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Roth Conversion
Old 05-23-2019, 12:01 PM   #1
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Roth Conversion

Hello All
Attended mtg and topic was Roth Conversion. The argument that taxes will have to go up cause of the ever increasing deficit makes sense to me. If that's true, doing Roth conversion for our TSP and regular IRAs seems to make sense. A little painful but makes sense

Am I missing something?

Kannon
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Old 05-23-2019, 12:14 PM   #2
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Future tax rates (future anything, really) is anyone's guess.

It is true the US has both a deficit (annual) and a debt (cumulative). If, how, and when that addressed in the future is, again, anyone's guess.

Roth conversions create taxable unearned ordinary income in the year in which you do the conversion. If you think your rates are going to be higher in the future AND you expect to live for a while AND EITHER your TSP/IRA beneficiaries are also in a similar or higher bracket OR you're more focused on your own situation rather than your combined (you plus beneficiaries) situation AND you are confident that the government won't change the rules on Roths being entirely after tax - there are rumblings of taxing Roths from time to time (*) - THEN it probably makes sense to some degree.

Several people do Roth conversions up to the top of the 12% bracket, and some even go to 22%. At 22% and beyond it becomes more situational.

(*) As an example, I would guess that some of the current proposals for annual wealth taxes would include Roth IRA balances in the calculations. As another example, they are talking about limiting stretch IRAs, which I assume would also apply to inherited Roths.
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Old 05-23-2019, 01:04 PM   #3
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Before the last tax cut, I would've guessed taxes would go up rather than down, and I obviously was wrong. This cut is set to expire in 2025. It may be made permanent, but I really can't see them going lower. However, if the tax model was switched to more of a consumption tax, then income taxes could possibly be dropped, so it's impossible to be certain. Make your best assumption, hedge your bets if you feel the need, and make the best choices you can with that.

Whether to do Roth conversions needs to be examined for YOUR specific case. If you're still working and making decent money, it may not make sense to convert now. Many of us early retirees have a window where we've stopped working and are not yet forced into taking RMDs are receiving SS or pensions, and we chip away at the tIRA with conversions during these years. If you think your tax rate will be higher with RMDs due to SS benefits, pensions, or just tax rate increases, it favors doing some conversions now. Probably not all at once. 2Cor is right that your heirs' tax situation may also be a factor.

Regarding Roths being taxed, I haven't heard anything about that. If there is a wealth tax, I'd rather have it based on post-tax (Roth) money rather than higher pre-tax (tIRA) money. I just can't see them changing the rules entirely and taxing Roth withdrawals after taxing the conversion. That would kind of be like taxing the proceeds on a stock trade rather than the gains, IMO.

Regarding taxing conversion taxes being painful, I never feel that. I look at my tIRA and I see a deferred tax expense still to be paid. If I convert, I'm just paying off that expense I'll eventually have. In a way it's kind of like a mortgage. You have this big principal balance you'll eventually have to pay off. If you decide to pay it off all at once, or in big chunks, of course it has an impact but it also gets that debt off your back for good. Just pay it off in a way that makes sense. For Roth conversions, don't convert at a 32% tax rate if you could be paying 22% later.
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Old 05-24-2019, 03:44 PM   #4
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A key focus is the inheritance part of the Roth IRA

Before recent rules change discussion, I was hoping that inherited Roth IRAs could be stretched so that the kids could benefit from longer deferred status and hopefully keep to a lower marginal tax bracket (vice a lump sum distribution).

Am I correct that traditional IRAs and 401ks would have to be taken out within 5 years? That would favor the Roth IRA.
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Old 05-24-2019, 04:46 PM   #5
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Quote:
Originally Posted by kannon View Post
A key focus is the inheritance part of the Roth IRA

Before recent rules change discussion, I was hoping that inherited Roth IRAs could be stretched so that the kids could benefit from longer deferred status and hopefully keep to a lower marginal tax bracket (vice a lump sum distribution).

Am I correct that traditional IRAs and 401ks would have to be taken out within 5 years? That would favor the Roth IRA.
Well we need to see what the text finally says if or when it gets enacted into law.

