Roth Conversion Process: Form 1099-R

[ERD50]

Trad IRA to Roth Conversion. I did this last year, and there were some fine print details. I'm preparing to do it again this year, and I'd like to run this by the smart people here to see if I'm missing anything. I'm shooting to max out the 15% bracket.

1) Before EOY, convert more than I think I need to put me to the top of the 15% tax bracket. Remember that deductions and brackets probably changed from last year, so estimate on the high side, or (gasp) look it all up and do your taxes before EOY (I don't think you can - the forms are not finalized?).

2) Get my taxes done as quick as I can, and determine exactly how much to 'recharacterize' to avoid going over the 15% bracket (or to avoid any credits from being reduced - this was one 'gotcha' from last year for me).

3) Send in the rechar paper work to the IRA administrator and make sure it gets processed before filing my taxes.

Another thing that I think I learned from last year - when you rechar, they make adjustments based on the fund value change from the time you converted to the time you rechar. That just makes things a bit more complex. So I am going to add a step:

Before Step 1) Open a Money Market account in my Roth IRA so the conversion goes into a dollar stable fund. That should simplify the rechar - no adjustment to make for fund value changes (maybe they count the interest? that should be minor anyhow). Move it if I wish after the taxes are all set.

Am I missing anything?

TIA - ERD50

PS - I just added 'Form 1099-R' to the title, cause I know that always gets Martha's attention

 

[riskadverse]

I'm getting ready to start this process myself, and having never done it before, your topic is timely. One thing I was thinking is that if I over estimate by just a few thousand, the process of recharacterization would probably not be necessary as they are only taxing at 15% the amount that goes over the 15% threshold not the whole amount. This could be a relatively small amount of money, if you are reasonably accurate in your estimate.

 

[ERD50]

...they are only taxing at 15% the amount that goes over the 15% threshold not the whole amount. This could be a relatively small amount of money, if you are reasonably accurate in your estimate.

Correct. I may be over-analyzing this a bit. Last year my tax situation changed dramatically from the prior year (lump sum severance, almost 2x my annual income), so it was tougher to predict. I should come reasonably close this year.

Sometimes, I consider going right up through the 25% bracket. I don't think taxes will be going down in the future, and that 15% bracket is pretty generous (relatively), IMO. I have a few years before SS and pension kick in, so I'm trying to get this in while I can.

-ERD50

 

[mickeyd]

I have converted part of my IRA stash to a Roth for the last several years and it has gone smoothly @ Vanguard.

I'm not sure if all the rechar process is necessary. You should be able to get pretty darn close to calculating your gross income up to $78,200 or taxable income to $61,300 by this late in the year so you do go over to 25%. If you are a few hundred short, so what?

 

[Nords]

I'm shooting to max out the 15% bracket.
2) Get my taxes done as quick as I can, and determine exactly how much to 'recharacterize' to avoid going over the 15% bracket (or to avoid any credits from being reduced - this was one 'gotcha' from last year for me).
Am I missing anything?

Yikes-- I just estimate our deductions as best as I can, plug through form 8606, and don't worry about squeezing out every last cent under the 15% ceiling. And here I thought I was being a #$%^ing nuke by calculating our mortgage interest down to the dollar!

If you do go over the top, you're only penalized a dime for every dollar into the 25% bracket. Over the limit by $100 would cost you an extra $10, and even going over by a thousand would only cost $100. I'd rather pay the higher tax rate than go through the pain of recharacterizing, especially if I wasn't too sure that the fund company could do it right the first time!

The other option would be to fall short of the ceiling by a thousand or two, thereby prolonging the conversion process by an extra year. We have at least 24 years to RMD and we only need another 6-8 conversion years so I don't mind "wasting" a little of the 15% bracket from one year to the next.

 

[ERD50]

I If you are a few hundred short, so what?

Agreed if it is a few hundred. But I had additional complications. I planned on hitting the max AGI for 15%, and THEN found that there were additional limitations for tuition credits for my kid. I had to take my AGI down $12K, or I would have lost $1250 in credits. That's diff from just paying 25% vs 15% on a few hundred.

Those tuition credits are a little tricky, and can change from year-year (Hope, Lifetime Learning, etc). TurboTax actually had some sort of optimization routine that it ran to figure which would work best for you.

Some of this stuff is so interdependent, it's hard to predict until you actually load it all in.

And I don't have 'extra years' to convert this. When I get pension and SS, it probably won't make sense anymore. I'm trying to maximize a window that will shut soon.

-ERD50

 

[Martha]

It sounds like you are doing as good a job as you can. At least recharacterizations are possible. When does TurboTax usually come out with their forms? Of course, nothing final from the IRS because who knows how the law might change before year end. . . Or even after year end but retroactive.

Here is a summary of this years tax changes, with exemption amounts, etc: http://www.irs.gov/formspubs/article/0,,id=109876,00.html

 

[bpp]

Of course, nothing final from the IRS because who knows how the law might change before year end. . . Or even after year end but retroactive.

OT, but why on earth are retroactive tax changes legal? Not that I'm bitter or anything.

 

[Martha]

The retroactive ones are generally to the taxpayer's benefit.

 

[OAG]

A good place to start to estimate 2006 taxes is www.taxact.com. They have a free 2006 program that is accurate. Can't use this early version to file your taxes but they also have a usable free and low cost version which will be released about the first of the year. Great tool to get the ROTH conversions accurately accomplished. The program is written by former Parsons Technology people for those that remember the old Parsons Software company.

