Think twice before converting to a ROTH.

[Lakewood90712]

A few years ago . BTIB (before the internet bubble) , I converted my traditional IRA (from many years of low income work) to a ROTH IRA.

Oh what a great feeling paying income tax on gains that evaporated ! 

Not too smart.  I just went with the flow , not thinking about what the future of the market could be. 

Back then 99-2000 , I also subscribed to The Street . Com and used the advise.
Also not too smart.   


John

 

[vic]

My income is supposed to drop to non-existent levels next year. I was just thinking the opposite and start converting my self-directed real estate IRA to a Roth IRA. Since the commercial property in the IRA is debt financed, the amount of money in it is limited compared to the pending capital gains. I will glady pay 10 or 15% conversion tax on the transaction before the property is sold. Will shoot off an email to that custodian company right away!

Vicky

 

[Nords]

My income is supposed to drop to non-existent levels next year. I was just thinking the opposite and start converting my self-directed real estate IRA to a Roth IRA.

An IRA conversion is a great idea as long as the cap gains continue to accumulate...

A few years ago . BTIB (before the internet bubble) , I converted my traditional IRA (from many years of low income work) to a ROTH IRA.

Oh what a great feeling paying income tax on gains that evaporated ! 

Not too smart.  I just went with the flow , not thinking about what the future of the market could be. 

I don't know what the time limit is on recharacterizing a Roth IRA conversion... usually that's the only way to recover from that "surprise".

 

[Cut-Throat]

A few years ago . BTIB (before the internet bubble) , I converted my traditional IRA (from many years of low income work) to a ROTH IRA.

Oh what a great feeling paying income tax on gains that evaporated ! 

Not too smart.  I just went with the flow , not thinking about what the future of the market could be. 

Back then 99-2000 , I also subscribed to The Street . Com and used the advise.
Also not too smart.   

John

I have made a lot of stupid mistakes also. To quote Uncklemick - 'My best moves have been to do absolutely nothing'

 

[Helen]

I will be retiring in 7.5 years. I will live on the money I have socked away in my non tax sheltered accounts for at least four years. It might be a good idea for me to roll my 401k money into an IRA and start converting it to a Roth while my tax bracket is next to nothing.

-helen

 

[burch64]

And if the "Fairtax" people get their way the Roth IRA is technically no longer tax free.

By that I mean when you spend it you will be taxed at 20% or whatever figure they come up with.

 

[RockMiner]

I will be retiring in 7.5 years.  I will live on the money I have socked away in my non tax sheltered accounts for at least four years.  It might be a good idea for me to roll my 401k money into an IRA and start converting it to a Roth while my tax bracket is next to nothing.

-helen

I'm having similar thoughts about Roth conversions..no one knows what the laws will be like in the future, but my guess is income tax rates will rise.  The early, low tax years of retirement may be the best opportunity to lessen the "Tax Torpedo" effect of high marginal rates on combined IRA (+SS) distributions.  A Roth conversion taxed at 0-15% could be a bargain compared to potential marginal rates 2-3 times that a few years down the road.  These calculations could be tricky though and I'm not sure if there is consumer software available to model different scenarios?  I'm guessing there must be "professional" financial planning software that could do the optimizing.  This might require a (aargh) CFP.  It's something to look into 

 

[ESRBob]

And if the "Fairtax" people get their way the Roth IRA is technically no longer tax free.

By that I mean when you spend it you will be taxed at 20% or whatever figure they come up with.

If I recall, the Fairtax proposal is shifting from taxing income to taxing spending? Maybe get the last laugh by passing it on to heirs who can withdraw it (again taxfree) in their lifetimes and reinvest it.

If circumstances permit and you can move to the idea of perpetual portfolios across generations (in other words, live off an SWR forever and don't ever draw down the portfolio principal itself) then you can still have this work in your favor, since you don't actually spend the $.

It may not be realistic or even desirable for everybody here, but it could work for a lot of long term retirees if our plans work out somewhat better than the worst-case projections. This is the way the wealthy families think -- keep real principal intact in perpetuity -- and why they are able to live the life of Reilly generation after generation.

 

[Nords]

I'm having similar thoughts about Roth conversions..no one knows what the laws will be like in the future, but my guess is income tax rates will rise.  The early, low tax years of retirement may be the best opportunity to lessen the "Tax Torpedo" effect of high marginal rates on combined IRA (+SS) distributions.  A Roth conversion taxed at 0-15% could be a bargain compared to potential marginal rates 2-3 times that a few years down the road.  These calculations could be tricky though and I'm not sure if there is consumer software available to model different scenarios?  I'm guessing there must be "professional" financial planning software that could do the optimizing.  This might require a (aargh) CFP.  It's something to look into 

There's a bezillion calculators out there, although some of the better ones are at Fairmark.com.

