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Traditional IRA to Roth - Tax
Old 08-15-2016, 11:34 AM   #1
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Traditional IRA to Roth - Tax

Background Info

I was 59 1/2 this year and am considering converting a portion of my IRA to a Roth IRA to the top of my current tax bracket for each year until I need to take RMDs. This will reduce my tax bill in the years after I am forced to take RMDs. I am planning on paying most of the current taxes on this rollover from the proceeds of the rollover. I believe that this allows for a direct comparison of the tax savings of this strategy.

Question

Most financial planning websites seem to recommend paying the current taxes on a conversion of this types from other non-retirement accounts so that the total amount can be rolled over. However, isn't that equivalent to increasing your effective retirement savings? I don't see adding money from a non-retirement account to pay for this conversion a part of this comparison. Isn't saving more always better? What am I missing?
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Old 08-15-2016, 11:58 AM   #2
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A Roth IRA is the best place to have your money, because you pay no taxes on withdrawals, and no taxes on gains. When you do your comparison, don't forget to consider future gains, and the taxes on those gains you are avoiding in your taxable account by using that money to pay for the conversion, to get the maximum amount in your Roth.
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Old 08-15-2016, 12:26 PM   #3
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If you can pay the tax from funds outside the IRA, then it is like an additional contribution. I know that I do these Roth conversions and pay with money from my taxable account. I have to sell some shares in the taxable account, but since I am in the 15% marginal income tax bracket and the long-term capital gains tax rate is 0%, so I do not pay extra tax to do the conversion.

So yes, I am putting more money than I otherwise would into my Roth IRA. And that's better than keeping it in a traditional IRA for me.

I suggest that you not pay the tax from the IRA. As for direct comparison, I'm not sure I would worry about that at all, but I suppose you have to get something squared away in your own mind. In that case, just compare the sum of "converted amount + taxes paid from outside" to Roth IRA going forward. That will make it more apples-to-apples.

In the same way, folks compared tIRA+taxable account versus a Roth account.
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Old 08-15-2016, 01:16 PM   #4
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Originally Posted by LOL! View Post
If you can pay the tax from funds outside the IRA, then it is like an additional contribution. I know that I do these Roth conversions and pay with money from my taxable account. I have to sell some shares in the taxable account, but since I am in the 15% marginal income tax bracket and the long-term capital gains tax rate is 0%, so I do not pay extra tax to do the conversion.

So yes, I am putting more money than I otherwise would into my Roth IRA. And that's better than keeping it in a traditional IRA for me.

I suggest that you not pay the tax from the IRA. As for direct comparison, I'm not sure I would worry about that at all, but I suppose you have to get something squared away in your own mind. In that case, just compare the sum of "converted amount + taxes paid from outside" to Roth IRA going forward. That will make it more apples-to-apples.

In the same way, folks compared tIRA+taxable account versus a Roth account.
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Excellent answer.

OP - doing the lousy way simply so you can compare is not doing the best you can.

This comparison has already been done a lot. No need to try to re-invent the wheel.
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Thanks LOL!
Old 08-15-2016, 01:20 PM   #5
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Thanks LOL!

I believe we are thinking along the same lines. To further expand, in your case as long as you only take long term capital gains and stay in the 15% tax bracket the 2 cases are nearly identical. The Roth will be tax free as is the cash account with long term capital gains. The only difference is the requirement of only taking long term gains from the cash account and only taking from the Roth funds that have been there for 5 years. Of course depending upon market returns it may be difficult to stay in the 15% tax bracket after RMDs kick in.
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Additional Info
Old 08-15-2016, 03:15 PM   #6
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Additional Info

So I've calculated how much to convert going forward and what the savings are for doing this long term. As suggested I will look closer at paying the taxes from a brokerage account as an additional analysis. A complicating factor is that I have a calculated SWR from my combined tax adjusted nest eggs (After tax account, Roth IRAs, and traditional IRAs). One of my reasons for wanting to pay the taxes from the conversion amount was to make the after tax account last as long as possible. If I use the after tax account to pay for IRA conversion taxes, I will likely deplete the after tax account before getting to the RMD age and the Roth conversions will stop earlier (unless I don't spend my SWR). Additional complicating factors are an unknown return rate, unknown future tax rates, and decisions on SS. More tabs in the spreadsheet!
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Old 08-15-2016, 03:23 PM   #7
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Don't forget that a Roth IRA has no RMD and actually IS an after-tax account.
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Old 08-15-2016, 06:05 PM   #8
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Are you worried about depleting the taxable before RMD (70.5), or before 59.5, which is when you can tap the IRA accounts? Big difference, as you should really only be worried about 59.5. And if you actually made contributions to the Roth in addition to the conversions, those contributions can be withdrawn anytime without penalty.
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Old 08-15-2016, 08:26 PM   #9
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Our taxable accounts will be depleted before 70.5, and we're Roth converting the entire time, with taxes paid by taxable accounts. However, we'll still have tIRA funds to fill the lower tax brackets for a long time.

