Another ROTH conversation question....

[Looking4Ward]

Another ROTH conversion question....

I'm really trying to wrap my head around this but am having a hard time. I ER'd last year so this is the first year I won't have any W-2 income.

• 65% of my portfolio is in a taxable account. The dividends and cap gain distributions it provides are more than enough to meet my needs, yet I still have plenty of room before I'm pushed out of the 15% tax bracket filing single head of household with a minor dependent.
  
  
• 35% of my portolio is in an IRA that was the result of a 401K rollover last year.
  
  
• I'll turn 55 next summer.

Given the above parameters:

Can I contribute to a ROTH using my taxable assets, convert some of my tax advantaged assets to a ROTH, or both?

If so, how much?


Thanks for any input, because I have this nagging feeling that I'm not taking advantage of something I should be.

 

[jim584672]

You would need earned income to make new contributions. Or you could convert and pay taxes from an existing Traditional IRA to a Roth. There is a five year wait to avoid the penalty on the converted amount, meaning you can remove the converted amount, even if you are under 59.5, if you wait 5 years.

 

[RE2Boys]

1. You can not contribute new money to a retirement plan as you had no earned income (W2 wages or self-employment profit).

2. You can no longer convert any part of a traditional IRA to a Roth IRA for 2014 as it would have needed to be completed by Dec 31, 2014.

 

[GrayHare]

(btw, Roth is a person's name, not a "Retirees Owe Taxes, Ha!" acronym.)

You can convert as much as you want. People often split their conversions across multiple tax years so as to avoid pushing themselves into a higher bracket any one year. Keep in mind that if you anticipate having deductions in the future (medical, etc.) you may be able to use those to offset taxes due on tIRA withdrawals. Via that method if you have enough deductions, your tIRA withdrawals can be tax free.

 

[Looking4Ward]

Thanks - so contributing to a ROTH in any amount using funds from my taxable account is out of the question as long as I have no W-2 income.

That leaves me with my existing IRA, which I can start moving funds out of and into a ROTH this year and won't pay any 2015 taxes on the conversion as long as I stay within the 15% tax bracket?

(I don't plan on needing those funds - IRA or ROTH - for at least 15 years).

 

[mpeirce]

I'm in a similar situation: 53, 28% of assets in tIRA.

We've been doing Roth conversion for the last three years (plus some cg harvesting) in the 15% federal bracket. I expect to keep this up for a while.

As others have noted, you're past the deadline for 2014 - unlike new IRA contributions, you need to do your Roth conversion in the calendar year, not before the next April 15th.

I usually meet with my CPA in October/November to plan year end tax related stuff like Roth conversions and then make whatever moves we've decided on before year end.

Between SS and RMDs from tIRA's we expect to be in 25% federal bracket in another 17 years, so doing the Roth conversion thing seems worthwhile. If nothing else, Roth IRAs give us more flexibility in the future. Flexibility might be the main advantage depending how tax laws change by then.

 

[mpeirce]

That leaves me with my existing IRA, which I can start moving funds out of and into a ROTH this year and won't pay any 2015 taxes on the conversion as long as I stay within the 15% tax bracket?

um, no, you will pay taxes on the conversion amount. You said you're in the 15% federal bracket, so you'll pay 15% (plus state if applicable) on the amount. TANSTAAFL

 

[Looking4Ward]

As others have noted, you're past the deadline for 2014 - unlike new IRA contributions, you need to do your Roth conversion in the calendar year, not before the next April 15th.

Yes - my intent is to start this year for 2015 tax purposes.

um, no, you will pay taxes on the conversion amount. You said you're in the 15% federal bracket, so you'll pay 15% (plus state if applicable) on the amount. TANSTAAFL

See, that's where my misunderstanding comes in. I thought it was possible to avoid any taxes at all on the conversion.

For instance, I was just toying around with TaxCaster using a filing status of single, head of household, with one minor dependent and standard deductions.

I entered the following estimates with no W-2 income:

Qualified Dividends: $18K
Short term cap gains: $3K
Long term cap gains: $25K
IRA distributions: $21K (if I converted $21K from tIRA to Roth, correct?)

The "Total Income" comes to $67K
The "Taxable Income" comes to $50K
"Regular Taxes" is $793, but there is a child tax credit of $793.

TaxCaster shows total federal tax due of $0. This is using the 2014 version so the 2015 version will probably allow for slightly higher income, standard and personal deductions.

What am I missing?

 

[travelover]

.........What am I missing?

In the 15% tax bracket, you don't pay capital gains, but you do pay deferred taxes on IRA money.

 

[Looking4Ward]

In the 15% tax bracket, you don't pay capital gains, but you do pay deferred taxes on IRA money.

Ah! So my mistake is in entering the converted amount as an IRA Distribution and instead I should be entering it as Taxable Wage Income? When I do that, it's still showing $0 tax due.

 

[travelover]

Ah! So my mistake is in entering the converted amount as an IRA Distribution and instead I should be entering it as Taxable Wage Income? When I do that, it's still showing $0 tax due.

Hmmm....no, it should be an IRA distribution which is different than an earned wage.

 

[Looking4Ward]

Hmmm....no, it should be an IRA distribution which is different than an earned wage.

Hmmmm.....when I enter it that way it shows $0 tax due.

