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Roth Conversions
Old 09-30-2009, 06:58 AM   #1
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Roth Conversions

Any logic in converting 401k to Roth after leaving employer ? Friend of mine was asking - left Megacorp at 50, plans to ER at 58.

Most folks would be in lower tax rate upon retirement - so I don't understand benefit of converting now.

What's "plan to leave savings to their heirs" mean ? I guess Roth money gets transferred to heirs with no estate tax ? What's the tax treatment on regular IRA money ? Thanks !

Few savers plan to switch to Roth IRA: survey - MarketWatch

Given the potential benefits of a Roth -- contributions are made after-tax, but distributions including any investment earnings come out tax-free as long as certain conditions are met -- investors at least should consider such accounts, said Chris McDermott, vice president of retirement and financial planning at Fidelity Investments.

"If investors have at least 10 years before making withdrawals, anticipate a higher tax rate in retirement or plan to leave savings to heirs, they should consider a conversion," he said.
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Old 09-30-2009, 07:10 AM   #2
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For non-spouse heirs, inherited Roth IRAs still have RMDs. If you are old and in a low tax bracket, your heirs may be younger and in a higher tax bracket. In this case, I would guess that one should get the taxes paid by the person in the lower tax bracket.

For someone who inherited a traditional IRA and is "stretching" it by taking only the annual RMD, that RMD will be taxed at their marginal rate. If they are in their 40's and 50's that may be their prime earning years and highest marginal tax rate years. Ouch!

So the logic of converting is to convert at a tax rate that is lower than not-converting. Very simple if you can figure that out.

I certainly intend to be converting while living off of taxable assets (return of capital is tax-free!) and before starting SS benefits. I expect my tax rate to be close to 0% during those years of conversion.
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Old 09-30-2009, 07:20 AM   #3
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If tax rates get raised in a few yrs bc of deficit, they possibly could be lower now even while working, than they might be when he ERs at 58 ? Since many unknowns, not obvious that this would be true.

Roths don't require RMDs at 70.5 like TIRAs so conceivably might be larger as an inheritance if he lives a long time. Also while they are still included as part of the estate, because of the tax you pay at conversion, the estate is possibly smaller than it would be w/ a TIRA so subject to less estate taxes. These 2 statements (Roth might be bigger; Roth might be smaller) actually seem a bit contradictory and again because of unknowns (tax rates, estate tax rates, tax brackets w/ & w/o RMDs) , it is not obvious which is better.

Both Roth and TIRAs are included in estate . Whether they get taxed or not depends on the size of estate; if small enough ,neither might be. TIRA withdrawals will be subject to income tax by heirs, but they could stretch out over lifetime if down properly. Both subject to RMD by heirs(assumed to be nonspousal).

try googling for more like this:http://www.smartmoney.com/personal-f...roth-ira-7966/
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Old 09-30-2009, 08:25 AM   #4
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Gotta agree. I've diligently maxed out my 401(K) for years and years to the tune of probably 80% of my retirement $$ are in tax deferred options.

We are heading for higher tax rates IMHO. In fact, the tax rates since Reagan dropped them into the mid-30%'s have been the anomaly in the history of the US tax system. For most of the other periods since the income tax was implemented in the early 1800's, the top tax rates have been in the 70%'s and higher!!

I feel like I fell for the carnival barker's line. I now only 401(K) save to the match and everything is going into taxable accounts and Roths from here on ou
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Old 09-30-2009, 09:52 AM   #5
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Quote:
Originally Posted by Delawaredave5 View Post
Any logic in converting 401k to Roth after leaving employer ? Friend of mine was asking - left Megacorp at 50, plans to ER at 58.

Most folks would be in lower tax rate upon retirement - so I don't understand benefit of converting now.

What's "plan to leave savings to their heirs" mean ? I guess Roth money gets transferred to heirs with no estate tax ? What's the tax treatment on regular IRA money ? Thanks !

Few savers plan to switch to Roth IRA: survey - MarketWatch

Given the potential benefits of a Roth -- contributions are made after-tax, but distributions including any investment earnings come out tax-free as long as certain conditions are met -- investors at least should consider such accounts, said Chris McDermott, vice president of retirement and financial planning at Fidelity Investments.

"If investors have at least 10 years before making withdrawals, anticipate a higher tax rate in retirement or plan to leave savings to heirs, they should consider a conversion," he said.
Not really a simple answer here as there are a lot of factors and "crystal balling" to be taken into consideration.

If your friend doesn't expect to need to tap the Roth during retirement it is a nice way to pass on tax free wealth to heirs although I do believe it is subject to estate taxes if the estate is large enough and there are RMD's required of the heirs but the remaining balance of the Roth grows tax free.

I don't believe there are RMD's on a Roth and the money is generally considered to be a bit more accessible than traditional IRA's and 401k's as it only needs to sit for five years or until 59 and 1/2 whichever comes first.

Traditional IRA Conversion to Roth IRA option in 2010 would allow your friend to defer taxes on the conversion to 2011 and 2012 (split evenly) or pay all the taxes in 2010. Just depends where you think taxes will be in 2011/12 versus 2010. He might have to roll the 401k into a traditional IRA and then to the Roth. Pretty simple process. Just don't pay the taxes out of the IRA or it sort of defeats the purpose of making the conversion as you'll have a smaller prinicple amount that will grow tax free.
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Old 09-30-2009, 10:22 AM   #6
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Originally Posted by huskerblue View Post
Gotta agree. I've diligently maxed out my 401(K) for years and years to the tune of probably 80% of my retirement $$ are in tax deferred options.

We are heading for higher tax rates IMHO. In fact, the tax rates since Reagan dropped them into the mid-30%'s have been the anomaly in the history of the US tax system. For most of the other periods since the income tax was implemented in the early 1800's, the top tax rates have been in the 70%'s and higher!!

I feel like I fell for the carnival barker's line. I now only 401(K) save to the match and everything is going into taxable accounts and Roths from here on out
True, but you have to look at the rates that will effect you, not just the top rates (unless that is you). Most of us retirees will be pretty much "under the radar" with our taxable income probably being in the middle-class range.


I do agree with you in that I also expect tax rates to go up, and I am trying to convert as much as I can to ROTHs. I'm just not so sure that the increases will be so great for retirees. I would not be surprised if my usual marginal 15% rate got pushed to 25%, so I am converting. Flexibility is part of that - it might be good to have a non-taxable source of income in certain years. We won't know until it's too late, call it "tax diversification".

-ERD50
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Old 09-30-2009, 03:48 PM   #7
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Originally Posted by huskerblue View Post
We are heading for higher tax rates IMHO. In fact, the tax rates since Reagan dropped them into the mid-30%'s have been the anomaly in the history of the US tax system. For most of the other periods since the income tax was implemented in the early 1800's, the top tax rates have been in the 70%'s and higher!!

I feel like I fell for the carnival barker's line. I now only 401(K) save to the match and everything is going into taxable accounts and Roths from here on ou
You must have missed the line "Only those making more than $250K will see their
taxes increase", the politician said it, so it must be true.

I wouldn't bet the farm on Roths, never know, they may tax those, indirectly or "for those rich people
making more than X).

TJ
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Old 09-30-2009, 04:18 PM   #8
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I wouldn't bet the farm on Roths, never know, they may tax those, indirectly or "for those rich people
making more than X).
Possible, though in reality I doubt they'd ever directly tax Roth distributions. They might stop allowing new contributions at some point, though.

In reality, the worst thing that could happen for people relying heavily on Roths is if the income tax was ever largely or completely replaced by a national sales tax or VAT.
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