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To Start the ROTH Conversion -- Or Not?
Old 01-08-2014, 07:14 PM   #1
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To Start the ROTH Conversion -- Or Not?

2014 will be my first full year of ER and I'm looking at converting my 401K to a Vanguard ROTH IRA. I've run ORP calculator and it suggests converting it over the next 7 years in 60K chunks keeping me in the 15% tax bracket.

That all sounds good; however, I'm also evaluating the college FAFSA and trying to reduce our Expected Family Contribution (EFC). If I can keep our income below 50K and file a 1040A instead of the 1040, it reduces our annual EFC by 14K. We're facing 8 years of college for 3 children. So question is will it be worth it to convert over and lose the reduction in our expected college cost for the tax-free ROTH money down the road? I understand it's not so cut and dry as to whether one benefits from converting over to a ROTH.

We still have 3 children at home so even though I'd be taking the 401K distribution each year, our overall tax should still be fairly low given the 5 exemptions. Also, if I wanted to stay with the 1040A, I lose the ability to itemized deductions which would raise the taxes about $1000.

Not an easy choice from where I sit.
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Old 01-08-2014, 09:01 PM   #2
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If you keep your income below $50k won't you also qualify for higher Obamacare health insurance subsidies and possibly assistance with deductibles and co-pays as well?

It seems to me that the $14k reduced EFC will exceed the benefit of staying in the 15% bracket vs going into the 25% bracket.
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Old 01-08-2014, 09:07 PM   #3
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If you keep your income below $50k won't you also qualify for higher Obamacare health insurance subsidies and possibly assistance with deductibles and co-pays as well?

It seems to me that the $14k reduced EFC will exceed the benefit of staying in the 15% bracket vs going into the 25% bracket.
I think you have a good point there. Two for the price of one. Thanks.

BTW…I don't make the laws, I just try to live within them.
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Old 01-08-2014, 09:09 PM   #4
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Very roughly the Roth conversion should save you 25% - 15% = 10% of each dollar converted. If you save $14k/year at a particular conversion level, then you would probably want something like a $140k conversion to save an equal amount each year. For my specific circumstances it was slightly better for me to convert $40k and give up a $2.5k tuition tax credit. Which is even worse than that rough estimate. I don't think a $60k conversion will come close to matching $14k/year, and may not be worth even $5k/year.
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Old 01-15-2014, 11:08 AM   #5
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But reducing your EFC by $14K is not equal to a grant of $14K. Your EFC affects how much you get in grants and loans. If you money in savings and a low income, you still may not be getting any grants at all, only loans. Our experience was that our children were not going to get any grants at all, only loans, because of our taxable savings. We didn't need the loans so it makes more sense to do the Roth conversions for us.
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Old 01-15-2014, 12:17 PM   #6
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But reducing your EFC by $14K is not equal to a grant of $14K. Your EFC affects how much you get in grants and loans. If you money in savings and a low income, you still may not be getting any grants at all, only loans. Our experience was that our children were not going to get any grants at all, only loans, because of our taxable savings. We didn't need the loans so it makes more sense to do the Roth conversions for us.
+1

My experience was that if you have enough funds in taxable accounts to do Roth conversions you won't get any grants. I don't think it pays to do Roth conversions out of pre-tax funds although, as I recall, that is what ORP suggested for me.
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Old 01-15-2014, 12:29 PM   #7
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Guess I am lost as how you will be able to convert $60K a year over and stay in the 15% bracket. You don't have much/any other income coming in? $72,500 is the limit to go to 25%. I will try to move over maybe $35K this year....and then with the pension etc on top of that I would be close to $72K.......do I have that right?
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Old 01-15-2014, 12:37 PM   #8
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Why is Roth Conversion taxed at 15% better than LTCG's taxed at 0%?
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Old 01-15-2014, 12:48 PM   #9
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Why is Roth Conversion taxed at 15% better than LTCG's taxed at 0%?
In my case.....a likely move to the UK is coming in a couple of years. Supposedly the UK will not touch my Roth.....they might grab part of my TSP as I sell it over the years. If I were to stay in this country.....then I wouldn't bother to move anything.
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Old 01-15-2014, 01:29 PM   #10
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That all sounds good; however, I'm also evaluating the college FAFSA and trying to reduce our Expected Family Contribution (EFC). If I can keep our income below 50K and file a 1040A instead of the 1040, it reduces our annual EFC by 14K.
AS others have mentioned, reducing the EFC is not the same thing as actually receiving financial aid that is not loan-based. Just because your EFC is $14k less doesn't mean that someone actually gives you (well, your child) that money.

