Roth conversion for dummies

[bobbyr]

I have some basic questions about Roth conversions, which I have never done (conversions). Thank you in advance for simple responses to a not financially savvy individual.

I turn 62 soon, retired about a year ago. I have IRA (traditional and roth) with Edward Jones (20% of our retirement savings). Wife has roth account (10% of our retirement savings) with vanguard and the rest in Vanguard 401k. I like the vanguard low fees of course.

We've been on COBRA for the last year and it runs out Nov 30. As I look at marketplace, I think I need my income to be low, so as to not get too hammered on health care expense as I bridge the gap to medicare.

We have generous HSAs from company buyout, but would like to maintain HSA balance past 65 to pay for supplemental insurance out of it. A cheaper marketplace selection would enable that. The company retirement option is not affordable. (I opted for COBRA because it was simple and the cost was a little under $1k/mo for both of us.)

Our current retirement income is low. Pension is about $20k/yr. Rental is $24k but much lower with various depreciations and expenses. Otherwise living on cash when needed. So our current income is let's say $30k.

My questions are:

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?

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)

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?

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

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

Thank you

 

[lordjust]

I have some basic questions about Roth conversions, which I have never done (conversions). Thank you in advance for simple responses to a not financially savvy individual.

I turn 62 soon, retired about a year ago. I have IRA (traditional and roth) with Edward Jones (20% of our retirement savings). Wife has roth account (10% of our retirement savings) with vanguard and the rest in Vanguard 401k. I like the vanguard low fees of course.

We've been on COBRA for the last year and it runs out Nov 30. As I look at marketplace, I think I need my income to be low, so as to not get too hammered on health care expense as I bridge the gap to medicare.

We have generous HSAs from company buyout, but would like to maintain HSA balance past 65 to pay for supplemental insurance out of it. A cheaper marketplace selection would enable that. The company retirement option is not affordable. (I opted for COBRA because it was simple and the cost was a little under $1k/mo for both of us.)

Our current retirement income is low. Pension is about $20k/yr. Rental is $24k but much lower with various depreciations and expenses. Otherwise living on cash when needed. So our current income is let's say $30k.

My questions are:

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?

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)

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?

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

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

Thank you

I am interested in this thread as well... I believe you will run into an issue (pro-rata) if you convert your entire 401k to a IRA in one shot with the intent of moving parts of it to a Roth. I will wait to let the experts chime in on this one.

 

[RunningBum]

I'm assuming you have a traditional tax-deferred 401K. 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.

1. I believe you do have to roll your 401K to a tIRA before converting. I rolled all of mine at once. Unless you have some great investment in your 401K that you can't get to in a tIRA, I don't see why you wouldn't do this. I would roll it all to Vanguard to avoid EJ fees, but that's up to you.

2. Cost basis doesn't apply. It doesn't matter how much of your 401K was contributed and how much of it is growth or dividends.

3. You would convert exactly what you want to convert. Neither VG nor EJ would make any adjustments.

Be careful. If you go $1 over the subsidy cliff, you will get $0 in subsidies. Now that we can do conversion recharacterizations, most of us leave a safety buffer. Especially in your first year when you may find something you didn't consider.

4. I don't know the aspects of a younger spouse. Hopefully someone else will respond on this.

 

[camfused]

I believe you are going to take a large tax hit if you try to do this all at once, and that will mess up your ACA subsidy qualification.

Interesting thread to me, since I have the same desire, and the same problems.

This is a fairly easy to understand guide: https://www.nerdwallet.com/blog/investing/backdoor-roth-ira-high-income-how-to-guide/ Pay attention to the bad idea section at the bottom.

 

[bobbyr]

I'm assuming you have a traditional tax-deferred 401K. 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.

1. I believe you do have to roll your 401K to a tIRA before converting. I rolled all of mine at once. Unless you have some great investment in your 401K that you can't get to in a tIRA, I don't see why you wouldn't do this. I would roll it all to Vanguard to avoid EJ fees, but that's up to you.

yes traditional 401k, tax deferred. I am not sure why i didn't roll it over initially, I think I was focused on having to roll it over to EJ (with their fees). I assume the roll over is no tax implications...not sure if the fees are different for tIRA with vanguard vs company 401k (that may be why I didn't roll it over)

Thank you

 

[bobbyr]

I believe you are going to take a large tax hit if you try to do this all at once, and that will mess up your ACA subsidy qualification.

Interesting thread to me, since I have the same desire, and the same problems.

This is a fairly easy to understand guide: https://www.nerdwallet.com/blog/investing/backdoor-roth-ira-high-income-how-to-guide/ Pay attention to the bad idea section at the bottom.

great link, thanks for providing

 

[Dash man]

A bit off topic, but why are you still with EJ since you know their fees are too high?

 

[zinger1457]

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

Should read up on the Modified Adjusted Gross Income (MAGI) calculation for the ACA subsidy, there are quite a few threads here discussing it. MAGI for ACA purposes is based on 'household income', I don't believe it makes any difference what filing status you use.

