversions up to the top of the 12% bracket, and some even go to 22%. At 22% and beyond it becomes more situational.

(*) As an example, I would guess that some of the current proposals for annual wealth taxes would include Roth IRA balances in the calculations. As another example, they are talking about limiting stretch IRAs, which I assume would also apply to inherited Roths.
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Old 05-23-2019, 01:04 PM   #3
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Before the last tax cut, I would've guessed taxes would go up rather than down, and I obviously was wrong. This cut is set to expire in 2025. It may be made permanent, but I really can't see them going lower. However, if the tax model was switched to more of a consumption tax, then income taxes could possibly be dropped, so it's impossible to be certain. Make your best assumption, hedge your bets if you feel the need, and make the best choices you can with that.

Whether to do Roth conversions needs to be examined for YOUR specific case. If you're still working and making decent money, it may not make sense to convert now. Many of us early retirees have a window where we've stopped working and are not yet forced into taking RMDs are receiving SS or pensions, and we chip away at the tIRA with conversions during these years. If you think your tax rate will be higher with RMDs due to SS benefits, pensions, or just tax rate increases, it favors doing some conversions now. Probably not all at once. 2Cor is right that your heirs' tax situation may also be a factor.

Regarding Roths being taxed, I haven't heard anything about that. If there is a wealth tax, I'd rather have it based on post-tax (Roth) money rather than higher pre-tax (tIRA) money. I just can't see them changing the rules entirely and taxing Roth withdrawals after taxing the conversion. That would kind of be like taxing the proceeds on a stock trade rather than the gains, IMO.

Regarding taxing conversion taxes being painful, I never feel that. I look at my tIRA and I see a deferred tax expense still to be paid. If I convert, I'm just paying off that expense I'll eventually have. In a way it's kind of like a mortgage. You have this big principal balance you'll eventually have to pay off. If you decide to pay it off all at once, or in big chunks, of course it has an impact but it also gets that debt off your back for good. Just pay it off in a way that makes sense. For Roth conversions, don't convert at a 32% tax rate if you could be paying 22% later.
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Old 05-24-2019, 03:44 PM   #4
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A key focus is the inheritance part of the Roth IRA

Before recent rules change discussion, I was hoping that inherited Roth IRAs could be stretched so that the kids could benefit from longer deferred status and hopefully keep to a lower marginal tax bracket (vice a lump sum distribution).

Am I correct that traditional IRAs and 401ks would have to be taken out within 5 years? That would favor the Roth IRA.
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Old 05-24-2019, 04:46 PM   #5
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Quote:
Originally Posted by kannon View Post
A key focus is the inheritance part of the Roth IRA

Before recent rules change discussion, I was hoping that inherited Roth IRAs could be stretched so that the kids could benefit from longer deferred status and hopefully keep to a lower marginal tax bracket (vice a lump sum distribution).

Am I correct that traditional IRAs and 401ks would have to be taken out within 5 years? That would favor the Roth IRA.
Well we need to see what the text finally says if or when it gets enacted into law.

Under current rules, both traditional and Roth IRAs can be stretched over the beneficiary's lifetime (assuming the beneficiary is a person who is not a spouse, and a few other criteria).

I don't think the proposed laws treats traditional and Roth IRAs any differently, but I could be mistaken.

In other words, as far as stretching goes, I don't think the Roth has any advantage over the traditional under either the current or proposed rules.
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Old 05-24-2019, 10:40 PM   #6
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IMO speculating on tax rates decades from now is ... pure speculation, no matter how big a case you think you can build for one result or another.
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Old 05-24-2019, 10:54 PM   #7
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Quote:
Originally Posted by kannon View Post
A key focus is the inheritance part of the Roth IRA

Before recent rules change discussion, I was hoping that inherited Roth IRAs could be stretched so that the kids could benefit from longer deferred status and hopefully keep to a lower marginal tax bracket (vice a lump sum distribution).

Am I correct that traditional IRAs and 401ks would have to be taken out within 5 years? That would favor the Roth IRA.
If that law passes, it could end up being inherited (not spouse) has to withdraw in 5 or 10 years.

You could also focus on non-retirement stock holdings, currently upon death they get stepped up basis, meaning no capital gain when selling all $300K of them, as an example.
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