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.
Dog said:
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).
Dog said:
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/