However the subject is a thought experiement:
- If your income will be roughly the same in retirement and you think that today's tax brackets can't get any lower, then a conversion may be a good idea. Your projected retirement income has to include IRA RMDs and SS receipts as well as the usual pensions, dividends, & cap gains.
- If retirement (including RMDs) will put you in a higher tax bracket than your current working tax bracket, then a conversion is probably a good idea.
- If retirement income (RMDs again) will subject your SS income to taxation, then a conversion is probably a good idea. Of course if your working income is the highest tax bracket and your retirement will be a couple brackets lower then SS taxes may not cost as much as you're "saving" by dropping down a couple brackets. This is a difficult assessment.
- If, between your working years and your commencement of SS & RMDs, your income will be very low for a few years, then small conversions during that low period are almost always a good idea. You'll be paying conversion taxes at no more than 15% or even 10%. We're doing that every year up to the top of the 15% bracket for the next 7-8 years.
- If the taxes on the IRA conversion can be paid from funds outside the IRA, then conversion is almost always a good idea. You're effectively transferring the amount of the tax from taxable funds to a Roth IRA which boosts its basis and its compounding. For example, instead of converting a $100K conventional IRA to an $80K Roth, when you pay the taxes outside the IRA then your Roth basis starts at $100K. Remember that conversions are taxed as regular income, not as cap gains or dividends. (Even if your IRA investment gains are cap gains & dividends, they're taxed as regular income.)

If someone can explain to me why anyone would be financially motivated to donate heavily to a congressional candidate who's sponsoring fair tax legislation, then I'm willing to listen. If you think that Congress will scrap the current tax code, with all its loopholes for special interest contributors groups, and replace it with a "fair tax" that has no special deals for anyone, then you're not thinking.

 

[RockMiner]

[quote aut hor=Nords link=topic=4965.msg87041#msg87041 date=1133128754]
- If, between your working years and your commencement of SS & RMDs, your income will be very low for a few years, then small conversions during that low period are almost always a good idea.  You'll be paying conversion taxes at no more than 15% or even 10%.  We're doing that every year up to the top of the 15% bracket for the next 7-8 years.

Nords, Thats some post!  You have a very active mind

The above scenario is what I was talking about, and it does seem like a no-brainer though what I am after is some software to crunch all the variables and predict pre vs post-tax portfolio balances etc.,while optimizing use of post-tax, Roth, pre-tax RMD, and SS funds to minimize taxes.  It would be nice to see such a plan in spreadsheet form however I am an Xcell idiot so ain't gonna happen without help 

I did a quick software search and it appears that the popular consumer level programs may not handle all this.  Thanks for the tip about Fairmark..I'll investigate further.

 

[azanon]

A few years ago . BTIB (before the internet bubble) , I converted my traditional IRA (from many years of low income work) to a ROTH IRA.

Oh what a great feeling paying income tax on gains that evaporated ! 

Not too smart.

John,

You're misunderstanding what you paid taxes on.   

The reason your eligible for any IRA is because you have earned income.  The taxes you paid/owed was taxes on your earned income (ie:  from your occupation), not the market gains/losses within the IRA's themselves.   Neither the traditional or Roth IRA tax you on your gains.   The difference between the two is when you have to pay taxes on your earned income;  upfront for the Roth, and deferred for the Traditional.   The amount of money you earned in a given year is a specific amount and does not change with the market flucations.  Thus, the market going up or down after your conversion was irrelevant, and inconsequential because you had the same amount of money invested before and after the conversion.

If anything, John, your conversion to a Roth before the market dropped might have been a good thing in the event that you liquidated a portion of any equities you held at the time to pay the taxes you owed (due to the conversion).

Azanon

 

[ESRBob]

Neither the traditional or Roth IRA tax you on your gains.

When you withdraw funds from a traditional IRA or 401k, you are taxed at ordinary income tax rates on the entire amount withdrawn -- initial principal and any gains which might have accrued over the years. In this way, you typically pay a higher 'capital gains tax' on these IRA funds than you would on the gains in ordinary taxable savings.

However, the ability to put the funds in and get a tax break, and have them compound without having to pay annual income taxes on gains, dividends etc. would almost surely put you ahead in an IRA. The Roth, however, is the best place to be long term since you can eventually take out all those accumulated gains without any taxes on the withdrawals,( though you get no taxbreak on the money initially put into the Roth.)

