Roth conversion for non-retirement taxable accounts idea

[Animorph]

This probably doesn't apply to many, but seems like a neat trick if it does. If you have taxable accounts you are not allocating to retirement, you may be able to convert them into Roth accounts.

Our situation:
DW and I hold individual taxable accounts that are not included in my retirement calculations. We can spend them as we like. Probably additional travel at 4% withdrawals per year and the balance available for LTC self insurance.

We'll convert traditional IRA/401k accounts to Roth for our retirement savings as long as the taxable retirement accounts hold out (living expenses plus conversion taxes). Staying under the next tax bracket of course.

When our taxable retirement account funds run out we'll be withdrawing from the traditional IRA/401k up to the tax bracket and supplementing with the Roth funds. We'll still have a few years of this before both RMD's hit and we'll have to withdraw more than we want and exceed the target tax bracket for good.

Here's my thought for the day:
During those normal IRA/401k withdrawal years I'm going to characterize the withdrawal amounts as a Roth conversion instead. We'll use our individual taxable accounts to replace the converted amounts, so it's a wash as far as retirement funding is concerned. The new Roth amounts will be held in new individual accounts for DW and I, effectively transferring some of our taxable individual savings into Roth accounts.

So we will have taken non-retirement taxable funds and converted them to non-taxable Roth accounts, still for our individual use. Seems like a nice way to save taxes if you have non-retirement cash and above-RMD IRA/401k withdrawals and don't mind Roth accounts.

 

[Spooky]

We'll use our individual taxable accounts to replace the converted amounts, so it's a wash as far as retirement funding is concerned.

Hi, I'm new here and definitely am not an expert, so I don't quite understand the part above. Are you replacing the money that was converted from a traditional IRA into the Roth IRA? Are you planning on still working at that point? I thought you had to have earned income to make any IRA contributions.

 

[devans0]

Converting existing IRA money is different than putting in new money by the new rules and is now allowed as I understand my reading. I plan on doing the same thing in a few years.

 

[kaneohe]

When our taxable retirement account funds run out we'll be withdrawing from the traditional IRA/401k up to the tax bracket and supplementing with the Roth funds. We'll still have a few years of this before both RMD's hit and we'll have to withdraw more than we want and exceed the target tax bracket for good.

Here's my thought for the day:
During those normal IRA/401k withdrawal years I'm going to characterize the withdrawal amounts as a Roth conversion instead. We'll use our individual taxable accounts to replace the converted amounts, so it's a wash as far as retirement funding is concerned. The new Roth amounts will be held in new individual accounts for DW and I, effectively transferring some of our taxable individual savings into Roth accounts.

So we will have taken non-retirement taxable funds and converted them to non-taxable Roth accounts, still for our individual use. Seems like a nice way to save taxes if you have non-retirement cash and above-RMD IRA/401k withdrawals and don't mind Roth accounts.

I must confess that I've read/re-read this OP multiple times and still am not getting it........I don't see what you mean about saving taxes........aren't you doing a Roth conversion and having to pay taxes on that conversion? Whether that conversion makes sense or not.......doesn't that depend on your tax rate when you do that conversion vs what it would be if you hadn't done the conversion and withdrawn the funds from the TIRA instead? Are you saying that if you don't do the Roth conversion, your RMDs would drive your tax bracket higher than they would be if you converted the funds earlier to a Roth? That would make sense to me.

Or are you saying you will convert the RMDs to a Roth? (can't do that)

Or maybe , you're saying something else and it's too late from my brain to understand

 

[Animorph]

I must confess that I've read/re-read this OP multiple times and still am not getting it........I don't see what you mean about saving taxes....

I'm talking about having money not included in our retirement plan (our personal investment accounts), that I had never considered as a source of funds to support Roth conversion. By converting some of that money we avoid taxes on future dividends and capital gains for the converted amounts.

For example, an emergency fund held in a taxable account could be moved to a Roth account by characterizing any IRA withdrawals in excess of RMD as a conversion.

Another example is receiving an inheritance not already in an IRA. If you have some IRA/401k withdrawals that exceed the RMD, you could move some of the inheritance into a Roth. No change in current taxes, but new funds placed in the Roth are free from future taxes.

Any time IRA/401k withdrawals exceed RMD's you should be looking for any taxable accounts you can convert into a Roth.

 

[Independent]

Like kaneohe, I'm having trouble (even after post #5). Can you give some sample numbers at various ages?

 

[RunningBum]

My understanding is that the OP has money in the following piles:
1) taxable account not needed for retirement
2) taxable account needed for retirement
3) IRA/401K needed for retirement
4) Roth IRA needed for retirement

Pile 1 is used for non-essentials, like travel, hobbies, etc. It's a way of keeping track of how much can be spent on these extra activities.

At some point, pile 2 is used up for living expenses. Pile 3 is used, but since that generates taxable income, pile 4 may be used as well to keep out of a higher tax bracket.

Instead of just spending pile 3, he's going to convert that amount to his Roth IRA, and take from pile 1 to make up for it.

So in essence I think he's creating another pile: Roth IRA money that is not needed for retirement.