A simple example:
Withdraw $10,000 from tIRA for a Roth conversion.
Pay $1,500 in taxes, leaving $8,500.
Roll $8,500 into the Roth account.

or

Withdraw $10,000 from tIRA for a Roth conversion.
Pay $1,500 in taxes, leaving $8,500.
Add $1500 from a taxable account to restore the full $10,000.
Roll $10,000 into the Roth account.


The net effect of paying the conversion taxes with taxable money is as if you are taking that tax amount out of the taxable account and placing it into the Roth account. Generally that is a good thing. However, if you can avoid all taxes in your taxable account (0% capital gains and no ordinary dividends) it could be a wash. Or if you end up taking it out of the Roth after just a few years of market losses and miss a capital loss tax deduction you would be better in a taxable account. But I'm maxing out the Roth.
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Old 08-16-2016, 07:38 AM   #10
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I "probably" can go the ~10 years until I get to the RMD age on my current after tax (non-Roth) account and my existing Roth accounts. However, I can definitely get to the ~5 year mark when these Roth conversion contributions will be eligible for withdraw.

In the case of paying taxes on the conversion with after tax money, is filling out the paperwork for estimated taxes and submitting a check(s) required? Or since this is the first year of increased earnings, could I wait until I submit my taxes in April 2017 and get by without a penalty?
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Old 08-16-2016, 08:02 AM   #11
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If you're 59.5, I don't think you have to wait 5 years to withdraw the converted money. Distributions After a Roth IRA Conversion - Fairmark.com Fairmark.com . Since you talk about ~10 years to RMD I assume you are around 60 now.


You don't have to fill out paperwork for estimated taxes. Just make the quarterly payments online at https://www.eftps.gov/eftps/ or send in a payment with the paper form. I guess that is paperwork but you don't have to fill out any part of the 1040.


For the most part the IRS is going to want to see pretty even payments each quarter, or else you'll have to fill out another form showing that you made your payments for the quarter after which you got the income. If you did a large conversion today, you could send in the corresponding payment at the end of this quarter (Sep 15) and they won't ding you for not making payments the first two quarters, but you'll have to fill out a form showing when all of your income and deductions were incurred for the year to show that you paid as you go. You wouldn't be able to wait until April and pay it then. I think there are some exceptions if you have taxes withheld from another source, such as a paycheck.


I find it best to convert early in the year, to get that money in the Roth as quickly as possible so it won't be taxed anymore, and do even quarterly payments for the year. An unexpectedly large mutual fund distribution at the end of the year can throw this off, so I overestimate a bit, or make sure my quarterly payments equal last year's tax due to avoid penalty.
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Old 08-16-2016, 08:22 AM   #12
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Originally Posted by RunningBum View Post
If you're 59.5, I don't think you have to wait 5 years to withdraw the converted money. Distributions After a Roth IRA Conversion - Fairmark.com Fairmark.com . Since you talk about ~10 years to RMD I assume you are around 60 now.


..................................................
When you turn 59.5, the 5 yr conversion clocks on each conversion are replaced by a single 5 yr clock based on when you opened your first Roth IRA.
If that clock is expired, all funds including earnings can be withdrawn tax and penalty free.

If that clock is still ticking, you can withdraw any contributions and conversions but the earnings are still subject to tax.
Fairmark Forum :: Retirement Savings and Benefits :: Roth IRA Rules - Table Approach
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Old 08-16-2016, 09:06 AM   #13
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Originally Posted by kaneohe View Post
When you turn 59.5, the 5 yr conversion clocks on each conversion are replaced by a single 5 yr clock based on when you opened your first Roth IRA.
If that clock is expired, all funds including earnings can be withdrawn tax and penalty free.

If that clock is still ticking, you can withdraw any contributions and conversions but the earnings are still subject to tax.
Fairmark Forum :: Retirement Savings and Benefits :: Roth IRA Rules - Table Approach
Thanks for the clarification. Fairmark is a fantastic site for issues like this, but I didn't look at everything. I assume the OP wouldn't have chewed through all the conversions in 5 years and started in on the earnings already, which as you say is the only part that would be taxed in that situation.
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Old 08-16-2016, 09:16 AM   #14
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And the 5 years, becomes a little over 4 years, since the paperwork I just submitted is counted as though it occurred on Jan 1, 2016. Paying federal tax from an after tax account, but did withholding for the state tax. Thanks for the help.
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Old 08-19-2016, 06:32 PM   #15
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Roth conversions can provide great benefit, but they can be different for many people depending upon specific circumstances. Many will state conclusively that you should never use the proceeds from a tIRA to pay taxes on a conversion, but that may not be true when considering future RMDs and estate planning. That said, it is generally always better to use other funds if such funds are available. One possible exception is when the taxable accounts might be owned by a spouse, etc. who is in very bad health (potential near term step up - sorry for the morbid point).
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Old 08-21-2016, 05:10 PM   #16
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I was thinking of doing this until I realized a hidden tax ding.