Fairmark is a good source of info on these and other tax matters:

http://fairmark.com/rothira/index.htm

 

[mathjak107]

a roth vs traditional is only about 1 thing.where you think tax rates are headed .there is not 1 penny difference between the both of them if tax rates are the same....most of the comparisons are never done correctly and compare putting in an after tax amount vs putting in the same amount pre-tax...if done correctly it should look like this:
assume 20% tax rate ...401k vs roth 401k


401 k would have say 5,000 pretax dollars put in,,,you would have 5,000 working for you invested ,1,000 comming back to you as a tax refund..
lets say 2 years later its worth double...10,000 -20% tax =8000 - 4000 cost basis = 4,000 net gain.


401k roth start with same 5,000 pretax dollars...thats where most comparisons go wrong...5000- 20% tax = 4000 invested in the 401k....assuming the doubling its now worth 8,000 tax free dollars less cost basis of 4.000= 4,000 net gain......

did anyone really think our government would give us something that pays less tax ha ha...of course the flexibility of taking out a roth is far better

 

[mathjak107]

2 years ...oops i mean 10 years...but either way dosnt matter,the out come is the same

 

[unclemick]

I play games with the ORP calculator - the assumptions you put in make a big difference. Wanting to end with an inheritance really alters the Roth/trad withdrawal sequence.

Put in context - single, married, tax bracket, pension, SS, RE, etc, died with money on the table/or not - Not a perfect calculator but it gives my case a better overview than a Roth/trad trade off only calculator.

Takes some fiddling - but it gives me a feel for my particular situation.

 

[sgeeeee]

a roth vs traditional is only about 1 thing.where you think tax rates are headed .there is not 1 penny difference between the both of them if tax rates are the same....most of the comparisons are never done correctly and compare putting in an after tax amount vs putting in the same amount pre-tax...

IORP has a good discussion of this point and presents an equation showing that a traditional and a Roth IRA are exactly equivalent if you assume equivalent tax rates.

When I was working full time, I was not eligible for a Roth. My thinking was that I would convert traditional to Roth once I retired and my income was low. I figured this would be good insurance against rising tax rates in the future as long as I managed the conversions so as not to trigger higher tax rates. Also, the Roth offers more flexibility in withdrawals. Of course the conversion would create a new account and the shares would not be Admiral shares -- so fees would be higher. Probably not a big deal either way, so I continue to think about it.

 

[LOL!]

a roth vs traditional is only about 1 thing.where you think tax rates are headed .there is not 1 penny difference between the both of them if tax rates are the same....most of the comparisons are never done correctly ...

You are correct except, the tax rates are never the same. 

When you contribute to a traditional deductible IRA (or 401(k)), then you save taxes at your marginal income tax rate.  Folks often have a lower marginal rate just because they get to exclude their retirement contributions from their AGI.

When you withdraw from your IRA, you usually don't pay all your taxes at your marginal rate because your initial withdrawal is taxed at 0%, then it creeps up to your marginal rate.

 

[retire@40]

You are correct except, the tax rates are never the same.

Sometimes they are the same.  Sometimes they are higher.  And sometimes they are lower.

You just have to try and forecast those rates out to your specific situation.

Since it's practically as impossible as forecasting the weather on a specifc day years from now, you just have to go with current tax law and keep tweeking your financial forecasts as you get closer to that future day.

 

[mathjak107]

lets not forget that rates dont have to end up being higher when we retire...there are 2 ways to pay the huge federal deficit...increase taxes or print money...since politically increasing taxes isnt good ,sneakly printing money sounds more likely.....

 

[Nords]

Since it's practically as impossible as forecasting the weather on a specifc day years from now, you just have to go with current tax law and keep tweeking your financial forecasts as you get closer to that future day.

If you can forecast that pension income or RMDs will put your income into the 25% bracket, and you're currently in the 10-15% bracket, then it makes sense to start partial Roth conversions up to the top of the 15% bracket. It also beats starting 72(t)s or IRA withdrawals at 59 1/2, with their subsequent taxable investments, to reduce RMDs.

That forecast is pretty straightforward...

 

[cute fuzzy bunny]

Unless there is a change in the tax code to a flat tax or a national sales tax...

 

[Nords]

Unless there is a change in the tax code to a flat tax or a national sales tax...

Yeah boy, and I'm holdin' my breath about that one!

 

[cute fuzzy bunny]

20-25 years is a long time...

 

[Nords]

20-25 years is a long time...

Not as long as the decades I'll have after I hit RMD to say to myself (and anyone foolish enough to wander in range) "I coulda, shoulda, woulda..."

 

[cute fuzzy bunny]

Bet we have a vastly different tax scheme before we have nationalized health care...

I'm gonna split the difference. By the time we get there, our roths and (my ira+wifes403b) should be about the same amount.

If my biggest problem is paying tax on the oodles of money pouring out of our accounts, i'm ok with that.