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To convert to Roth or not?
Old 03-17-2010, 02:06 PM   #1
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To convert to Roth or not?

I am curious about how many of you out there are planning to convert some or all of their IRA or 401K to a ROTH this year. Also, if you plan to pay all the tax in 2010 or split it up in 2011-2012. Wife and I are just 64, retired and I find it emotionally hard to use most of my cash in a regular account to pay for the ROTH conversion. I'm not that worried about leaving money tax free to the kids eventually and we probably will be able to stay at the top of the 15% tax level through the years. I know it makes sense and I just keep reading that converting at least some is the right thing to do!
Again, What are your thoughts!
Thanks
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Old 03-17-2010, 02:11 PM   #2
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The question to ask is...

Will my marginal tax rate be higher than now when I liquidate the Roth accounts. If the answer is yes then A Roth conversion may make sense.
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Old 03-17-2010, 11:15 PM   #3
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Even if the tax rates are the same, you do get the benefit of sort of adding those tax dollars to your Roth. More after-tax value saved in the Roth than the traditional IRA/401k.

I think after age 59.5 you don't need to worry about the 5 year waiting periods any longer, but that's something to confirm.

Try the Fidelity calculator or one of the others on the web.

I doubt you'll see a tremendous difference between your options, but maybe it'll be worth it to you.
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Old 03-17-2010, 11:41 PM   #4
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I had a TIRA that I started years ago. I've been contributing to a Roth IRA instead and I finally got around to rolling it over into my Roth, just to get it out of my hair. And I only procrastinated for three or four years !
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Old 03-18-2010, 01:08 AM   #5
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Regarding paying the tax on a conversion now or splitting it between 2011-2012, I spoke with our accountant about this yesterday. She said that if you pay it now, you pay this year's tax rates on the conversion; if you split it between 2011 and 2012, you pay those years' tax rates on the conversion. Her concern: "With the rate the government is spending money, I would not be surprised if taxes went up in the next couple of years."

Of course, she does not have a crystal ball, but it's something to consider. If you think tax rates will stay the same in the next couple of years, splitting it is probably a more attractive solution. But if you think they might go up, paying the tax this year makes more sense.
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Old 03-18-2010, 02:05 AM   #6
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Quote:
Originally Posted by Animorph View Post
.
I think after age 59.5 you don't need to worry about the 5 year waiting periods any longer, but that's something to confirm.
According to flowchart on p. 65 of Pub 590, this is true for the 5 yr waiting period for each conversion, providing that the first Roth you ever opened is at least 5 yrs old and you are over 59.5 yrs old.
http://www.irs.gov/pub/irs-pdf/p590.pdf

If the above is true, consider 2 cases: both in 25% bracket; both start w/
10K in TIRA and 2.5K in cash.
1) A converts to Roth. Tax on 10K conversion is 2.5K so A is left with only
10K in Roth. All 10K can be removed w/o tax/penalty provided A has
had a Roth for 5 yrs.........assume he had opened one more than 5 yrs
ago....and is over 59.5 y.o.
2) B does not convert so still has 10K in TIRA and 2.5K in cash. Although the gross amount is more than A, if he has to pull the 10K out of the TIRA,
he will owe 2.5K in tax so effectively does not have any more "useful" funds than A. Since the income earned by the cash in a taxable account is taxed, the Roth is actually somewhat better.

Even though I think I know this, it still is hard emotionally to convert and pay the taxes. Maybe living w/ the idea long enough will help. Another factor is that when RMDs from TIRAs are required after 70.5, the extra income could increase your tax bracket and make you worse off than if you had converted.


A.
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Old 03-18-2010, 06:27 AM   #7
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My DW/me are 62. We do not plan on converting any TIRA's to Roths.

In our case, we have more than enough to live on (planning through age 100) and don't see any pressing need to pay taxes if not due. As someone said, "A tax delayed is a tax not paid".

We also have a special situation as after we both pass, our liquidated residual estate proceeds will be going to charity. Assuming the laws remain the same, our bequests (as to our TIRA's) will be tax-free to our named charities...
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Old 03-18-2010, 10:50 AM   #8
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Originally Posted by MasterBlaster View Post
The question to ask is...

Will my marginal tax rate be higher than now when I liquidate the Roth accounts. If the answer is yes then A Roth conversion may make sense.
To the OP - what Master Blaster said is what should drive the decision - however, if one looks at the current US economic environment along with projected expenditures as well as meeting current expenditures, the aging of the populations, etc., I believe there is a high probability that the lowest tax brackets (aside form those who don't pay taxes) will still be at a higher percentage than what it is now. With the Bush tax roll backs set to expire, passive income will be taxed at a higher rate as well. This leads me to believe tax rates in general in the future will be higher than they have been. For me, I like the idea of having access to a tax-free fund to augment my other streams of income. Additionally, my IRA is not a significant amount of money, so the taxes I would pay now would not be onerous (i.e. I could pay it of cash I have laying around). I do have other tax-deferred investment vehicles which I will not be converting (would need to convert them to a self-directed IRA anyhow beforehand). I do know of some who are slowly converting their IRAs to Roths as they truly believe in having the tax-free income available, however, they have nice pensions which are taxed, so adding the RMDs into that situation make them end up forfeiting more of their hard earned money.