I've been looking at this myself. We have 2 kids in college and have never done FAFSA in the past because our EFC was so high. But, this year we are spending down taxable money. We have some income from long term capital gains but we won't owe any tax on it. In fact, unless we do Roth conversions (or withdraw money from the IRA this year to pay for next year), we will owe zero federal income taxes for this year. DH receives SS but no pension.

When I run the Fafsa 4caster we have a very low EFC. However, the amount of non-loan based grants that show up are basically the Pell grant which is capped at $5645 a year. Even with kids attending low cost state schools that doesn't cover a year's costs.

It is certainly possible that a school - particularly very expensive schools - may have grants available beyond the Pell grant. But, I would personally be very wary of relying on getting those. That is, the benefit you get from the Roth conversions you can model that right now. But, if you forego the Roth conversions, you may or may not get any grant based financial aid.

Also, bear in mind that for Pell grants they phase out very quickly.

We have a similar dilemma. If we do Roth conversions this year (or simply withdraw money from the IRA for spending in 2015), then we make sure we are in the 15% tax bracket for 2015. If we don't do Roth conversions or withdraw for 2015 during this year, then we will be in the 25% tax bracket in 2015. If we get Pell grants for 2015, then that offsets the higher taxes in 2015 and is probably the best choice.

But, it is already complex to model. Also, because of the low taxable income we can itemize medical expenses (we are at 7.5% still) and get some benefit there but only if we do Roth conversions (or withdrawals) so we have some income to deduct against. If medical expenses are above a certain amount then, it makes sense to forego the Pell grant route and just do the conversions and get the medical expense and other itemized deductions.
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Old 01-15-2014, 02:33 PM   #11
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Why is Roth Conversion taxed at 15% better than LTCG's taxed at 0%?
I've tried that with my retirement calculations, and for me the Roth conversion is better. More spending allowed each year. I save 10% by not paying 25% on RMD's later, but that's not a 15% savings. I think the rest is due to essentially adding the taxes paid by the taxable account into the Roth as additional tax free value.

Roth convert $10k from a tIRA and you might pay $1.5k in taxes. The after tax value of that $10k was actually just $8.5k. But now you have the full $10k in the Roth. The after tax value of $10k in a Roth is $10k. So now you have more tax free value in your retirement account. You're paying no taxes on $1.5k that used to be taxable. That appears to be worth more than the extra 5% savings on capital gains.

For me, the other benefit was that I was Roth converting beyond the 15% tax bracket. Even if the tax rate is the same now as it will be for RMD's, you still get that higher tax free value for a ling period if you do the Roth conversions early.

I don't recall how suboptimal taking LTCG's over Roth conversions was for me, but I suspect the difference was not large if you remained within the 15% tax bracket.
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Old 01-16-2014, 08:51 AM   #12
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NanoSour,
I saw on another thread that you have 48% of your savings in taxable. If you have $400K in taxable you are probably not going to get any grants. Have you run your numbers through something like FAFSA4caster to see what you estimated grant amount is? Are you counting on your kids getting subsidized loans for college? I think you need to look at this more closely.
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Old 01-16-2014, 09:07 AM   #13
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+1

My experience was that if you have enough funds in taxable accounts to do Roth conversions you won't get any grants. I don't think it pays to do Roth conversions out of pre-tax funds although, as I recall, that is what ORP suggested for me.
Unless things have changed, retirement accounts aren't listed on the Federal financial aid form that most universities use. Of course, the OP won't be getting any/much financial aid for his children if he has a couple of hundred thousand in non-retirement accounts. Not having an income will help.
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Old 01-16-2014, 09:57 AM   #14
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When running FAFSA4caster, I noticed it didn't have inputs for the simplified means test; i.e. whether a 1040A or 1040EZ was filed. I'm wondering if this test has been removed for 2014-2015 FAFSA. Much of what I'm basing our EFC on depends on meeting the SMT. The results of which may, or may not get our kids more financial aid, but I have to try.
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Old 01-16-2014, 11:37 AM   #15
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Unless things have changed, retirement accounts aren't listed on the Federal financial aid form that most universities use. Of course, the OP won't be getting any/much financial aid for his children if he has a couple of hundred thousand in non-retirement accounts. Not having an income will help.
We are in agreement. I have sold my house and have enough in taxable accounts to build my retirement home. I think my income is low enough to qualify for grants but I did not qualify because of the cash in the bank. The college would more than happy to let me borrow lots more money to give them for my son's education.
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