 

[Martha]

OT, but why on earth are retroactive tax changes legal? Not that I'm bitter or anything.

In 1994 the Supreme Court unanimously held that retroactive tax laws were constitutional in United States v. Carlton.

 

[bpp]

In 1994 the Supreme Court unanimously held that retroactive tax laws were constitutional in United States v. Carlton.

Thank you. Googling up the text, I am struck by Scalia's scathing concurrence:

If I thought that "substantive due process" were a constitutional right rather than an oxymoron, I would think it violated by bait-and-switch taxation.[...]Retroactively disallowing the tax benefit that the earlier law offered, without compensating those who incurred expenses in accepting that offer, seems to me harsh and oppressive by any normal measure.[...]

The reasoning the Court applies to uphold the statute in this case guarantees that all retroactive tax laws will henceforth be valid. [...]I welcome this recognition that the Due Process Clause does not prevent retroactive taxes, since I believe that the Due Process Clause guarantees no substantive rights, but only (as it says) process, see TXO Production Corp. v. Alliance Resources Corp., 509 U. S. ___, ___ (1993) (slip op., at 2) (Scalia, J., concurring in judgment).

I cannot avoid observing, however, two stark discrepancies between today's due process reasoning and the due process reasoning the Court applies to its identification of new so called fundamental rights, such as the right to structure family living arrangements, see Moore v. East Cleveland, 431 U.S. 494 (1977) (plurality opinion), and the right to an abortion, see Roe v. Wade, 410 U.S. 113 (1973). First and most obviously, where respondent's claimed right to hold onto his property is at issue, the Court upholds the tax amendment because it rationally furthers a legitimate interest; whereas when other claimed rights that the Court deems fundamental are at issue, the Court strikes down laws that concededly promote legitimate interests, id., at 150, 162. Secondly, when it is pointed out that the Court's retroactive tax ruling today is inconsistent with earlier decisions, see, e.g., Nichols v. Coolidge, 274 U.S. 531 (1927); Blodgett v. Holden, 275 U.S. 142 (1927); Untermeyer v. Anderson, 276 U.S. 440 (1928), the Court dismisses those cases as having been "decided during an era characterized by exacting review of economic legislation under an approach that `has long since beendiscarded.' " Ante, at 8, quoting Ferguson v. Skrupa, 372 U.S. 726, 730 (1963). But economic legislation was not the only legislation subjected to "exacting review" in those bad old days, and one wonders what principled reason justifies "discarding" that bad old approach only as to that category. For the Court continues to rely upon "exacting review" cases of the Nichols Blodgett Untermeyer vintage for its due process "fundamental rights" jurisprudence. See, e.g., Roe, 410 U. S., at 152-153, 159 (citing Meyer v. Nebraska, 262 U.S. 390, 399 (1923), and Pierce v. Society of Sisters, 268 U.S. 510, 535 (1925)); see also Griswold v. Connecticut, 381 U.S. 479, 483 (1965) ("[w]e reaffirm the principle of the Pierce and the Meyer cases").

The picking and choosing among various rights to be accorded "substantive due process" protection is alone enough to arouse suspicion; but the categorical and inexplicable exclusion of so called "economic rights" (even though the Due Process Clause explicitly applies to "property") unquestionably involves policymaking rather than neutral legal analysis. I would follow the text of the Constitution, which sets forth certain substantive rights that cannot be taken away, and adds, beyond that, a right to due process when life, liberty, or property is to be taken away.

I may not exactly be a political fellow-traveller of his, but that's some great s#@t. He'd be fun to debate on a web forum.

Back to my original tangent, I don't suppose that with the new Democratic Congress that there is any chance of rolling back this year's retroactive Republican tax hike...

 

[retire@40]

OT, but why on earth are retroactive tax changes legal? Not that I'm bitter or anything.

Massachusetts had a retroactive tax law change at the end of 2005 for year 2002 that required some people to pay for a retroactive increase in taxes, hehehehe.....plus penalties and interest since by definition everyone would be paying late. Oh ya, and the first batch of state notices was received by many people the day before Thanksgiving and the retroactive taxes plus penalties and interest was due Christmas day.

Luckily, Gov. Mitt Romney fought it and the law was reversed so people got refunds instead of owing.

 

[heyyou]

At top of 15% bracket, the effective rate is 10.8%, so you could overflow into the 25% until you reached a average tax rate that you can sleep on. <--humor opportunity. You don't have to stop just because the marginal rate steps up. You only paid 15% tax on the last half of your total income in that bracket, a little less than half at 25% in that bracket. Your average rate is an increasingly sloped line, not a staircase.

Nords--About your 6-8 years left of needing to convert, that is different than most, since most stop due to income increases (SS, RMDs, etc.) If one has a choice, when does one stop converting? Does one convert the whole TIRA, or just down to a small RMD size ($100k TIRA = $2740 RMD) relative to pension and SS income?

 

[Nords]

Nords--About your 6-8 years left of needing to convert, that is different than most, since most stop due to income increases (SS, RMDs, etc.) If one has a choice, when does one stop converting? Does one convert the whole TIRA, or just down to a small RMD size ($100k TIRA = $2740 RMD) relative to pension and SS income?

Well (I think I've said this once or twice before) my spouse's pension is going to put us in the 25% tax bracket, so we're going to do Roth IRA conversions until we no longer have to take RMDs.

We're 24 years away from RMD so there won't be any other income increases.

In other words we're gonna convert the whole thing.