Roth conversion for dummies

[pb4uski]

Quote:

Originally Posted by Truckinalong My situation Retire in a couple years. Roll company 401k into IRA. Bond fund income from taxable fund $30G a year, but need $50G to live. Plan is to convert $20G IRA to Roth IRA per year to obtain said $50G. That should then be $50G in income as I see it for ACA purposes?

Yes, $50k of income for ACA... $30k bond interest and $20k Roth conversion.

However, Roth conversions don't give you money to live on... it just transfers $20k from your tIRA pocket to your Roth IRA pocket. But you can probably get that extra $20k you need for spending from redemptions of your taxable portfolio.

As an aside, you might want to look at how your portfolio is positioned for tax efficiency.... having bonds in a taxable portfolio is very tax inefficient... especially if it means that as a result you end up with equities in yout tIRA which effectively converts qualified dividend income and long-term capital gains that is taxed at preferential rates into ordinary income that is subject to higher tax rates.... but that is a whole different discussion.

[Truckinalong]

I have taxable in muni bond fund (VWAHX) now to manage high tax bracket while working. That said, I am in at a good cost basis and will likely just keep it and live off interest plus principal reductions before 59.5. Convert just enough IRA to roth each year to manage ACA income while IRA balance continues to grow and tap that when 59.5. Overall it all shakes out to about a 50/50 allocation.

Is it most efficient, probably not, but seems to work for me and my risk tolerance.

[pb4uski]

Thanks for the clarification.... munis make sense... not taxed but counts for ACA... wasn't clear before.... sounds like you are on top of it.

[SevenUp]

Quote:

Originally Posted by bobbyr 1. Can I do roth conversion from 401k (first create IRA in Vanguard and roll 401k to it, then start doing conversions?) or do I have to move money to EJ?

No need to move money to EJ. May not need to use the 401k->tIRA step. Our Megacorp 401k with Fidelity allows directs 401k->Roth IRA conversions.

Quote:

1a. If answer to 1 is yes, do I convert just the amount I want to roll over each year? (I think fees are a bit higher if I move out of 401k into ira with vanguard)

Yes, the marginal tax rate you will pay on the conversion (including ACA and/or IRMAA effects) should guide your conversion amount.

Quote:

2. I have been reading about cost basis. Let's say I need my income to be below $50k/yr for health care considerations, that would mean I could convert $20k per year for the next 3 years?

https://thefinancebuff.com/tax-calcu...e-subsidy.html describes a tool that should be useful for you regarding this (and, for that matter, the generic marginal tax rate calculation).

Quote:

3. Would I convert $20k exactly or would Vanguard or EJ provide me an adjusted amount based on cost basis?

That will be your choice - don't expect a broker to do those calculations for you.


I'll pass on #4....

[SecondCor521]

Quote:

Originally Posted by bobbyr 4. My wife is 5 yrs younger, so that would be five more years of keeping income low for her marketplace considerations I assume. Wondering if we should stop filing jointly at that point, so I could have a really low cost health option for her from the marketplace. Maybe I could hold off converting her traditional until this time and just focus on my conversions until I am 65.

Emphasis added.

This is not workable plan. If you file separately, your wife would not be eligible for an ACA subsidy, per:

https://www.healthinsurance.org/faqs...hange-subsidy/

[bobbyr]

Quote:

Originally Posted by SecondCor521 Emphasis added. This is not workable plan. If you file separately, your wife would not be eligible for an ACA subsidy, per: https://www.healthinsurance.org/faqs...hange-subsidy/

Thank you

"the rules are clear that married couples must file a joint tax return in order to qualify for subsidies in the exchanges."

[2retireearly]

Quote:

Originally Posted by RunningBum A 401K->tIRA rollover does not result in a tax hit. It's fine to do all of this at once. The tIRA->Roth conversion is fully taxable, at regular income rates. Nowhere did the OP or anyone else suggest they do this all at once though.