Your mileage will vary depending on your situation, however, my crystal ball says the good times will become less so in the future, so I'm going to take advantage of this brief respite (of course Congress will find a way to close this loophole).

Sort of aside - it seems that if you have a pension of some sorts, making the other streams of income more tax efficient becomes important, otherwise, you will be seeing quite a bit of your entitlements (I know bad word, but can't think of another one) and assets be taxed at higher rates.

Sorry if I'm repeating myself :-)
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Old 03-18-2010, 12:29 PM   #9
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I am planning to convert as much as I can within the "headroom" I have between my estimated income for 2010 and the upper limit of my tax bracket. Unrelated to that conversion, I just sold part of a fund to trim back my equity allocation. I plan to use the CG from that sale to pay the taxes on the Roth conversion.

I expect that my tax bracket will not change in the future (unless, of course, taxes increase.)
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Old 03-18-2010, 01:28 PM   #10
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With the Bush tax roll backs set to expire, passive income will be taxed at a higher rate as well. This leads me to believe tax rates in general in the future will be higher than they have been. For me, I like the idea of having access to a tax-free fund to augment my other streams of income.
I suppose that one must also have a government trust caveat on the Roth IRA money. Do you trust the government some decades out, desperate for resources, to not slap a "use" fee or an "excess withdrawal penalty" tax on that Roth. There certainly is historical precedence for such.
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Old 03-18-2010, 01:43 PM   #11
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I suppose that one must also have a government trust caveat on the Roth IRA money. Do you trust the government some decades out, desperate for resources, to not slap a "use" fee or an "excess withdrawal penalty" tax on that Roth. There certainly is historical precedence for such.
what precedence do you have in mind?
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Old 03-18-2010, 02:30 PM   #12
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Originally Posted by MasterBlaster View Post
I suppose that one must also have a government trust caveat on the Roth IRA money. Do you trust the government some decades out, desperate for resources, to not slap a "use" fee or an "excess withdrawal penalty" tax on that Roth. There certainly is historical precedence for such.
No, no, no, no! They wouldn't do THAT! People would notice and us Boomers are still a major "stick" in the political "stick ball" game. No, I think they are getting everyone comfortable with the idea of essentially, a national sales tax (call it VAT or excise or whatever). So no one can accuse them of taxing Roth gains or withdrawals. "No, we aren't taxing Roths, Mr. X. As long as you don't spend the money - there's no tax!!"

Seriously, I have no more insight than the next person regarding future taxation or what form it will take - that really is up to all of us, er, U.S. We'll get the tax increases we'll put up with. My guess is that "tax the rich" will become the battle cry - until the middle class folks find out that THEY are the rich.

Related elsewhere on the forum, I'm in the process of converting significant traditional IRA's to Roth IRAs. Since most of my starting "stash" was in trad. IRAs, I thought this might be a good hedge. I'll end up with some of each by the time RMD's roll around. My SWAG comes down on the side of higher taxes (in one or many forms) in the future. It would be nice if I were wrong.
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Old 03-18-2010, 02:45 PM   #13
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I think on all of this it also depends how much available cash you have (to pay the taxes) and whether you have so much in IRAs that the RMDs will raise your tax bracket in the future. Also on where you are today, financially. If you make less in the future, higher tax rates might not affect you.

I've got a weird addition to the stories... I have an 89 year old father. If he dies and leaves me some money (which I expect, the question is when...) that could significantly change my income afterward. How to plan !!!

I mean, at 89 there is no telling the future. My mother seemed fine and died in 3 weeks of starting to feel ill, at 85. Dad still plays tennis . Who knows...

Not asking for advice, but this is something I haven't heard mentioned.
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Old 03-18-2010, 03:13 PM   #14
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what precedence do you have in mind?
Prior to 1997, if you took more than a certain amount out of an IRA you paid an excess distribution penalty tax of 15%. That was on top of any income taxes due or any early withdrawal penalties (if applicable).

That's the precedence I had in mind.
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Old 03-18-2010, 03:36 PM   #15
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Prior to 1997, if you took more than a certain amount out of an IRA you paid an excess distribution penalty tax of 15%. That was on top of any income taxes due or any early withdrawal penalties (if applicable).

