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Is now the time to Convert from Traditional to ROTH IRA?
Old 10-25-2008, 08:37 PM   #1
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Is now the time to Convert from Traditional to ROTH IRA?

I am a long time lurker that is unusure of what to do these days. I am a single 32 year old and am 100% in equities. Yes I am feeling some pain right now. I am wondering now with my IRA being half of what it was a year ago is now a good time to convert it or at least a piece of it to a ROTH IRA?

My Stats: 2008 is the first year I was able to max out my 401k and ROTH IRA. I am also contributing $10,000 into a company ESPP which gives a 15% discount. My salary is $75,000. Debt wise, I am 5 years into a 30 year fixed 5% mortgage with $150k left on it, $19k of student loans at 4.6% and $5k on a credit card at 0% until September 2009. Right now I am living on a very tight budget to make this happen. As of today my ROTH is $20k, Rollover IRA is $35k, 401k is $35k, tax accounts with stocks is $40k and I do not have an emergency fund.

My current Rollover IRA balance is $35k. I was thinking of converting $10k-$15k of it this year. Would this make sense? How is the income treated? Could I offset it with capital losses from stocks? I am still holding a few from the internet bubble in a taxable account.

At the beginning of this year I was looking at the age of 50-55 for an early date. The downturn in the market might change that.

Any other comments on my situation.

Thank you for your responses.
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Old 10-25-2008, 09:24 PM   #2
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Someone smarter will come along in a minute, I'm sure. Until then, here's how I remember it: The amount you convert will be treated as income. I believe that income can be offset by capital losses, but these would have to comwe from accounts outside your IRA--have you got any of those? Regardless, as you've hit on, converting to a Roth now (while your Traditional IRA prices are beaten down) will save money compared to converting later. In addition, if you believe taxes are headed up, then converting to a Roth earlier is better for this reason as well.

How much should you convert? There are two factors:
1) How much tax can you afford to pay this year? Only convert as much as you can afford to pay the tax on.
2) It often makes the most sense to convert up to the point where a taxpayer reaches the next tax bracket. After all your deductions and exemptions are taken, then convert up to the top of your tax existing bracket. Do the same in succeeding years until you've converted all you want to convert. I'd probably bend that rule a little bit, since you are going to be in the 25% bracket up to $78,850 in income (again, after all deductions and exemptions), and the 28% rate is only bit higher than the 25% you are already paying (it's not nearly the jump seen at lower levels). You might wind up better off by converting as much as you can afford before the prices start heading back up. The 3% saved in taxes isn't much compared to the increased tax you'll pay if your Traditional IRA holdings go up 25% in the coming year while you are waiting to convert it.
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Old 10-27-2008, 01:05 PM   #3
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I would reiterate #2- convert up to tax bracket cap. Know your taxable income from 2007, look at 2008 tax tables, and convert up to the difference.
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Old 10-27-2008, 02:26 PM   #4
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Quote:
Originally Posted by laune75 View Post
I am a long time lurker that is unusure of what to do these days. I am a single 32 year old and am 100% in equities. Yes I am feeling some pain right now. I am wondering now with my IRA being half of what it was a year ago is now a good time to convert it or at least a piece of it to a ROTH IRA?

My Stats: 2008 is the first year I was able to max out my 401k and ROTH IRA. I am also contributing $10,000 into a company ESPP which gives a 15% discount. My salary is $75,000. Debt wise, I am 5 years into a 30 year fixed 5% mortgage with $150k left on it, $19k of student loans at 4.6% and $5k on a credit card at 0% until September 2009. Right now I am living on a very tight budget to make this happen. As of today my ROTH is $20k, Rollover IRA is $35k, 401k is $35k, tax accounts with stocks is $40k and I do not have an emergency fund.

My current Rollover IRA balance is $35k. I was thinking of converting $10k-$15k of it this year. Would this make sense? How is the income treated? Could I offset it with capital losses from stocks? I am still holding a few from the internet bubble in a taxable account.

At the beginning of this year I was looking at the age of 50-55 for an early date. The downturn in the market might change that.

Any other comments on my situation.

Thank you for your responses.
If you don't have an emergency fund, that's the FIRST order of business.

If you lost your job, you would likely have more worries than whether to covnert your IRA accounts..........
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Old 10-27-2008, 08:23 PM   #5
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Quote:
Originally Posted by samclem View Post
Someone smarter will come along in a minute, I'm sure. Until then, here's how I remember it: The amount you convert will be treated as income. I believe that income can be offset by capital losses, but these would have to comwe from accounts outside your IRA--have you got any of those? Regardless, as you've hit on, converting to a Roth now (while your Traditional IRA prices are beaten down) will save money compared to converting later. In addition, if you believe taxes are headed up, then converting to a Roth earlier is better for this reason as well.
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Sam good post. I am not 100% sure but my reading of the rules on Fairmark says that you calculate your modified Adjusted Income, which includes capital gains. Since capital loss can only be used to offset 3,000 of ordinary income you can't use a Roth conversion absorb the losses.

So for instance if you had $50,000 in income 40,000 in losses and want to convert 30,000 in your traditional IRA to a Roth. Your income would be 50K -3K + 30K for the conversion or $77K.

All the other reasons you posted make sense I am going to make a conversion this year.

I should stress, I am far from certain of my conclusion, and I would be delighted to be shown I'm wrong.
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Old 11-03-2008, 02:01 PM   #6
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Agree with FD, get an Emergency Fund first.
All in all, a great time(IMO) to convert with the market down. Gotta "git er did" before the end of the year tho to count toward 2008 taxes. You don't have the April 15 deadline on conversions. Also, worst case, convert, and if the market tanks substantially further , can recharacterize back before the end of the year, then try for a redo next year.
I believe in 2010 you can convert a bunch and spread the tax liability over 2 years.
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Old 11-03-2008, 08:08 PM   #7
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Quote:
Originally Posted by samclem View Post
Someone smarter will come along in a minute, I'm sure. Until then, here's how I remember it: The amount you convert will be treated as income. I believe that income can be offset by capital losses, but these would have to comwe from accounts outside your IRA--have you got any of those?
Capital gains can be offset by capital loses in taxable accounts, but only up to $3000 of ordinary income can be offset. This amount has been unchanged for as long as I can remember. Another example of our darling governemnt robbing us.

Get ready for more.

Ha
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