Under current rules, both traditional and Roth IRAs can be stretched over the beneficiary's lifetime (assuming the beneficiary is a person who is not a spouse, and a few other criteria).

I don't think the proposed laws treats traditional and Roth IRAs any differently, but I could be mistaken.

In other words, as far as stretching goes, I don't think the Roth has any advantage over the traditional under either the current or proposed rules.
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Old 05-24-2019, 10:40 PM   #6
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IMO speculating on tax rates decades from now is ... pure speculation, no matter how big a case you think you can build for one result or another.
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Old 05-24-2019, 10:54 PM   #7
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Quote:
Originally Posted by kannon View Post
A key focus is the inheritance part of the Roth IRA

Before recent rules change discussion, I was hoping that inherited Roth IRAs could be stretched so that the kids could benefit from longer deferred status and hopefully keep to a lower marginal tax bracket (vice a lump sum distribution).

Am I correct that traditional IRAs and 401ks would have to be taken out within 5 years? That would favor the Roth IRA.
If that law passes, it could end up being inherited (not spouse) has to withdraw in 5 or 10 years.

You could also focus on non-retirement stock holdings, currently upon death they get stepped up basis, meaning no capital gain when selling all $300K of them, as an example.
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Old 11-16-2019, 06:35 PM   #8
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Old thread, new question.

Based upon my pension, SS and other investment income, I am at the top of my tax bracket. So my next earned dollar will be taxed in the next bracket. I do not see my basic income changing much for the foreseeable future.

I am a 2+ years away from my tIRA RMD. I am not in need of this money and once converted, it will all be taxed at the next level as it will be a new income stream. If I convert now, the tax will be the same percent but I will be able to move the money to a Roth. In my understanding of using an online Roth calculator conversion, suggests a break even scenario. Having said that, I am not sure I am using the calculator correctly.

Converting the funds and paying the taxes does not pose a financial burden. However it seems wise to invest the FUTURE RMD (taking money out of my IRA) into a Roth today since taxes will be the same, when I am required to withdraw the RMD. That makes sense to me but the calculator is making me feel I am missing something.

If you have some thoughts about this, it would be appreciated. If you need more information to provide feedback, let me know.

Thanks
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Old 11-16-2019, 06:44 PM   #9
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Generally speaking, one cannot reinvest / convert RMD's into Roths. RMD's can be reinvested in a taxable account if not consumed. If you have earned income, that changes the scenario a bit. But it more of a mental game rather than a real financial move. Use the income to live on and contribute RMD's to Roth vs live off the RMD and contribute earned income to the Roth. same - same.
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Old 11-16-2019, 07:00 PM   #10
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Generally speaking, one cannot reinvest / convert RMD's into Roths. RMD's can be reinvested in a taxable account if not consumed. If you have earned income, that changes the scenario a bit. But it more of a mental game rather than a real financial move. Use the income to live on and contribute RMD's to Roth vs live off the RMD and contribute earned income to the Roth. same - same.
Thanks CRLLS, based on your response I made a correction to my post, The 'RMD' I was referring was the future RMD. Right now, I am very young, 2+ years under the 70.5 RMD. But, I understand the confusion of referring to the RMD in my original post.

My IRA withdrawal will be similar and maybe even more than my future RMD as I am thinking of transferring money from the tira to the Roth to the top of the tax bracket.

Thanks for your reply.
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Old 11-16-2019, 09:13 PM   #11
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davef, will the taxes be paid with taxable money or from tax-deferred money (IRA withdrawal or part of the conversion)?
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Old 11-16-2019, 10:37 PM   #12
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[QUOTE=pb4uski;2325891]davef, will the taxes be paid with taxable money or from tax-deferred money (IRA withdrawal or part of the conversion)?[/

I saw on another post that the best approach would be to pay with taxable money. But, I would be interested in your thoughts. I can manage the payment either way. Thanks
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Old 11-16-2019, 11:45 PM   #13
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[QUOTE=davef;2325907]
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Originally Posted by pb4uski View Post
davef, will the taxes be paid with taxable money or from tax-deferred money (IRA withdrawal or part of the conversion)?[/

I saw on another post that the best approach would be to pay with taxable money. But, I would be interested in your thoughts. I can manage the payment either way. Thanks
Yes paying the tax from taxable is beneficial because you are putting more in the Roth where gains are tax free compared to leaving the funds in taxable where the gains are taxable. You can do some simple examples that illustrate this.

