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$ limits on Roth conversions
Old 08-04-2017, 12:41 PM   #1
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$ limits on Roth conversions

We plan to FIRE in 2 years @ 59 yo. The plan is to use cash savings the first two years of FIRE, during which we would like to do Roth conversions since our tax base will effectively be zero thus triggering little to no tax on the conversions if we stay below certain limits. My queries are:
1. Am I missing anything on this concept around mitigating taxes based on zero taxable income the first two years
2. Is there a conversion dollar limit (much as there is a current contribution limit today) if one has no other taxable income or would we still be held to the annual contribution limits as if we were still working/contributing.
3. We currently have never qualified for Roths and made no sense tax wise to do back doors with our current tax rates.(not a question, just fyi)
4. If the answer to no. 2 above is yes, could we open more than one Roth and do individual conversions, I assume yes?

Any quick insights are truly appreciated.
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Old 08-04-2017, 01:11 PM   #2
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You're on the right track but it would be better to think of it as low-cost rather than little or no cost.

For example, if you were married filing jointly in 2017 with standard deductions and your only income was Roth conversions and you convert to the top of the 15% tax bracket, you could convert $96,700. After $8,100 of personal exemptions and $12,700 of standard deductions, your taxable income would be $75,900... the top of the 15% tax bracket in 2017. Your tax would be $10,453... 10.8% of what you converted and likely much lower than the taxes avoided when you deferred that income or the taxes that you will incur if you wait until later. If your marginal tax rate when you deferred was 28% then you will have saved 17%... a very substantial benefit.

The first $20,800 is tax-free because the conversion is offset by deductions and exemptions. The next $18,650 is taxed at 10% and the last $57,250 is taxed at 15%. Blend them all together and you get 10.8%.

Note that this is for illustration and YMMV depending on other income sources, capital gains, itemized deductions, etc.

There is no limit. Also, if you convert too much and it throws you into a higher tax bracket, you can reverse it (called a recharacterization) as long as you do so before your return is filed.
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Old 08-04-2017, 01:14 PM   #3
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Quote:
Originally Posted by gregory r. View Post
My queries are:
1. Am I missing anything on this concept around mitigating taxes based on zero taxable income the first two years
2. Is there a conversion dollar limit (much as there is a current contribution limit today) if one has no other taxable income or would we still be held to the annual contribution limits as if we were still working/contributing.
3. We currently have never qualified for Roths and made no sense tax wise to do back doors with our current tax rates.(not a question, just fyi)
4. If the answer to no. 2 above is yes, could we open more than one Roth and do individual conversions, I assume yes?

Any quick insights are truly appreciated.
Roth IRA and Other Roth Retirement Accounts - Fairmark.com Fairmark.com
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Old 08-04-2017, 01:15 PM   #4
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I think the best advice with Roth conversions includes:

1. Model your tax return AHEAD of time.

2. Convert into 2 or 3 different Roth IRAs (his, hers, and one more of his or her) so that recharacterization is easy.

3. There are no limits nowadays, but one can always undo a conversion by doing a recharacterization.

I have done multiple conversions and multiple recharacterizations.

Reasons to do a recharacterization:

a. Your Roth lost money after a conversion, or
b. You converted too much and put yourself in a higher tax bracket than desired, so you want to undo enough to get back into a lower tax bracket.
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Old 08-04-2017, 01:15 PM   #5
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If you truly have no taxable income, then yes you can convert as much as you want and can afford tax wise.

Now check you what your taxable $ might be earning. Do you have any Qualified or non qualified dividends? What about LTCG? While LTCG and Q-Divys are not taxable below the top of the 15% bracket, your conversion will be income that effectively sits below these and will lift them up to the 15% bracket. When they get pushed past the 15% bracket, the effective marginal rate can be higher than 15% as both the last conversion $ is taxed and the last Qdivy $ pushed above the 15% marginal bracket is taxed.