Is the part I'm not understanding is that a Roth conversion is always a taxable event, with the amount of the tax determined by the tax bracket, with the tax bracket being determined by including the amount of the Roth conversion?

For instance, the above example puts me at the very top of the 15% tax bracket when I include a $21,000 rollover from tIRA to Roth. So even though TaxCaster indicates $0 tax, I would actually have to pay $3150 in federal tax on the $21,000?

 

[Rustward]

I input your numbers into this tax site 1040 Tax Calculator and got taxes due of $0.

Congratulations!

BTW, the converted amount is taxed like an IRA distribution (not earned income). You had it right in post #8.

BTW again, I am not a CPA or tax person.

 

[GrayHare]

Along the lines of my earlier post, you have enough deductions to cancel out that much conversion.

 

[Looking4Ward]

I input your numbers into this tax site 1040 Tax Calculator and got taxes due of $0.

Congratulations!

BTW, the converted amount is taxed like an IRA distribution (not earned income). You had it right in post #8.

BTW again, I am not a CPA or tax person.

Awesome! So it appears it IS possible to convert portions of a tIRA to Roth and not have to pay any federal taxes.

Sweet - that $21K can grow to almost $65K in 15 years at an average 7.5% annual return. And no federal taxes would ever have to be paid? I'm definitely starting this year.

 

[Looking4Ward]

Along the lines of my earlier post, you have enough deductions to cancel out that much conversion.

Thanks!

For some reason it was very hard for me to get my head around it - I suppose it just seemed to good to be true.

 

[RE2Boys]

Hmmmm.....when I enter it that way it shows $0 tax due.

Is the part I'm not understanding is that a Roth conversion is always a taxable event, with the amount of the tax determined by the tax bracket, with the tax bracket being determined by including the amount of the Roth conversion?

?

Some of the money may be taxed at 10%, then 15% depending upon other factors in your particular situation. As you found in Taxcaster, you would have a tax liability of $793, but you are also eligible for a child tax credit not to exceed $3000 or your tax liability. So the result is zero for this scenario. But the year your dependent child turns 17, your no longer eligible for the child tax credit and thus would owe, everything else staying the same, $793 in income tax for that year.

 

[RetireAge50]

No tax for LT capital gains and q dividends. So taxable income would be the 3k plus the 21k which then gets reduced by 9k standard deduction and 8k personal exemptions. So net taxable is 7k. Tax rate is 10% for taxable up to about 13k so tax would be $700. Then you get child tax credits reducing tax to 0.

 

[Looking4Ward]

Thank you, everyone, for helping me understand this.

I wanted to add that I just opened a new Roth account and set up an initial transfer of $1K from my existing IRA to fund it. Took all of 3 minutes on the Vanguard site.

Now I've got a nice screen showing my taxable accounts, brokerage account, IRA account, and new ROTH account.

I'll wait and see how capital gains distributions and dividends work out this year before deciding how much to convert before the end of the year, but I'm sure glad I asked the question today!

 

[Animorph]

Not to complicate things too much, but you also have the ability to "recharacterize" your Roth conversions basically up until you file your taxes. This allows you to reduce your Roth conversion amount if your taxes look too high when you get the final numbers. I'm not sure how great that would work if you are kind of DCA'ing into your Roth account. Vanguard would have to figure out how to remove your excess conversion plus any gains from that amount.


On the other hand, if you only go into the 25% tax bracket by $100 it's not a big deal. But watch out for your Roth conversions costing you 15% in tax and pushing some of your capital gains above the 15% tax bracket, where they become taxable at 15%. At that point you are paying a marginal rate of 30% (15% on the Roth conversion and 15% on capital gains that you weren't paying before.) You won't want to do that.

 

[Debinnov a]

So, you can convert IRAs to Roth before the age of 59.5? I didn't realize you could do that and not pay the penalty.

Sent from my KFJWI using Tapatalk

 

[RunningBum]

1099-R is used for a bunch of different types of distributions. You have to check the right box that shows it is a conversion and a taxable event (I think this is box 7--distribution code). I think you may be missing that so the tool is not considering it a taxable event. I could be wrong, maybe having the child and tax care credit is helping you more than I think. It just doesn't sound right to me.

You could try this test. Run the same scenario without the 21K distribution. If you get the same $793 tax, I'd be pretty certain you are missing something.

If all of your income less deductions and exemptions exceeds 37,900, you're going to pay 15% on any cap gains above that. As Animorph says, this is effectively a 30% rate on any conversion above that limit until all of your capital gains and dividends are taxed.

 

[Animorph]

So, you can convert IRAs to Roth before the age of 59.5? I didn't realize you could do that and not pay the penalty.

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Yes, you can Roth convert at any age.

 

[cranberryjoe]

For a Roth conversion your 1099-R will show a box 7 code of 2 if you are under age 59.5, and the IRA box will be checked. Your tax software will also ask you if this is a conversion to a Roth IRA. Answer yes, and it will treat the distribution as taxable but no penalty applies.

 

[jim584672]

So, you can convert IRAs to Roth before the age of 59.5? I didn't realize you could do that and not pay the penalty.

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You need to wait 5 years to withdraw the converted amount without penalty. Roth conversion ladders are an excellent alternative to a 72t withdrawal strategy.