 

[pb4uski]

What I would consider is backing onto the amount of Roth conversions that will still get you a subsidy. The ceiling for subsidies is 400% of the federl poverty level in income, which is ~$69k for 2020. Then subtract the sources of income that you have with no Roth conversions.... so if that is $30k you could do as much as $39k of Roth conversions.

IMPORTANT: The way the subsidies work if you are under 400% FPL then you get them but if you are over 400% FPL then they are $0.... aka as the "cliff"... you don't want to have some unexpected income on your tax return that causes you to fall off the cliff and end up owing a bunch in tax because you had just a little extra income... so undershoot in your estimations.

Also, since the subsidies are based on income there is a tradeoff between Roth conversions and lost subsidies... you'll probably need to do a number of scenarios to figure out where your sweet spot is.

 

[mountainsoft]

I have IRA (traditional and roth) with Edward Jones (20% of our retirement savings). Wife has roth account (10% of our retirement savings) with vanguard and the rest in Vanguard 401k. I like the vanguard low fees of course.

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?

Personally, I would move all the accounts to Vanguard equivalents. That will make conversions easier, and it will be easier to manage if everything is in one location.

As long as the money goes directly from Edward Jones to Vanguard you won't pay any taxes.

https://investor.vanguard.com/401k-rollover/how-to-roll-over

So our current income is let's say $30k.

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

If your income is $30K and you want to stay under $50K for health care, I would probably convert less than $20K to be safe. Maybe 15K to 17K to give you a little wiggle room. Worst case you might have to do an additional year of Roth conversions.

Ideally, you should pay the taxes on the Roth conversion from taxable savings and not from the IRA balance.

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

I would probably start converting whichever account has the lowest balance. That way you would be able to eliminate one of the traditional IRA's sooner. Otherwise, I don't think it matters which account you convert first. You could even convert a little of each traditional IRA if you wish, as long as the total is less than the $20K you are trying to stay under.

You could get a joint family marketplace plan until you start Medicare. Then your wife could get a single marketplace plan until she can get Medicare.

 

[RetireAge50]

Our situation is close to yours as we have about 36k in income with our pensions currently. We also have cash available and deferred accounts (401k, IRA’s, etc.).
In our case we have not done any Roth conversions. Although we are well under the “cliff” the slope of the hill before the “cliff” is very steep (marginal rate close to 27%).

 

[BrianB]

Also keep in mind that before you reach the "cliff" at 400% FPL, subsidies are reduced as your income increases (and Roth conversions are "income").

As you near the cliff, the reduction is about $100 per $1000 of income, so I consider it a 10% tax. Adding that to your marginal income tax rate makes conversions less compelling.

We are resigned to waiting until we are off the ACA system and on Medicare to do conversions. YMMV.

 

[RunningBum]

I believe you are going to take a large tax hit if you try to do this all at once, and that will mess up your ACA subsidy qualification.

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.

 

[Sunset]

OP - I'm also going to say you NEED to move your EJ account to Vanguard.
Phone Vanguard and tell them you want to open an account and move your EJ accounts there. They will walk you through it and you will save a TON of money over the years.

Then you can move your 401K to Vanguard IRA, again phone them and they will walk you through it.

Vanguard as you know has no fee's for having an account there.

 

[camfused]

I could be mistaken, but I thought the EJ takes money off the top as your put it into your accounts. Once it is in there, they do not skim any more. Is that not right?

 

[RunningBum]

Also keep in mind that before you reach the "cliff" at 400% FPL, subsidies are reduced as your income increases (and Roth conversions are "income").

As you near the cliff, the reduction is about $100 per $1000 of income, so I consider it a 10% tax. Adding that to your marginal income tax rate makes conversions less compelling.

We are resigned to waiting until we are off the ACA system and on Medicare to do conversions. YMMV.

This is all correct. However, some people (myself included) find it's worthwhile to do partial conversions anyway, because the tax rate once SS and RMDs start are going to increase by more than 10%. Another factor for married couples is that if one passes, the other is now taxed at the single rate.

You are also correct that the window when you get off ACA (age 65) and before RMDs (72) is a sweet spot for conversion. There's even more room for 5 years if you defer SS to age 70. Then the question becomes whether you can convert all you want to in that window, or if you would be better off converting some earlier.

The standard YMMV that you included is very true here. What works for one person may not work well for another. I'm not sure it's even possible to know with certainty what is best. I take my best educated estimate and go with that. If I'm off a little, it's probably only costing me a few % on a small amount (other than falling off the ACA subsidy cliff), so I'm not going to worry about that. Each year I see if anything is different which would change my plan, but usually (for me) there's nothing.

 

[pb4uski]

I could be mistaken, but I thought the EJ takes money off the top as your put it into your accounts. Once it is in there, they do not skim any more. Is that not right?

Not if your money ends up in their proprietary high-fee funds or ETFs.... in that case, the hits just keep on coming.

 

[camfused]

^^^ Good to know, thanks

 

[Sunset]

I could be mistaken, but I thought the EJ takes money off the top as your put it into your accounts. Once it is in there, they do not skim any more. Is that not right?