Roth conversions are typically done using after tax $ to pay the taxes. Obviously they can be done with a withdraw from the TIRA, however doing so may make such conversions less desirable.
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Old 08-04-2017, 01:24 PM   #6
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There is no conversion limit. Any amount you convert will be considered federal taxable income (as implied by pb4uski), so the only considerations are how much money is in your traditional IRAs and how much income taxes you want to pay.

You are *not* limited by earned income. So if your W-2 income is $5K you can still Roth convert $50K if you like.

You are *not* limited by the contribution limit. Contributions and conversions are completely different things with different rules.

If you are filing jointly and you each have a traditional IRA (and a Roth IRA to receive the conversion proceeds, of course), you can both do conversions in any amount you like, again subject to paying federal income tax on the total amount of conversions done.

A few other points:

1. You may also have to pay state income tax on the converted amounts.
2. Conversions need to be done by the end of the calendar year.
3. You can use something called a "recharacterization" to undo part or all of any Roth conversion that you have done. There are other rules for this, but the one key is that you can do recharacterizations any time up until your filing deadline (~April 15). This allows you to dial in your taxes.
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Old 08-05-2017, 05:33 AM   #7
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A useful technique for doing conversions to best advantage is
the Roth horse race

It is a little hassle but well worth the effort if a person is in
the position to benefit from Roth conversions anyway.
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Old 08-05-2017, 06:33 AM   #8
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Thank you all for the responses and as usual the input was extremely helpful. Questions answered. Thanks once again, what a site!!!!!!!
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Old 08-05-2017, 06:46 AM   #9
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Originally Posted by bada bing View Post
A useful technique for doing conversions to best advantage is
the Roth horse race

It is a little hassle but well worth the effort if a person is in
the position to benefit from Roth conversions anyway.
I guess one can do a tax free roth conversion is one truly has zero taxable income before standard deduction, exemption and HSA contribution (if any). I don't understand what good a re-characterization would be inn the case of truly tax free roth conversion. It would not give you lost money back, but reduce your tax bill.... but not below zero.

For me doing conversions up to the top of (at least) the 15% MB makes more sense. It is likely best to look at long term effects on taxes and MRDs to determine what is best. For me tax free now would cost a lot at MRD time.
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Old 08-05-2017, 07:45 AM   #10
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Many people mentioned to use taxable account money to pay the Roth conversion tax. I think this should best be decided by how much you paid tax for your taxable account money. If it was higher than 25%, then just withdrawing more to pay tax is better if you do not need to pay the 10% penalty.
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Old 08-05-2017, 07:49 AM   #11
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Originally Posted by bingybear View Post
I guess one can do a tax free roth conversion is one truly has zero taxable income before standard deduction, exemption and HSA contribution (if any). I don't understand what good a re-characterization would be inn the case of truly tax free roth conversion. It would not give you lost money back, but reduce your tax bill.... but not below zero.

