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Old 04-18-2012, 02:32 PM   #21
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RunningBum, it is difficult to gauge what you have done and how much you have really
"saved." I still contend that you may save taxes this year, or the next year or so on...but it is really a deferment and eventually you'll have to pay taxes on that money. But, I have not done this, just thought about it at a high level, so perhaps some hard numbers (either fictitious or real) could help me to understand?
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Old 04-18-2012, 03:26 PM   #22
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I'll skip the unimportant complication of the partial recharacterization, and just call it a full conversion. I'm also rounding the numbers but they are very close. I pay taxes on my ROTH conversion with other funds.

In 2010, I converted $30K, and prepared to pay taxes on it. Let's say it was at 15% (even though it was actually 25%, but I don't want to muddy the picture by showing conversion at different rates), so I prepared to pay $4500 in taxes. Later that year, the stocks dropped in value so I recharacterized it before the end of the tax year, so I didn't owe the $4500 in taxes. At this point I have just deferred the taxes because the funds were back in a TIRA that would eventually be taxed.

In 2012, I've re-converted the IRA. It is now at $20K at the time of conversion. Bad investments, but these are very close to the real numbers. So, I'll be paying $3000 in taxes this year at 15%. That's $1500 less than I would've paid in 2010 had I not recharacterized. The money is now in the ROTH IRA so there are no more taxes to pay. Nothing is deferred anymore. I clearly saved $1500 in taxes.

It's certainly true that at $20K, my ROTH IRA is $10K less than before, so I'm actually coming out $8500 behind rather than $1500 ahead. But since I was making the same investment decisions whether the funds were in a TIRA or a ROTH IRA, they would be worth $20K no matter what. Converting, re-characterizing, and re-converting had no effect on that. What it did do was let me soften the blow by paying $1500 less in taxes, so I'm $8500 behind rather than $10,000 behind. There's nothing I could do to retroactively avoid the drop in value from $30K to $20K. But I could retroactively change which amount I paid the conversion tax on.

It wasn't a guaranteed tax savings. Had the funds recovered back to $30K while in the TIRA after the re-characterization, it would've essentially been a wash, and if they had gone above $30K, I'd have paid more taxes. But they didn't.
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Old 04-18-2012, 03:49 PM   #23
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thanks for that! you are correct, it can save you more money when playing with all of the funds. if only doing partials over long periods of time, it seems the benefit wouldn't be as great?
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Old 04-18-2012, 04:39 PM   #24
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That's too general of a question to answer absolutely. I don't think there's any strategy to decide whether to convert all or partial based on how recharacterization works. You convert based on whether it makes tax sense over your lifetime to do so (and usually that means partial conversions over time), and you don't plan on losing money once it's in the Roth. But if it does, you consider recharacterizing to get some taxes back. Certainly if you've only converted part, you get less of a tax benefit.

One strategy I've heard of is to convert some amount into a new Roth account, and then make your riskiest investments in that account. If they payoff, you've got a big gain tax-free, since the gain is post-conversion. If they fail, you recharacterize, put the remaining funds in safer investments in your TIRA, and most likely you'll convert a lower amount and pay less taxes later.
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Old 04-18-2012, 06:55 PM   #25
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Quote:
Originally Posted by ronocnikral View Post
thanks for that! you are correct, it can save you more money when playing with all of the funds. if only doing partials over long periods of time, it seems the benefit wouldn't be as great?
but to the 1st order, isn't the total the sum of the partials? Of course, not all
of the conversions will benefit from recharacterization bc the market will be
up after some of them, rather than down, so maybe you'll only get half the benefit, but that could still be significant.....depending on how much fussing you want to do.