That's the precedence I had in mind.
OUCH!!!! This is no longer true, correct? I never heard of limits on withdrawals, just RMDs.
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Old 03-18-2010, 03:38 PM   #16
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This is no longer true, correct?
Since 1997 it hasn't been true, prior to that it was.
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Old 03-18-2010, 03:53 PM   #17
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Originally Posted by MasterBlaster View Post
Prior to 1997, if you took more than a certain amount out of an IRA you paid an excess distribution penalty tax of 15%. That was on top of any income taxes due or any early withdrawal penalties (if applicable).

That's the precedence I had in mind.
hmmmm i dont think i know what that was, can you provide details (like how much was too much, was it age dependant, etc.)?
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Old 03-18-2010, 04:22 PM   #18
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Originally Posted by thinker25 View Post
I've got a weird addition to the stories... I have an 89 year old father. If he dies and leaves me some money (which I expect, the question is when...) that could significantly change my income afterward. How to plan !!!

I mean, at 89 there is no telling the future. My mother seemed fine and died in 3 weeks of starting to feel ill, at 85. Dad still plays tennis . Who knows...

Not asking for advice, but this is something I haven't heard mentioned.
Poison?
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Old 03-18-2010, 04:25 PM   #19
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Poison?
Tempting, but no.... He is ummmmm REALLY difficult!
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Old 03-18-2010, 05:13 PM   #20
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hmmmm i dont think i know what that was, can you provide details (like how much was too much, was it age dependant, etc.)?

<This is prior law and is therefore no longer directly applicable>
Prior law: Prior law contained provisions that assessed onerous penalties under four different sets of circumstances. Penalties are assessed for excess contributions to an IRA. This is a 6% nondeductible penalty, assessed each year that the excess is not withdrawn. A second penalty is assessed for excess distributions from an IRA and other qualified plans. This is a 15% nondeductible tax on total retirement distributions to an individual, during any one calendar year, in excess of a predeterminedpre·de·ter·mine
v. pre·de·ter·mined, pre·de·ter·min·ing, pre·de·ter·mines

v.tr.
1. To determine, decide, or establish in advance:
..... Click the link for more information. amount adjusted for inflation ($155,000 for 1996). Individuals with accrued benefitsAccrued benefits

The pension benefits earned by an employee according to the years of the employee's service.
..... Click the link for more information. of more than $562,500 on Aug. 1, 1986 are allowed to make a grandfather election that could exempt certain distributions from the excess distributions penalty. The third penalty provision is a 15% Federal estate tax (over the regular Federal estate tax) for excess retirement accumulations. The excess accumulation Excess accumulation

The amount of a required minimum distribution that an IRA holder fails to remove from an IRA in a timely manner. Excess accumulations are subject to a 50% IRS penalty tax. is the value at the date of death in the decedent's retirement plans over the present value of a single life annuity Single life annuity

An annuity covering one person. A straight life annuity provides payments until death, while a life annuity with a guaranteed period provides payments until death or continues payments to a beneficiary for a guaranteed term, such as ten years. with annual payments over predetermined amounts. The fourth penalty provision is a 10% excise tax Excise Tax

1. An indirect tax charged on the sale of a particular good.

2. A penalty tax applied to ineligible transactions in retirement accounts. This penalty is assessed by and paid to the IRS.

Notes:
1. on premature distributions from IRAs and other qualified plans. This penalty generally applies to distributions made before age 59 1/2 (with some exceptions). New law: Sec. 4980A(g), as amended by SBJPA Section 1452(b) (effective for years beginning after 1996 and before 2000), suspends the 15% excess distribution excise tax from IRAs and other qualified plans. This is an extremely valuable planning tool for any client with significant IRA and other retirement accumulations as a result of either corporate rollovers or successful retirement plan growth. The suspension of the 15% penalty on excess distributions not only avoids the excess distribution penalty for the three-year suspension period, but also can allow the taxpayer to reduce the plan total (in order to avoid the 15% penalty on excess retirement accumulations). Planning opportunity: Practitioners should carefully review their client lists to determine which clients may be subject to both the excess distributions and excess retirement accumulations penalties. Projections should be made using reasonable earnings assumptions for clients' current retirement balances and assumptions about their future income tax brackets Noun 1. income tax bracket - a category of taxpayers based on the amount of their income
income bracket, tax bracket

bracket - a category falling within certain defined limits under different life expectancy Life Expectancy

1. The age until which a person is expected to live.

2. The remaining number of years an individual is expected to live, based on IRS issued life expectancy tables. scenarios. These projections can be used to explain the likelihood of the application of these two penalties, and a joint decision can be made with the client as to the appropriateness of accelerating IRA and other plan distributions during the three-year suspension period for the excess distributions excise tax. The projections related to this issue are very complex. The factors to be considered include not only assumptions about retirement account earnings, future tax rates and life expectancy, but also present value calculations comparing potential future penalties to current income taxes (which would be voluntarily accelerated if earlier distributions are chosen).
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