I think this is essentially the same as combining piles 1 & 2 and spending from that until it is gone, and also converting the IRA/401K to Roth up to the top of the 15% bracket every year. The difference is in budgeting, and knowing what you have as "extra" money vs. what you need for living expenses. Is that right? I just include the extras in my yearly budget and combine piles 1 & 2.

One place I get lost was the part about moving from an emergency fund to a Roth. You've just lost some of your emergency fund.

I figured pile 1 was a "fun money" fund, and you are essentially moving it from a taxable account to a Roth.

That bolded part in post 5 is really confusing because you can't convert taxable accounts to a Roth, but I understand that this is just his accounting. In his books, he's spending from the IRA and converting from the taxable "extra" account. In reality, he's spending from the taxable account and converting from the IRA, because that's what the IRS allows.

I also think that bolded part is mis-focused because I think you should simply look for tax-advantaged opportunities to convert from an IRA to a Roth, which for many of us is converting up to the top of the 15% bracket. If for some reason you were in the 35% bracket and also had to withdraw from your IRA, you shouldn't also be converting into a Roth that year. And whether it exceeds RMD or not doesn't seem to be relevant.

Let me know if I've misread this. I don't think there is any real magic; I think you've just made it more complicated by the extra pile, but it works out the same.

 

[Alan]

I've done what OP is suggesting.

I had a taxable fund that was put aside for LTC, and I put money into it every year. With the new Roth conversion rules, I've re-characterized the some of my tIRA money to a Roth and continue to put into it each year by recharacterizing some IRA money. The old taxable fund is now a part of my RE investments.

 

[Animorph]

RunningBum:
Mostly close enough. My wife and I have individual "fun money" accounts I don't include in retirement calcs except as a backup plan. So I hadn't considered a Roth conversion using those funds, which I should have. Emergency funds were simply another likely taxable account that might not have been considered to enable Roth conversion. No reason you can't leave it in short term investments within the Roth account, available any time as long as you are old enough.

...
I also think that bolded part is mis-focused because I think you should simply look for tax-advantaged opportunities to convert from an IRA to a Roth, which for many of us is converting up to the top of the 15% bracket. If for some reason you were in the 35% bracket and also had to withdraw from your IRA, you shouldn't also be converting into a Roth that year. And whether it exceeds RMD or not doesn't seem to be relevant.

Let me know if I've misread this. I don't think there is any real magic; I think you've just made it more complicated by the extra pile, but it works out the same.

I'm doing the conversion up to the tax bracket early on. However there are a few years where our taxable accounts allocated for retirement are depleted and we're living off of straight IRA/401k withdrawals, but don't have RMD's to worry about yet. In this situation it doesn't matter what the tax bracket is, we will be making the withdrawal anyway. I'll be looking at any sources of taxable funds at that point and effectively converting them to Roth's, even if they're not intended for retirement.

My old thinking:
Taxable retirement account balance $0
IRA $ -> retirement expenses
Taxable Fun money -> Taxable fun money (not part of retirement plan)

New thinking:
IRA -> Roth Fun money account (conversion into a new Roth account)
Taxable Fun money $ -> retirement expenses

Probably not worth this long of a discussion, but not something I had thought of before.

 

[RunningBum]

Ahh, gotcha on the emergency funds, they are available to you from whichever acct you want once you're able to withdraw from IRAs.

 

[kaneohe]

Animorph......thanks for your clarification. I don't have any bucket or piles so I got confused. Just seems to me that if you can justify doing a Roth conversion, it doesn't matter if it's taxable A or taxable B funds....they're the same old green stuff........except....don't forget you have 5 yr clocks on the conversion or else the earnings are taxable.

 

[Koolau]

This is all WAY too complicated for my pea sized brain. But, having said that, I've been the cheer leader for converting as much TIRA money as possible to ROTH and paying the taxes out of the "extra" money you have sitting around. In this way, a portion of your "extra" money becomes Roth IRA money. i.e., You essentially end up with a "bigger" Roth IRA than your TIRA (because you get to keep all of it when you take it out). The "price" for this step up in value is the taxes you have to come up with. Obviously, there are a bunch of factors involved when one makes such a conversion (tax brackets now and later are probably the biggest).

I guess my thinking has most to do with assuming tax RATES will only go up. The sooner I pay the taxes on my TIRA money, the less likely I'll have to pay a higher rate. Of course, I could be wrong. I was once. And, hey, YMMV.

 

[LOL!]

The explanation above is complicated. Let me simplify it:

Keep converting tIRA money to Roth IRA every year when you can and when it makes tax sense. It doesn't matter if one is taking a RMD or not --- even though the RMD withdrawal is NOT a conversion.

In any event, it is premature to think too hard about this since RMD-time is a long way off. One also has to remember that there is a 0% tax bracket that you have to fill up every year for the rest of your life. If you convert ALL your tIRA/401(k) to a Roth IRA early at a 15% or 25% or other tax rate, you may end up paying too much taxes. During RMD-time, you can say that some of your RMD is taxed at 0% as it fills up the 0% tax bracket. This may not hold true if you get a pension because you might say your pension filled up the 0% tax bracket.

 

[Independent]

Okay, got it. The key is that you've mentally built buckets.

I think you hit it on the head with this comment "No reason you can't leave it [emergency fund] in short term investments within the Roth account, available any time as long as you are old enough."

Lots of people don't think of that.