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ROTH conversion - do it now
Old 11-20-2008, 09:48 AM   #1
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ROTH conversion - do it now

It occurred to me this is EXCELLENT time for ROTH conversions!

With the market down so much, converting now will minimize taxes (by converting an ever shrinking IRA balance) and provide you with the benefit of the (eventual) upswing and higher balance in the ROTH account.

I wish we could convert some of out IRAs to ROTH! Than again, I should be careful what I wish for - we just may get a chance after all if we get laid-off...
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Old 11-20-2008, 11:49 AM   #2
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I have been planning this in 2011 on a large scale and maybe a little bit in 2010 when DW retires on Jan 1. The income cap is gone in 2010, but it is more advantagous to wait to DW has retired and income is low to zero allowing to convert up to 25% bracket limit. It would be even nicer if BO had reduced taxes on elderly etc to a higher limit.

Tax laws are always made difficult to understand but easy to take advantage of if you do.
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Old 11-20-2008, 12:39 PM   #3
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I called yesterday and the papers are in the mail. It's now below $5000.
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Old 11-20-2008, 12:56 PM   #4
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Not to state the obvious, but if you're converting you're gonna pay taxes in the IRA withdrawals you're using. Withdraw too much and you might be raising your tax bracket so much you neutralize the benefit of the strategy.

Take out $200K from your IRA to deposit in your Roth and you're now in the marginal 33% bracket on that money. Just a reminder.
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Old 11-20-2008, 01:20 PM   #5
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I already did my annual conversion last February, hoping further growth of converted assets would take place in Roth accounts. I convert enough annually to max out the 15% bracket. Now, of course, I wish I'd waited. So many more shares could have been converted at today's prices for the same tax bill. C'est la vie.

January 2009 is coming soon, and if the market's still down I will get a larger share conversion this time around.
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Old 11-20-2008, 02:09 PM   #6
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Originally Posted by Rich_in_Tampa View Post
Not to state the obvious, but if you're converting you're gonna pay taxes in the IRA withdrawals you're using. Withdraw too much and you might be raising your tax bracket so much you neutralize the benefit of the strategy.

Take out $200K from your IRA to deposit in your Roth and you're now in the marginal 33% bracket on that money. Just a reminder.

Good point! With large sums such as these, another thing to consider is whether one has the extra cash to cover the tax liability on hand and is willing to part with it in this climate!

Personally, if I was eligible and had cash on hand, I would convert to the top of 25% bracket at least (maybe even 28%, since taxes are likely to go up anyway). I am in mid 30is and it would be great to kick off ROTH growth with a 50-100K.
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Old 11-20-2008, 02:40 PM   #7
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And, not that anyone here is a market timer or looks at valuations, BUT some people would balk at paying any extra to the tax man right now when stocks are available at a bargain price.

And--do we trust that the laws on Roth's won't change? There's no doubt that they look very tempting to those in DC wanting more money to spread around. And, even if Roth's don't get formally taxed, an article I read (Forbes I believe, this month) discusses the likelihood of some kind of VAT being instituted in the US. These exist in most of the industrial world, they don't discourage savings or productivity. If instituted, they would effectively amount to taxation of Roth IRA money (assuming you withdraw it in order to spend it). Not that Roth's would be affected much more than traditional IRAs due to this taxation, but it's still a factor to consider when computing possible expenses in the outyears.

Just chiming in. No one really knows what is coming, that's one argument for a mix of Roth and Traditional IRAs--more flexibility if the game changes.
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Old 11-20-2008, 04:13 PM   #8
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I apologize for complicating an already thick subject...but there is a special IRS provision relating to conversions made in tax year 2010. 50% is allotted to 2011 and 50% to 2012, with no taxes due in 2010. Before my portfolio began collapsing, this was my plan. Now, for reasons already discussed, I will strategize with my CPA to determine how much to convert this year.