And the tax is based on your entire taxable income for that year. So many people only convert a portion of the trad Ira to a Roth at a time, due to big taxes. Or...many don't do this conversion at all.

[sengsational]

Not to discount any of the intricate chess game that this stuff is, but even if you play a "perfect game", it's not going to make a really huge difference in your ability to spend or gift. A measurable difference, yes. Worth the trouble, probably. But, for example, moving from an income tax state to a non-income tax state (all else equal, which it never is, but if it were), would probably have a much larger impact than converting perfectly versus not converting. The i-orp modeling tool lets you turn off and on Roth conversions. The model isn't perfect, but can give you an idea about the magnitude of savings.

[BigMoneyJim]

Quote:

Originally Posted by RunningBum I think I've heard of some that have a mix of tax-deferred and post-tax, but I don't know all the answers to that so I'm only answering the basic case.

Not related to OP's situation, but I somehow had some Roth 401k funds mixed in one of my Fidelity-held 401ks, and I just rolled it into IRAs. I had to open both a rollover IRA and a Roth, and they sorted it all out in the rollover.

[FIREarly]

Something to look into that might have already been discussed (did not read all of the pages of info) is a Roth Conversion Ladder. I am a rookie to this concept and might do it for the first time this year. It is to convert tIRA to Roth IRA (there is a max AROUND $17,500/year) and no taxes when staying within the limits. I believe this is one way to reach the triple tax savings of putting money in tax free, growing tax free, and converting within the limits so the money is taken out tax free from a Roth IRA.

You are talking about a 401k and not sure the process to moving your money to tIRA initially. There MIGHT be some kind of 401k Conversion Ladder (complete guess) or if you can move from 401k to tIRA and then tIRA to Roth IRA to avoid taxes.

This is all thoughts that have not been attempted yet. I am still growing investment/retirement income and studying for new certifications to increase income (to invest/save more).

Hope this provides you some added information to legally get your money tax free.

[SevenUp]

Quote:

Originally Posted by FIREarly It is to convert tIRA to Roth IRA (there is a max AROUND $17,500/year) and no taxes when staying within the limits.

There is no IRS-imposed limit on tIRA to Roth IRA conversions.

If you are trying to pay no federal tax, the sum of conversions plus all other ordinary income must stay below your standard deduction amount.

If you want to convert up to some marginal tax rate, that is also doable.

[whatnot]

It was my understanding that taxes need to be paid on the amount withdrawn from the 401k and converted to the Roth.

[RunningBum]

Quote:

Originally Posted by whatnot It was my understanding that taxes need to be paid on the amount withdrawn from the 401k and converted to the Roth.

Your understanding is correct. Technically you have to roll the 401K over to an IRA first. That is not a taxable event. Then you can convert as little or as much as you want. That is a taxable event. FIREarly is glossing over or ignoring that.

5 years after each conversion you can access that money penalty and tax-free, even if you are under 59.5. That's the ladder part. You convert some every year, and you withdraw from the conversion you did 5 years prior. But you have a 5 year starting gap, plus whatever taxes you owe on the conversion.

[RetireBy90]

Coup,e items to consider, if wife is 5 years younger, I would start with converting your tIRA and 401K first, then wife’s as she has additional 5 years to convert before RMDs.

Second, if your 401K has costs or investments that you wanted to keep, check with administrator to see if they have a Roth 401K and if they allow conversions. My old company had 401K administered by Fidelity that had a Roth option.

[SevenUp]

Quote:

Originally Posted by RunningBum Technically you have to roll the 401K over to an IRA first.

Not necessarily. E.g., Megacorp's 401k allows partial withdrawals and Fidelity is happy to send those directly to a Roth IRA.

And yes, a 1099-R will be issued to document that amount of taxable income.

