Roth conversions for early retirees

[LOL!]

It looks like early retirees with children can make out like bandits with their Roth conversions. I saw this on the MSN TaxCorner board. Is this really true?

Suppose one retires in 2005 as a 45 year old. They have enough cash in the bank to cover living expenses for a few years. You know, the safe withdrawal rate of 4% per annum, so they have 10% of assets in cash and use some of that for living expenses. They convert some of their tIRA to a Roth IRA. The conversion amounts stay below the threshold where they will owe any taxes, thus they pay no taxes.
Let's say they have two school-age kids living at home, $2K in qualified dividend income, no other income, and take the standard deduction. They convert $41,000 from a traditional IRA to a Roth IRA. How much taxes do they owe

This suggests that an early retiree with tax-deferred IRAs can convert them to Roth IRA if they have no income and enough cash or other assets around to cover expenses for a few years. Y'all are very astute, so some of you must have done this already, right?

[FIRE'd@51]

Looks like for 2007, one could convert $42,180 and owe no Federal tax. The key to getting zero tax is the $2000 tax credit for the two school age kids.

It's a great idea. I haven't done it (too much other income and no kids under 18).

[wabmester]

Looks good in theory, but I'm gonna guess that the average family of 4 will require more than $40K/year income even in retirement. I know our family of 3 does.

That said, I'm planning to withdraw a lot in 2007. I'll try to prepay all of our expenses for the next 3 years. And then I'll take advantage of the 0% cap gains rate in 2008-2010 and do a bunch of Roth conversions.

[LOL!]

Originally Posted by wab

Looks good in theory, but I'm gonna guess that the average family of 4 will require more than $40K/year income even in retirement. I know our family of 3 does.

Yeah, but the $40K to $100K of required income has nothing to do with the Roth conversion. The premise appears to be that the family has $100K+ sitting in a money market fund and available for living expenses.

Here's another scenario to add to this one: Parents are 50 years old and about to retire. They each decide to earn $20,500 and enough to cover FICA taxes in the beginning of the year before retiring. They each put the entire $20,500 into their 401(k)s before pulling the plug for $41,000 total. They retire, rollover to IRAs, then convert to Roths.

Or they don't retire and keep pulling the same stunt until the kids are grown?

[wabmester]

I'll have to go through the numbers, but our port currently throws off too much income even if we're not consuming it. Even somebody with all of their nest egg in the S&P 500 is going to generate a lot of income unless it's all in tax-deferred accounts.

[LOL!]

Yep, but one could reverse the traditional advice and put all muni bonds in the taxable accounts and keep those pesky dividend payers in the tax-deferred accounts.

[Nords]

Originally Posted by LOL!

It looks like early retirees with children can make out like bandits with their Roth conversions. I saw this on the MSN TaxCorner board. Is this really true?
This suggests that an early retiree with tax-deferred IRAs can convert them to Roth IRA if they have no income and enough cash or other assets around to cover expenses for a few years. Y'all are very astute, so some of you must have done this already, right?

It's a combination of pension & investment income, plus whatever deductions can be lumped into that tax year.

Originally Posted by wab

Looks good in theory, but I'm gonna guess that the average family of 4 will require more than $40K/year income even in retirement. I know our family of 3 does.
That said, I'm planning to withdraw a lot in 2007. I'll try to prepay all of our expenses for the next 3 years. And then I'll take advantage of the 0% cap gains rate in 2008-2010 and do a bunch of Roth conversions.

See, you just need a bigger mortgage deduction...

[lsbcal]

We are doing something like this by converting IRA to Roth up to the top of the 15% bracket. Unless the tax code changes very dramatically I think it is a safe assumption that paying today at 15% max will be better then paying tomorrow when SS kicks in and especially when RMD's get added to the picture. But everyone's tax picture is slightly different.

Les

[ESRBob]

(Pst!: Page 213-215 of Work Less Live More...)
It's a great strategy, whether as lsbcal says you aim to pay zero tax, or simply to pay in the 10% or 15% bracket. Think of it as 'finessing' your Roth Conversion each year with the right amount to be able to soak up any remaining breathing area in your favorable tax brackets. And try like the dickens to pay your conversion taxes with taxable fund money, so you can effectively boost the amount of sheltered funds in the Roth.

[LOL!]

Originally Posted by ESRBob

(Pst!: Page 213-215 of Work Less Live More...)

I know the strategy has been written about quite a bit and that many folks on this message board use it. I just always thought that folks were converting a few thousand each year and not tens of thousands.

[ESRBob]

Sure, why make billions when we can make.... millions (Dr. Evil)

You can definitely do it for tens of thousands. The big bucks for Roths aren't in the annual 4 or 5k contributions, they are in converting your 401ks. I did 40k a year for multiple years in my first years of ER.

[lsbcal]

I know the strategy has been written about quite a bit and that many folks on this message board use it. I just always thought that folks were converting a few thousand each year and not tens of thousands.

If it's really a strategy then what good is it to do just a few 1K's ? Remember this is money you may want to really spend in a decade or so. Being able to blend non-taxable money with taxable to stay in lower brackets will be pretty nice in the future. Combining conversions with delaying SS will work for us, at least that's my bet. I believe taxes will be going up in the future no matter which political party is in control.

Les

[wabmester]

Originally Posted by ESRBob

I did 40k a year for multiple years in my first years of ER.

Man, you're good. I can get my taxes down pretty low, but I can't get my AGI down low enough to pull that off. IIRC, you sold your company, so you have pretty hefty sums in taxable accounts, right? How did you keep your dividends, interest, and cap gains low enough to pull that off? I don't think I could do it even with 100% stocks and no sales during the year.

Edit: Oops, I was assuming that the conversion amount was included in the AGI limit. It's not. Hmm, maybe I can do this....

[Ed_The_Gypsy]

wab, I am listening.

[LOL!]

Originally Posted by wab

Edit: Oops, I was assuming that the conversion amount was included in the AGI limit. It's not. Hmm, maybe I can do this....

The conversion amount IS included in one's AGI. Not sure what you mean about AGI limit.

[wabmester]

Originally Posted by LOL!

The conversion amount IS included in one's AGI. Not sure what you mean about AGI limit.

I believe you can't do the Roth conversion unless AGI is under $100K, and the conversion amount is not included in that $100K limit. Right?

Originally Posted by Ed_The_Gypsy

wab, I am listening.

Ed, you're still working right? Unlikely to be an issue for a high-earner like you, but we ER's have some flexibility in how we can structure our income, like switching to tax-free muni bonds for a couple years, for example.

[lsbcal]

Also if converting don't forget to deduct the correct percentage of your basis (if you made aftertax contributions to your IRA) to lower your tax bill. Programs like TurboTax automatically bring your basis forward into following years.

Les

[ESRBob]

Yeah, I think all that worked in our favor -- not remembering correctly now, but the AGI was definitely lower than the threshold (always is ) aided in those years early years because I still had a lot of muni funds, and capital losses (from selling stocks in market troughs!) meant I had no capgains, either. Not much work income to speak of, either. All in all, we taxed like the po' folks.

Just read something in today's WSJ that fully 40% of Americans don't pay any federal income tax now,-- there are at least a few benefits at the bottom of the food chain!

[Ed_The_Gypsy]

Ed, you're still working right?

Still.