Suppose you have 100K in TIRA and are in 22% bracket and will be in the same bracket when you withdraw funds from TIRA.

1) Leave funds in TIRA. After some yrs, the TIRA doubles to 200K. Withdraw the funds and pay 22% tax (44K) and you end up with 156K.
2) Withdraw 100K from TIRA. Pay 22% tax (22K) from the from the withdrawal and you end up w/ 78K to convert to Roth. After some yrs, this doubles to 156K ...........the same as in 1) where you left it in TIRA.

Now suppose you have 22K in taxable acct and the 100K TIRA.
3)Convert TIRA to Roth. Pay tax from TIRA withdrawal as in 2) above. You end up with 78K in Roth and still have the 22K in taxable. After some yrs,
they both double.........The Roth to 156K and taxable to 44K. The taxable account after paying 15% tax on the gain (22K)= 44K - 3.3K for a total of
200 - 3.3K.

4)You convert TIRA to Roth and pay tax from the taxable account leaving you
with 100K in the Roth and 0 in taxable. After some yrs, the Roth doubles to 200K. You are ahead of 3) by 3.3K. Of course, if your situation is that LTCGs are taxed at 0%, then there will be no difference between 3) & 4).

You can change the tax rates to fit your situation. The conclusions should be the same.
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Old 11-17-2019, 06:45 AM   #14
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Alternatively, if you pay Roth conversion taxes from the IRA, then future RMD's will be lower due to the lower amount left in the IRA. Further, if one of you were to pass on, filing single will certainly require higher taxes on those same RMD's. For me, it is not a one answer fits all. Last year I converted using IRA money up to the 12% tax bracket. I am thinking about increasing that this year. I have 2 more years left before RMD's begin.

BTW, there is nothing preventing you from doing a Roth conversion after RMD's begin. You just can't convert the RMD amount to Roth. You can however use that RMD money to pay the taxes on other money converted.
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Old 11-17-2019, 07:22 AM   #15
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Originally Posted by davef View Post
..... If I convert now, the tax will be the same percent but I will be able to move the money to a Roth. In my understanding of using an online Roth calculator conversion, suggests a break even scenario. Having said that, I am not sure I am using the calculator correctly.

Converting the funds and paying the taxes does not pose a financial burden. However it seems wise to invest the FUTURE RMD (taking money out of my IRA) into a Roth today since taxes will be the same, when I am required to withdraw the RMD. That makes sense to me but the calculator is making me feel I am missing something.

If you have some thoughts about this, it would be appreciated. If you need more information to provide feedback, let me know.

Thanks
If the tax rate will be the same whether you convert now or RMD later then the financial benefits are minimal... essentially the benefit is tax-free growth on the taxable account money used to pay the tax.

For example, say you have $10,000 in an IRA and $2,000 in a taxable account and the tax rate now or later will be 20% and over 5 years investments double.

If you convert, you'll end up with $10,000 in the Roth and $0 in taxable and in 5 years the Roth is worth $20,000.

If you don't convert, then the $10,000 in the IRA doubles to $20,000 with a $4,000 tax bill attached to it and the $2,000 in the taxable only grows to $3,508... it doesn't double because the growth in the taxable is taxed each year... so if you withdraw at the end of 5 years you only have $19,508.

The $492 advantage of the Roth conversion is essentially the taxes that would have been paid on the taxable account money if you didn't convert and was avoided because the tax money ended up in the Roth.

Another thing to consider is that if you are married and one of you passes that your tax rat on RMDs will be a lot higher so it is better to convert while you are in a lower rate.
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