I have qualified dividends taxed at zero or 15%. For every dollar more that I make I lose the zero and pay the 15%. So on top of my low tax I have to add 15%.

That takes a lot of fun out of it. It might be slightly still a good idea but to close to call.

Bob
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Old 08-21-2016, 09:37 PM   #17
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Thanks for pointing out the Fairmark Forum. It seems very interesting and I will add it to my reading list.
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Old 08-29-2016, 01:57 PM   #18
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Originally Posted by Dan32 View Post
Background Info

I was 59 1/2 this year and am considering converting a portion of my IRA to a Roth IRA to the top of my current tax bracket for each year until I need to take RMDs. This will reduce my tax bill in the years after I am forced to take RMDs. I am planning on paying most of the current taxes on this rollover from the proceeds of the rollover. I believe that this allows for a direct comparison of the tax savings of this strategy.

Question

Most financial planning websites seem to recommend paying the current taxes on a conversion of this types from other non-retirement accounts so that the total amount can be rolled over. However, isn't that equivalent to increasing your effective retirement savings? I don't see adding money from a non-retirement account to pay for this conversion a part of this comparison. Isn't saving more always better? What am I missing?
If you are planning to do “a” Roth conversion, the first term you want to investigate is “recharacterization”. This is basically a way to say “oops”, “never mind”, “undo” that.

The key is to open new Roth accounts at your broker for each symbol you are planning to convert and then do each conversion into a separate Roth account. Yes, you can do that, talk to your broker. If everything is in one account the calculations are done on the group of symbols, not one by one!

Determine up front how much you plan to convert, say enough to take you to the top of the 25% bracket. Then, do more individual conversions than you need to do.

You then have until April, but I do this in December, check the rate of return of each individual conversion. If any of them lost money, tell your broker to “undo”, “recharacterize” them, like they never happened! Why lose money in a tax free account when you can lose it in a taxable account!

Next, list the symbols by their rates of return and undo the lowest returns. This will keep you in the 25% bracket, or whatever your limit is, and give you the best bang for your buck.

Just remember, you are calculating all of this based on their values at the time of conversion, not today’s value.

We just did this using the BRexit drop in the market. For the sake of discussion, let’s say our combined federal, state, and local tax rate is 33.33% and the pre BRexit value of the symbol was $30,000. When England dropped out of the European Union the market dropped for two days. For example, let’s say that symbol dropped 15% to $25,500 and we did the conversion at the close on Monday. The taxes due would have been $8,500. On Thursday it would have been $10,000!

By the end of December let’s say that the symbol regains its loss and gains an additional 10%, now selling at $33,000 which would cost $11,000 to convert in December. So, we do not undo this one, pay the $8,500 taxes due back in June and end up with $33,000 in our Roth account!

$8,500 taxes on $33,000 is only 25.76%, way less than 33.33%!


Remember that the estimated taxes you paid along the way are on the final total, not on each symbol!

We also convert another symbol that dropped 10%, but it never regained its loss and actually lost more, so we “undid”, “recharacterized” that one so we lost that money in the taxable IRA account!

If multiple symbols gain well over 10%, we can just ignore our 25% rate limit and take the high gains tax free!

Research recharacterization on your own and talk to your broker about it!

As far as using “other money” for the taxes, that is like making additional Roth contributions over the max allowed, and yes that is a good idea!
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Old 08-29-2016, 04:20 PM   #19
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I was thinking of doing this until I realized a hidden tax ding.

I have qualified dividends taxed at zero or 15%. For every dollar more that I make I lose the zero and pay the 15%. So on top of my low tax I have to add 15%.

That takes a lot of fun out of it. It might be slightly still a good idea but to close to call.

Bob
Huh? I don't understand... can you give us an example?

If you are talking about the onerous ~30% effective tax rate if you break over the top of the 15% tax bracket by a little bit then there is an easy solution to that that I have used for years... I do my tax return and if I'm over the top of the 15% tax bracket I simply recharacterize any excess and reflect that recharacterization in the return... so my tax able income the last two years has been exactly the top of the 15% tax bracket. Problem solved!
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Old 08-29-2016, 04:32 PM   #20
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Huh? I don't understand... can you give us an example?

If you are talking about the onerous ~30% effective tax rate if you break over the top of the 15% tax bracket by a little bit then there is an easy solution to that that I have used for years... I do my tax return and if I'm over the top of the 15% tax bracket I simply recharacterize any excess and reflect that recharacterization in the return... so my tax able income the last two years has been exactly the top of the 15% tax bracket. Problem solved!
The way I read it is that Ducky is already over the 15% top if you include dividends and CGs. Some of them are already being taxed at 15%, and some aren't (0%). So he hits that phantom 30% bracket with every $1 converted being taxed at 15% + $1 more of dividends being taxed as well.
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