For me doing conversions up to the top of (at least) the 15% MB makes more sense. It is likely best to look at long term effects on taxes and MRDs to determine what is best. For me tax free now would cost a lot at MRD time.
I don't think you're understanding the horse race strategy. Whichever limit you are converting up to, you convert 2X that at the start of the year. At the end of the year, you pick the winner, and recharacterize the loser. If you don't recharacterize either, you will be over the 0% or 15% barrier and be paying more in taxes. It is better to keep the winner in the Roth because the gains were untaxed. The smaller gains or even the loss go back to the tIRA. I'm trying this for the first time this year.
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Old 08-05-2017, 07:52 AM   #12
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Originally Posted by flyingaway View Post
Many people mentioned to use taxable account money to pay the Roth conversion tax. I think this should best be decided by how much you paid tax for your taxable account money. If it was higher than 25%, then just withdrawing more to pay tax is better if you do not need to pay the 10% penalty.
How can you be paying 25% out of taxable but a lower rate on the conversion?
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Old 08-05-2017, 08:31 AM   #13
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I don't think you're understanding the horse race strategy. Whichever limit you are converting up to, you convert 2X that at the start of the year. At the end of the year, you pick the winner, and recharacterize the loser. If you don't recharacterize either, you will be over the 0% or 15% barrier and be paying more in taxes. It is better to keep the winner in the Roth because the gains were untaxed. The smaller gains or even the loss go back to the tIRA. I'm trying this for the first time this year.
Yes I glossed over it a bit. I was more focused on roth conversion tax free. To help MRDs I would need to use higher numbers and thus have more stilling in taxes (or pay penalties) if I left the re-characterization until the end. I'd have to look at how much and for how long I'd have $ in tax payments for the conversion. Maybe there would be no extra tax being held (or owed) if I got an extension and did not file until the last possible date and estimated accurately. I've just not played with that aspect of taxes.
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Old 08-05-2017, 08:55 AM   #14
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Yes I glossed over it a bit. I was more focused on roth conversion tax free. To help MRDs I would need to use higher numbers and thus have more stilling in taxes (or pay penalties) if I left the re-characterization until the end. I'd have to look at how much and for how long I'd have $ in tax payments for the conversion. Maybe there would be no extra tax being held (or owed) if I got an extension and did not file until the last possible date and estimated accurately. I've just not played with that aspect of taxes.
I don't have any idea what "stilling in taxes" means and I'm kind of lost on the rest of your post, since you say your were focused on tax free and then the rest of the post is about paying taxes.
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Old 08-05-2017, 10:45 AM   #15
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How can you be paying 25% out of taxable but a lower rate on the conversion?
I assume that the money in your taxable account came from your previous salary which was taxed at 25% or higher.
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Old 08-05-2017, 11:13 AM   #16
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Many people mentioned to use taxable account money to pay the Roth conversion tax. I think this should best be decided by how much you paid tax for your taxable account money. If it was higher than 25%, then just withdrawing more to pay tax is better if you do not need to pay the 10% penalty.


If you use tIRA funds to pay the tax on Roth conversions you have two negative consequences as I see it: 1- if you are under 59.5 then you pay the penalty on the withdrawal and 2- you are depleting the pool of funds that could be converted and then growing tax free.

If you are not subject to penalty and not planning on converting all of your tIRA then it might not matter where you pay the tax from.
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Old 08-05-2017, 12:03 PM   #17
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I assume that the money in your taxable account came from your previous salary which was taxed at 25% or higher.
Well, that's already been taxed and that's over with, and now the after tax money is sitting there for you to use. Roth conversion is a new and separate transaction. I don't see how it can matter how much you paid in taxes on money in a previous transaction.

The question in my mind is whether you have enough available to use for the conversion taxes. If not, you have to look more closely at whether it's worth doing the conversion at all if you have to pay taxes out of the conversion.
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Old 08-05-2017, 12:07 PM   #18
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Put it this way. Say you won the lottery, and had to pay 39.6% on most of the winnings, no matter what. Are you saying that if you did Roth conversions, you wouldn't use the lottery winnings to pay the tax, because that money had previously been taxed at 39.6%? The two events aren't related in any way that I can see, so that doesn't make any sense to me. Nor does it make sense to make that decision no matter what your tax rate on the money was. It's just money now.
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Old 08-05-2017, 03:06 PM   #19
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To the OP: your strategy in your first few years of retirement is very similar to ours. One additional recommendation, if you are enrolled in an HSA-eligible health plan, is to contribute the maximum to the HSA. Like a standard deduction, it reduces your taxable income and allows for a greater Roth conversion amount.
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Old 08-05-2017, 03:57 PM   #20
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I don't have any idea what "stilling in taxes" means and I'm kind of lost on the rest of your post, since you say your were focused on tax free and then the rest of the post is about paying taxes.
too many thoughts.
first-
when I read the the horse race link I was more focused in the roth conversion with no tax... not the horse race part so much. So I did miss some of the finer points in the horse race.

second -
stilling should be sitting as " having $ sitting in taxes" if I were to use the horse race as I don't see small roth conversions will help MRD levels in the future to the extent that is needed in our case.

third -
I think the OP was wanting to roth convert with no taxes owed. In that case where the $ come from to pay the taxes is not relevant.

sorry for being a bit dyslexic
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