Tom
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Old 11-20-2008, 04:30 PM   #9
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Maybe this has already been discussed elsewhere, but is there an opportunity to use tax loss harvesting to offset Roth conversion taxes?
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Old 11-20-2008, 05:33 PM   #10
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Maybe this has already been discussed elsewhere, but is there an opportunity to use tax loss harvesting to offset Roth conversion taxes?
Sure, and it's going gangbusters for our ER portfolio.

We did the first tax-loss swap sale a month ago and bought our asset allocation back yesterday (good timing, eh) to book a "bonus" second loss. That pretty much wipes out all cap gains for 2008 and possibly 2009-10. Assuming there is such a thing as a cap gain in 2009-10.

When all the cap gains have been offset, another $3000 of cap losses can offset ordinary income (AGI), which is how the gains on a conventional IRA are taxed. Since most of us are having few if any gains on our conventional IRAs this year, that $3000 may go a bit further toward the Roth IRA conversion...
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Old 11-20-2008, 07:11 PM   #11
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I've never done a conversion but the one concern that comes to my mind is the gap of time between the sale of assets in the trad. IRA and the buying of assets in the Roth. With the volatility in this market and the higher probability of being at, or close to, the bottom (I know, I know - but it could be ) with a violent and sudden upward leg, I'd be concerned about missing out on a 25-30% gain off the bottom of this market. Even one day could make that difference (and with my luck I'd miss that day). That would certainly lessen any advantage gained. That could turn into some really bad market timing.

One thing that could offset this is if a company (such as VG) could make the exchange on one day with no time out of the market.

Another possibility is if you could make a transfer of assets "in kind", without selling. Is that possible? I doubt it.

This is also a concern for rolling over a 401K (or similar plan) account to an IRA. Something I'll be looking at doing in the spring. I may wait for quite some time due to this concern.

Thoughts?
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Old 11-20-2008, 07:22 PM   #12
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I've never done a conversion but the one concern that comes to my mind is the gap of time between the sale of assets in the trad. IRA and the buying of assets in the Roth.
One thing that could offset this is if a company (such as VG) could make the exchange on one day with no time out of the market.
Another possibility is if you could make a transfer of assets "in kind", without selling. Is that possible? I doubt it.
This is also a concern for rolling over a 401K (or similar plan) account to an IRA. Something I'll be looking at doing in the spring. I may wait for quite some time due to this concern.
Thought?
It's easiest when the conventional & Roth IRA accounts are held at the same brokerage, but I can't figure it out from Fidelity's website. IIRC a year or two ago I was able to do a partial conversion online, but I don't remember if it was in kind or not.

Probably varies with each broker. And for rolling over a 401(k) it might also depend on the two custodians.
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Old 11-20-2008, 07:36 PM   #13
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Gardnr - Few years back we did a 401(k) to IRA rollover at the same custodian - I believe they managed to sell all 401(k) assets and buy into a set of predetermined IRA funds on the same day. Assuming you keep $$ in the same place, this may work for IRA to ROTH transfers as well.
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Old 11-20-2008, 07:43 PM   #14
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Setting aside the income limits.. DH booked 70.5 this year so will have MRD. As I read the code he can't also move additional IRA assetts to his Roth. Is that correct?
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Old 11-20-2008, 07:43 PM   #15
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I've never done a conversion but the one concern that comes to my mind is the gap of time between the sale of assets in the trad. IRA and the buying of assets in the Roth. ....

One thing that could offset this is if a company (such as VG) could make the exchange on one day with no time out of the market.

Another possibility is if you could make a transfer of assets "in kind", without selling. Is that possible? I doubt it.
Gardner, I'm going by memory here, dangerous, but IIRC...

You cannot move a Trad IRA to a new company and convert it at the same time. You need to either convert it at the old and then xfer; or xfer and then convert. IOW, you can only move "like-kind" IRAs.

But that still leaves you with a delay in the move. When I rolled my company 401K to a broker rollover-IRA, they messed it up three times. Fortunately for me, those investments dropped a bit in that time, and I did get them to pay simple interest on the delay - but it wasn't worth the worry and aggravation.