No.
I don't have an EJ account.
However, I know they charge fee's beyond any front end load.
This is on top of the fees that the mutual funds charge which vary (edited)

Example: for IRA accounts they charge $40 if you manage it yourself.
Then if you have something that does reinvestment of dividends, they take 2% of that money plus the normal transaction fee.

Now how easy is it to slip into their Investment Advisory status ? I don't know , but they charge extra for that like many brokerages do.

https://www.edwardjones.com/images/ira-schedule-of-fees.pdf

 

[bobbyr]

OP - I'm also going to say you NEED to move your EJ account to Vanguard.
Phone Vanguard and tell them you want to open an account and move your EJ accounts there. They will walk you through it and you will save a TON of money over the years.

Then you can move your 401K to Vanguard IRA, again phone them and they will walk you through it.

Vanguard as you know has no fee's for having an account there.

I have used my advisor a fair amount for consultation and have a sense of loyalty with her (explaining why i haven't moved) including advice related to my mother's LTC insurance and several other items where I have enlisted her help... I know I can get a lot of the advice I get through other means (like here), but I just like having that person if I need her. For me it is some peace of mind that I feel is worth the fee.

BTW, I actually did move my wifes roth (10% of our portfolio) from EJ and explained to her I wanted to compare performance against fees...I left it in Vanguard. I just haven't move my own $s over.

Thank you for your input

 

[Truckinalong]

"You’ll need the money in five years or less. Money converted from an IRA to a Roth IRA falls under a Roth five-year rule: If you don’t wait five years to withdraw it, you could owe taxes and a 10% penalty."

This throws a kink in my plan I think? I planned on pulling plug in a couple years. I intended to manage ACA subsidies with rolling my 401K to IRA and converting to Roth and using roth distributions as my income in combination with some bond fund income.

This makes it sound like I would need to wait 5 years and the income I generate alone from bond fund would kick me to medicaid?

 

[RetireBy90]

I would probably start converting whichever account has the lowest balance. That way you would be able to eliminate one of the traditional IRA's sooner. Otherwise, I don't think it matters which account you convert first. You could even convert a little of each traditional IRA if you wish, as long as the total is less than the $20K you are trying to stay under.

I would suggest you convert your IRA first as wife has 5 years without RMDs after yours. That is, if I remember your 62, you have 10 years to convert and wife has 15 years. Of course you would need to consider total amounts in each tIRA and if you plan to have all IRA/401K funds converted by age 72.

 

[Dash man]

I have used my advisor a fair amount for consultation and have a sense of loyalty with her (explaining why i haven't moved) including advice related to my mother's LTC insurance and several other items where I have enlisted her help... I know I can get a lot of the advice I get through other means (like here), but I just like having that person if I need her. For me it is some peace of mind that I feel is worth the fee.

BTW, I actually did move my wifes roth (10% of our portfolio) from EJ and explained to her I wanted to compare performance against fees...I left it in Vanguard. I just haven't move my own $s over.

Thank you for your input

My sister-in-law had EJ and was paying 1.65% annual fees not counting load fees on the mutual funds. Schwab or Fidelity will give you the same advice for half that fee if you need your hand held.

 

[lordjust]

Our situation is close to yours as we have about 36k in income with our pensions currently. We also have cash available and deferred accounts (401k, IRA’s, etc.).
In our case we have not done any Roth conversions. Although we are well under the “cliff” the slope of the hill before the “cliff” is very steep (marginal rate close to 27%).

Wouldnt RetireAge50's situation of multiple IRA's fall under the prorata rule i mentioned?

Assuming you have an existing tIRA with $5k and you then move your 401k into a second tIRA. Doesnt this affect your Roth conversion ? This is why i expressed concern regarding the full conversion of a 401k into a tIRA for the future purpose of a back door Roth. Or are others not discussing this because OP didnt mention other IRAs existing?

This appears to apply based on the "mind the rules section"

https://www.nerdwallet.com/blog/investing/backdoor-roth-ira-high-income-how-to-guide/

So wouldnt the OP want to shift a small percentage of his 401k to a tIRA and then move it to a Roth once per year?

I may be muddying the waters a bit with two different circumstances but others may find this applicable for the Roth conversions.

 

[bobbyr]

Personally, I would move all the accounts to Vanguard equivalents. That will make conversions easier, and it will be easier to manage if everything is in one location.

As long as the money goes directly from Edward Jones to Vanguard you won't pay any taxes.

https://investor.vanguard.com/401k-rollover/how-to-roll-over

thanks, with so many people suggesting this, I am leaning towards making that move

If your income is $30K and you want to stay under $50K for health care, I would probably convert less than $20K to be safe. Maybe 15K to 17K to give you a little wiggle room. Worst case you might have to do an additional year of Roth conversions.

good advice

Ideally, you should pay the taxes on the Roth conversion from taxable savings and not from the IRA balance.

agree, that's the plan

You could get a joint family marketplace plan until you start Medicare. Then your wife could get a single marketplace plan until she can get Medicare.

i am pretty uneducated on the marketplace options, going to study that soon