Maybe it's like tax loss harvesting......if you end up selling all the assets eventually, maybe the only gain is the time value of the tax savings and what returns you can get from them. I vaguely recall seeing some claim that TLH can add some fraction of a percent to your returns which on the surface doesn't seem like much but, like the low cost VG index funds, that small amount compounded over time can be significant.
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Old 04-18-2012, 09:40 PM   #26
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my thought is...TIRA w/ $100k. it only makes sense to convert $20k in one year b/c of tax bracket limitations. So, I convert the $20k in Jan 2012 to RIRA, jumping through all the hoops mentioned above. I wait until Oct 2013 to recharacterize, finding out my investments lost 10%. So, I save 15%*20k or $3k in taxes starting in Oct 2013 and another $18k in the TIRA. I can only convert $20k/year without jumping up to the next bracket, so does my next conversion happen Jan 2013? or oct 2013?

ahhh...i'll have to put together an overly complicated spreadsheet to figure this all out...seems like if you believe in longterm growth and you have a cap how much you can convert and you'll be doing this over many years, you'll most likely save very little or a marginal amount. Running bum's scenario is one where a person can realize a significant gain.
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Old 04-18-2012, 11:06 PM   #27
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this might be helpful Roth IRA Reconversion to Reduce Taxes

The section at the bottom about partial recharacterization is interesting.
The rules you may be thinking about re: timing of recharacterization and
then reconversion likely pertain to when you do a total conversion.
It looks like you have a lot more flexibility if you do a partial conversion/recharacterization with the timing of the second conversion because you are using different $$$.
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Old 04-19-2012, 07:45 AM   #28
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I wouldn't recharacterize for a 10% loss. It's not worth it, and it might well recover before you can reconvert.

I was just looking at my 2011 conversion and I think I'm going to recharacterize some of that for a different reason. I converted a lot last year because it was my last year of work income so divs and CGs were already at 15% and I wasn't hitting the phantom 30% bracket (15% income + moving divs & CGs from 0 to 15%). I went well into the 28% tax bracket and also triggered AMT, which I didn't expect. I ran a turbo tax scenario with a smaller conversion and found I can get out of the AMT, and I also want to not go into the 28% bracket. So, I'm going to recharacterize some of it, even though it had a small gain in a bond fund, to get back about 30% in taxes for that amount. When I reconvert it in chunks it'll be mostly at 15% with maybe a small amount to take as RMDs after age 70. I'm bringing back 90K, so if I save 15% on all of it it'll be $13.5K in taxes saved. This is all due to my mistake in converting so much in the first place so I could've saved all that up front and not be waiting for the money back from the treasury dept after I file a 1040X, but it's still nice to be able to undo my mistake.

I'll tell you what, the Roth IRA is a good deal but I've made so many mistakes with it. All have been correctable but it's caused me a lot of work.
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Old 04-19-2012, 09:01 AM   #29
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Quote:
Originally Posted by kaneohe View Post
this might be helpful Roth IRA Reconversion to Reduce Taxes

The section at the bottom about partial recharacterization is interesting.
The rules you may be thinking about re: timing of recharacterization and
then reconversion likely pertain to when you do a total conversion.
It looks like you have a lot more flexibility if you do a partial conversion/recharacterization with the timing of the second conversion because you are using different $$$.
But, if you have a cap at how much you can convert per year, recharacterizing limits how you can play with the partial conversions.

Quote:
Originally Posted by RunningBum View Post
I wouldn't recharacterize for a 10% loss. It's not worth it, and it might well recover before you can reconvert.

I was just looking at my 2011 conversion and I think I'm going to recharacterize some of that for a different reason. I converted a lot last year because it was my last year of work income so divs and CGs were already at 15% and I wasn't hitting the phantom 30% bracket (15% income + moving divs & CGs from 0 to 15%). I went well into the 28% tax bracket and also triggered AMT, which I didn't expect. I ran a turbo tax scenario with a smaller conversion and found I can get out of the AMT, and I also want to not go into the 28% bracket. So, I'm going to recharacterize some of it, even though it had a small gain in a bond fund, to get back about 30% in taxes for that amount. When I reconvert it in chunks it'll be mostly at 15% with maybe a small amount to take as RMDs after age 70. I'm bringing back 90K, so if I save 15% on all of it it'll be $13.5K in taxes saved. This is all due to my mistake in converting so much in the first place so I could've saved all that up front and not be waiting for the money back from the treasury dept after I file a 1040X, but it's still nice to be able to undo my mistake.

I'll tell you what, the Roth IRA is a good deal but I've made so many mistakes with it. All have been correctable but it's caused me a lot of work.
I believe the recharacterization rule was put in place for situations like this. It's difficult for a lot of people to gauge what their taxes will be before the end of the year.
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