The only other thing ( that I can think of anyway) to do is buy a derivative of what you are moving, like an option, but that will cost you something in premiums and will tie some money up. Or simpler, just transfer at a time when you are comfortable with it all in a MM or stable bond fund.


But talk with both sides to find out how to best grease the skids before the xfer. Or simpler,

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Old 11-20-2008, 07:45 PM   #16
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Nords,

Is it not the withdrawals, rather than the gains, of a traditional IRA that are taxed? The initial contributions were untaxed, ie deductible, and the subsequent earnings are tax-deferred. Deferred, that is, until the time of withdrawal. Isn't tax loss harvesting applicable only to taxable accounts, which carry a capital gains liability, or am I missing something? (Wouldn't be the first time I've "missed something"!)

Tom
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Old 11-20-2008, 08:17 PM   #17
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im unfamiliar with the process of converting to a roth. do the normal 5k/yr limits not apply in this situation? i couldnt determine one way or another by googling


thanks
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Old 11-20-2008, 08:24 PM   #18
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im unfamiliar with the process of converting to a roth. do the normal 5k/yr limits not apply in this situation? i couldnt determine one way or another by googling


thanks
Nope. If your joint AGI is under 100k (I think), you can convert as little or as much as you wish. You will, however, need to pay taxes on all converted funds (fed + state, if applicable) - if you do this, be mindful of tax brackets. Also, while you're doing this conversion, you are also free to fund yours + spouse ROTH ($5k each) as well...
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Old 11-20-2008, 09:21 PM   #19
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The only other thing ( that I can think of anyway) to do is buy a derivative of what you are moving, like an option, but that will cost you something in premiums and will tie some money up. Or simpler, just transfer at a time when you are comfortable with it all in a MM or stable bond fund.
Yeah, you could rearrange everything in the portfolio so that the IRA or 401K was in cash, within your current AA. That might be a pain but it would do the job. Another approach would be to just to small amounts at a time to minimize the exposure. Now that I think of it that might be the best way to go about it.

I may convert some money to Roth next year (bumping the 25% bracket this year), and the IRA's at Vanguard so it would be an in-house conversion. The 401K move will be from Russell Investments to VG. I looked back to 2002 when I did this before and it took 6 days for the transfer from selling to buying again in the rollover acct. I missed 2.2% of upward movement, but it was only about 7K (actually more than it is now ) so it didn't mean too much.
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Old 11-20-2008, 11:37 PM   #20
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Nords,
Is it not the withdrawals, rather than the gains, of a traditional IRA that are taxed? The initial contributions were untaxed, ie deductible, and the subsequent earnings are tax-deferred. Deferred, that is, until the time of withdrawal. Isn't tax loss harvesting applicable only to taxable accounts, which carry a capital gains liability, or am I missing something? (Wouldn't be the first time I've "missed something"!)
Tom
The last time I tried to understand the mechanics behind a Roth IRA conversion, a couple of CPAs advised me to stop asking questions and just fill out form 8606. That worked a lot better than I expected.

The withdrawals are indeed taxed as income if all contributions were deductible. However some IRA owners have made non-deductible contributions to their IRAs, which gives the IRA a basis, and those contributions (having been taxed before they went into the IRA) are not taxed at withdrawal. Form 8606, which is the form used to report the conversion of a conventional IRA to a Roth, is also the form that tracks an IRA's basis.

Tax loss harvesting generates short/long term capital losses which can be used to offset the short/long term gains of other taxable accounts. When all the short/long term gains are used up, though, if there's still short/long term cap losses then they can be applied to up to $3000 of taxable income. (An example of this taxable income would be a Roth IRA conversion.) If there's still cap losses left over after offsetting $3000 of taxable income then the cap losses are carried forward to future tax years.

Perhaps I should be really really happy that the stock market is collapsing the year before I start filling out FAFSAs for our kid's college. I couldn't have looked anywhere near as poor as this without Wall Street's help!
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