[Animorph]

Quote:

Originally Posted by SevenUp Not necessarily. E.g., Megacorp's 401k allows partial withdrawals and Fidelity is happy to send those directly to a Roth IRA. And yes, a 1099-R will be issued to document that amount of taxable income.

Yep. I rolled over some of DW's mixed 401k/Roth 401k to her Roth IRA. Megacorp wouldn't split them up at the time. I chose the Roth IRA because I didn't want Roth funds inside a tIRA, though Fidelity did say they would split it any way I wanted. And I was going to Roth convert at least that much anyway. The paperwork all worked out correctly. I only paid taxes on the non-Roth portion. That's not to say Megacorp might not allow that somehow, but it is OK with the IRS.

[bobbyr]

Quote:

Originally Posted by RunningBum Your understanding is correct. Technically you have to roll the 401K over to an IRA first. That is not a taxable event. Then you can convert as little or as much as you want. That is a taxable event. FIREarly is glossing over or ignoring that. 5 years after each conversion you can access that money penalty and tax-free, even if you are under 59.5. That's the ladder part. You convert some every year, and you withdraw from the conversion you did 5 years prior. But you have a 5 year starting gap, plus whatever taxes you owe on the conversion.

thanks, this helps

[RetireBy90]

Just to better understand,

Quote:

5 years after each conversion you can access that money penalty and tax-free, even if you are under 59.5. That's the ladder part. You convert some every year, and you withdraw from the conversion you did 5 years prior. But you have a 5 year starting gap, plus whatever taxes you owe on the conversion.

My understanding is that the 5 year clock starts when you open your first Roth IRA. So if you were to open a Roth today, and add funds (contribute or convert) in 2025 you could withdraw any or all funds without any tax or penalty.

Others can confirm or correct my understanding.

[RunningBum]

Quote:

Originally Posted by RetireBy90 Just to better understand, My understanding is that the 5 year clock starts when you open your first Roth IRA. So if you were to open a Roth today, and add funds (contribute or convert) in 2025 you could withdraw any or all funds without any tax or penalty. Others can confirm or correct my understanding.

https://www.investopedia.com/ask/ans...ra-conversions

Quote:

Each conversion has its own five-year period. For instance, if you converted your traditional IRA to a Roth IRA in 2018, the five-year period for those converted assets began Jan. 1, 2018. If you later convert other traditional IRA assets to a Roth IRA in 2019, the five-year period for those assets begins Jan. 1, 2019.

[kaneohe]

This table by kawill from the fairmark.com site may help clarify:
There are 2 types of 5 yr clocks. When you are < 59.5
y.o., the clocks are on conversions. Each conversion has its own clock and within each conversion there may be tax/non-taxable parts of the conversion. The ordering rules say that contributions are withdrawn first, followed by conversion (oldest first and within each conversion, the taxable amount is first), and then finally earnings............like like the order in the table.

After 59.5, a different 5 yr clock comes into play........the age of the first Roth ever opened.

Re: Roth IRA Rules - Table Approach
Posted by: KAWill (IP Logged)
Date: October 14, 2010 11:57PM


Roth IRA Distribution Table

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD NOT MET

Contributions: Tax-No; Penalty-No
Conversions: Tax-No; Penalty-Yes (Taxable Portion)
Conversions: Tax-No ;Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-Yes

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD MET

Contributions: Tax-No; Penalty-No
Conversions: Tax-No; Penalty-No (Taxable Portion)
Conversions: Tax-No; Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-Yes

OVER AGE 59.5
LESS THAN FIVE YEARS SINCE OPENING FIRST ROTH IRA

Contributions: Tax-No ;Penalty-No
Conversions: Tax-No; Penalty-No (Taxable Portion)
Conversions: Tax-No; Penalty-No (Nontaxable Portion)
Earni :x ngs: Tax-Yes; Penalty-No

OVER AGE 59.5
FIVE YEARS OR MORE SINCE OPENING FIRST ROTH IRA

All Distributions Are Qualified