Traditional IRA to Roth Conversion Question

[Dog]

OK - finally made the call to start the process of transferring from Edward Jones to Vanguard. I have a Roth and DH has a Roth IRA and a traditional IRA. I asked the fellow from Vanguard about rolling the $ from the IRA to his Roth. The IRA was opened in the early 90's and has just sat without any further $ added. My question is: will he be taxed on the original amount invested or the total balance. The Vanguard guy said he will have to check and get back to me. He was concerned that this could be viewed as tapping into the IRA early and incur taxes and penalties. The overall goal is simplification.

Does anyone have any experience with converting an IRA to a Roth?

[JohnEyles]

Originally Posted by Dog

OK - finally made the call to start the process of transferring from Edward Jones to Vanguard. I have a Roth and DH has a Roth IRA and a traditional IRA. I asked the fellow from Vanguard about rolling the $ from the IRA to his Roth. The IRA was opened in the early 90's and has just sat without any further $ added. My question is: will he be taxed on the original amount invested or the total balance. The Vanguard guy said he will have to check and get back to me ...

Wow, he sounds like a moron, frankly (else I'm misunderstanding and/or I'm the moron).

The tax would be on the amount converted to the Roth, whether it's original contribution
or growth/earnings. Of course, if some of the original contribution was after-tax money,
that wouldn't be taxable. And no, there wouldn't be any early withdrawal penalty as long
as the money goes directly to the Roth (no check cut to you, I think they call it trustee to
trustee). There can be some issue if you withdraw some of the converted amount FROM
the Roth before 5yrs have elapsed.

[Nords]

We've been converting our IRAs to Roths for the last three years, a little each year up to the top of the 15% tax bracket, with another 5-8 years remaining.

Originally Posted by Dog

My question is: will he be taxed on the original amount invested or the total balance.

You're taxed on the amount that you convert, and the conversion amount has a basis calculated from form 8606. Some of that basis may be after-tax dollars (your non-deductible conventional IRA contributions), some before-tax dollars (your deductible conventional IRA contributions). The after-tax basis is not subject to a second round of taxes. If you always made deductible contributions to a conventional IRA, then the basis is zero and the full amount of the conversion is taxable.

This sounds more confusing than it actually is. Form 8606 & form 5498 provide the numbers that are plugged into the back page of 8606's conversion calculation to determine the taxes. If you made non-deductible contributions then form 8606 will show a basis. Form 5498 is the fund company's report of your IRA value on 31 December.

In other words you're probably going to pay taxes now on the total balance-- in exchange for never having to pay taxes on anything associated with the Roth ever again.

A good general overview of Roth IRA conversions is on Fairmark.com's website at http://fairmark.com/rothira/howmuch.htm. Another reference is the IRS' Pub 590 at http://www.irs.gov/pub/irs-pdf/p590.pdf (page 37).

Originally Posted by Dog

He was concerned that this could be viewed as tapping into the IRA early and incur taxes and penalties.

That's the typical type of tax advice you get from a mutual-fund company's customer-service staff. (Vanguard spends less money on customer service than anyone else!) They're trained to discourage anything that smells like an early withdrawal and they're not so well trained in the exceptions.

As you've said, you want to do a trustee-to-trustee transfer to get the shares from EJ to Vanguard. Since it's just a transfer of custodian, there's no tax. Unless the IRA is in some exotic EJ asset, the shares are usually transferred in kind. Even if they have to cash you out of EJ's proprietary beev3r-cheese futures, there's still no tax. The custodians do all the paperwork and you should never get a check in the mail.

Do the custodian transfer and the conversion in separate steps. I wouldn't start a conversion until the shares are in Vanguard's hands (in the conventional IRA) so that the paperwork's account numbers leave no confusion as to who's getting the money (the custodian in your Vanguard IRA accounts). Once Vanguard has the IRA accounts, follow their conversion procedures for the amount you want to convert.

You want the conversion to go from the conventional IRA account to the Roth account so no money ever goes to your hands and there are no early-distribution penalties. You'll get a 1099R with a distribution code reflecting that the conversion is not subject to penalties. You should also request that Vanguard not withold any taxes from the transaction because you'll probably be paying those conversion taxes from funds outside of the IRA.

Conversions have to be accomplished by 31 Dec. Fidelity used to require a pile of conversion paperwork with original signatures (mailed, not faxed) and it could take a couple weeks. However last year all it took was a 10-minute phone call, and Vanguard may have streamlined their procedure too. Otherwise you may want to start the process no later than the end of October in order for them to get it done in November-- before the end-of-year conversion requests start rolling in.

I wouldn't ask Vanguard any more questions about the taxes. The best place to get a CPA's personal answers to your most obscure conversion questions is Ed Slott's IRA discussion board at http://www.irahelp.com/cgi-bin/forum/index.cgi/

[Dog]

Thanks Rusty and Nords for the great information. I think we will move forward with the conversion. It's worth the simplification today and in the future.

[lb]

I just went thru moving money to Vanguard and found that they didn't want to get involved with 'issues' - even basic ones like you had. I would suggest moving the money over to a standard IRA and then converting it once it is in Vanguards hands. I must admit I am rather disappointed in how they handle the transactions. Be very careful and check all the amounts.

In my case, they moved my non IRA money into one of my IRAs! And it was lots of money. They took over a week to move it to the correct account. And now I am worrying that I am going to get a 1099 next year saying I withdrew that amount. I have a call into the woman who supported my transition and have yet to hear back.

Not to hi-jack your thread, but does anyone have any suggestion who I should talk to at Vanguard about this? How can I know a verbal response in March won't mean anything when I get a 1099 next January?

[clifp]

Interesting my transfer (completed yesterday) to Vanguard went very smoothly. Called them up told them I was transfer X # of shares of a Vanguard GNMA fund from Schwab to them and wanted to get it convert to Vanguard Admiral Fund. Eventhough this was all part of a trust I just had to sign on the highlight spots and wait a few weekss and it got done with no problems.