Roth conversion analysis - could you review my math?

[Lisa99]

I've been reading about Roth conversion, filling up the 15% bucket and modeling in TurboTax, but I'm still not 100% confident that I understand the steps.

For those who do this regularly could you look at my scenario and let me know if my conclusion is right (Using hypothetical numbers).

Scenario - budget is $85k/year (includes fixed and variable expenses)

Pension - $13.5k
Dividends and interest - ~$12.5k/year from after tax investments (taken as cash rather than reinvested)
Shortfall - $56k (Sell $56k in investments of which $18k is capital gains)

Top of 15% tax bracket in 2014 is $73,800.
Assume that I have no carryforward losses.
SS is more than a decade away.

Is this the right answer?
I think the pension is the only ordinary income in the scenario so I think I would be able to convert $60,300 of my tIRA.

If my conclusion isn't right could someone show me the steps involved to determine how much I could convert to Roth IRA without causing my capital gains to become taxable?

 

[pb4uski]

2014 top of 15% bracket..................$73,800
2014 personal exemption x 2 .............. 7,900
2014 standard deduction................... 12,400

2014 total income.............................94,100

less pension.....................................13,500
less dividends and interest.................12,500

Roth conversion/pension income.........68,100

if you itemize then substitute itemized deductions for standard deduction above.

Your dividends and capital gains won't be taxable but are still included in the taxable income calculation. Play around with TT or TaxCaster to verify. You'll also find that if you increase your roth conversion by $1,000 that it results in $300 of tax (30% effective rate on the excess as going over the 15% tax bracket brings qualified dividends and LTCG into the tax calculation).

 

[kaneohe]

pb4uski is correct but he might have missed one small detail? Your 18K in LTCG from selling equity. Deduct that from the 68K he got and you get about 50K in headroom for the Roth conversion. Interest and nonqualified dividends are also taxed at ordinary income rates but that is not relevant to the question.

 

[pb4uski]

That was unclear to me but kaneohe is correct, if you anticipate $18k of capital gains then the Roth conversion would be reduced to $50,100.

 

[sengsational]

The wise have already answered, but my first intuition would be to plug the scenario into some tax software. Besides the year old rates and non-indexed values, which seem pretty small, would that would produce a good estimate?

 

[kaneohe]

Yes, always good to doublecheck w/ tax software/calculator like Taxcaster. For 2015 numbers, can look here Reference Room - Fairmark.com Fairmark.com

 

[RunningBum]

kaneohe is right, it's not just ordinary income you consider, but all taxable income. Otherwise if you go over 15% every dollar you convert pushes a dividend/cap gain dollar into being taxable, so you have 15% for the conversion + 15% for the div/CG for a 30% tax rate on the amount over. You can verify this with a tax program, paying attention to the dividend and LTCG worksheet.

 

[pb4uski]

Ok, so I overcooked my Roth conversion by ~$500 and that extra $500 is costing me $150 in federal tax. I can recharacterize the $500 back into my traditional IRA. If I do that, I assume that it is a 2014 tax event and will reduce my tax by $150...right? I have never done a recharacterization before.

Will my 2014 1099-R form be corrected (reduced by $500) or will i get another form for the $500 recharacterization? Just wondering how the mechanics of a recharacterization work and it is easier to ask than to try to look it up.

 

[kaneohe]

Ok, so I overcooked my Roth conversion by ~$500 and that extra $500 is costing me $150 in federal tax. I can recharacterize the $500 back into my traditional IRA. If I do that, I assume that it is a 2014 tax event and will reduce my tax by $150...right? I have never done a recharacterization before.

Will my 2014 1099-R form be corrected (reduced by $500) or will i get another form for the $500 recharacterization? Just wondering how the mechanics of a recharacterization work and it is easier to ask than to try to look it up.

Yes, it's a 2014 tax event. I think you get another 1099R for the reharacterization if it happened in 2015, probably too late for your 2014 tax yr. You explain the apparent discrepancy in a narrative you have to file anyway for the recharacterization. When you file the 2015 tax yr, you have to input the 2nd 1099R and also explain in a narrative what happened so any taxable 0's in line 15b are explained.

Reversing a Roth IRA Conversion - WSJ

 

[papadad111]

Very good information. I wondered about this myself. Sticky material...

 

[pb4uski]

Thanks for the response. As I thought. Appreciate it.

 

[sengsational]

Here's the way it went down for me, if you want to run a simulation...

In November of 2010 I did a Roth conversion. In early 2011 got a 2010 1099-R box 1 and 2a having the amount of the conversion. 2b was checked (taxable amount not determined). Box 7 had distribution code 2 (early dist, exception applies) and the IRA/SEP/SIMPLE was checked.

In February of 2011 I requested a recharacterization. In early 2012, I got a 2011 5498 with box 4 that had the recharacterization amount. I also got a 2011 1099-R with that same recharacterization amount in box 1, and nothing in box 2a. The box 7 distribution code R (Recharacterized IRA contribution made for 2010 and recharacterized in 2011). No other boxes had anything.