Roth Conversion Newbie with a question on taxes

[Octogirl]

Roth conversion

Thanks pb4uski and others for advice here on a plan to move money out of our tIRA's before RMDs hit.- 6 years for us.

2019 is my last year of full time work and 401 K contributions.
So in 2020, we 'll determine our conversion chart -



Another thought - although we are both in good health, if either of us dies before 70.5, the remaining spouse would be hit with heavier taxes on RMD - So tIRA conversion is also a protective mechanism - just in case.



Thanks again

 

[SecondCor521]

Thanks for this idea, NgineER - I will have to review my contributions and do some research on what is considered a "contribution". Back in 2010 I think the IRS offered a one-time chance to spread taxes on any conversions over two years, so I converted the entire amount of an old IRA at that time. I will be honest and say I didn't really understand what I was doing at the time -- probably it was a bad choice, but it's water under the bridge now. Not sure if that conversion amount counts as a "contribution" that can be withdrawn. If so, your idea could help, although the total amount of contributions into that account would not be enough to cover all our expenses without either doing some kind of SEPP or selling stock from the brokerage.

Definitely something to think about!

The basics:

Contributions and conversions are two different things. Contributions are whatever you put in. Conversions are when you move money from a traditional to a Roth.

Your Roth consists of three parts: contributions, conversions, and earnings. When you withdraw from your Roth, the IRS deems that it comes from contributions first (oldest to most recent), conversions (again, oldest to most recent), and earnings last.

For Roths: Contributions can generally be withdrawn tax and penalty free. Conversions can be withdrawn tax and penalty free as long as the conversion was done five tax years ago or more. Earnings can be withdrawn tax and penalty free only after age 59.5.

So its probable that your 2010 conversion would be tax and penalty free when withdrawn, but you'd be deemed to withdraw your contributions first.

See Form 8606 and instructions.

 

[SevenUp]

I ran the numbers for my taxes from 55 to dead. This interesting chart popped out:<snip>

Instead of "taxes paid" you might plot "spendable amount after tax."

When comparing traditional vs. Roth (or converting now vs. converting later), it's the tax rate one pays, rather than the amount of tax, that affects how much you get to spend.

E.g., look at a 22% tax rate now vs. a 12% tax rate later, and the investment doubling in that time. One can pay 22% * X now, or 12% * X * 2 later. Total tax higher in the latter case, but so is the spendable amount remaining.

 

[Bruno]

The basics:

For Roths: Contributions can generally be withdrawn tax and penalty free. Conversions can be withdrawn tax and penalty free as long as the conversion was done five tax years ago or more. Earnings can be withdrawn tax and penalty free only after age 59.5.

If you do a Roth conversion in 2020 you have to wait 5 years to sale any of the earnings? It was my understanding you only had to be in a Roth for 5 years before selling any of it.

 

[SecondCor521]

If you do a Roth conversion in 2020 you have to wait 5 years to sale any of the earnings? It was my understanding you only had to be in a Roth for 5 years before selling any of it.

Let's use proper terminology. You can buy or sell anything anytime inside the Roth without any tax or penalties. Withdrawing refers to removing money from the Roth.

If you do a Roth conversion of $20K in 2020, you can withdraw $20K from your Roth tax and penalty free on January 1, 2024 (five tax years is 2020 + 2021 + 2022 + 2023 + 2024). You will pay ordinary income taxes on the conversion in 2020. If the value of that $20K investment has gone up to $25K, for example, then the additional $5K is treated as belonging the third category (earnings).

Again, the IRS doesn't care what goes on inside the Roth. It's a black box as far as they're concerned in terms of investments / stocks / bonds / interest / dividends / whatever. They simply don't care. When one talks about contributions, and conversions, and withdrawals, the IRS only cares about dollar amounts and in which tax years those things took place.

You can withdraw contributions any time from a Roth without any penalty or taxes. Note that the IRS treats your withdrawals as being all contributions first, then conversions, then earnings last. You don't get to pick and choose. But that order is what most people would probably choose anyway, as it is the most tax advantageous.

 

[corn18]

This has always saved me when I get cornfused about Roth withdrawals:

ORDER OF DISTRIBUTIONS

Regular contributions
Taxable portion of first conversion
Nontaxable portion of first conversion
Each subsequent conversion, in order, with the taxable portion coming out first for each conversion
Earnings (any increase in value occurring inside the Roth IRA)

TAXES AND PENALTIES

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)*
Earnings: Tax-Yes; Penalty-No*

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

All Distributions Are Qualified*

No Taxes*
No Penalties*

 

[Bruno]

This has always saved me when I get confused about Roth withdrawals: Old and so much to learn. I just retired this year and trying to figure out if i needed to do a conversion next year.


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

All Distributions Are Qualified*

No Taxes*
No Penalties*

This is where i would fit in. Thanks for posting this...Bruno

 

[corn18]

I just made a spreadsheet with retirement spending and withdrawals from 56-90 and it was interesting to see the relationship between early conversions and the effect on my taxable account. Turns out I need to do conversions before 70 otherwise my taxable account is depleted pretty early on. Not a big deal because I have Roth accounts, but it will be good to convert to the top of the 12%/15% bracket and draw down the taxable to cover the difference and have some leftover. Leaves us with lots of options. Once SS hits @ 70, we don't need any more withdrawals, so that is good.

 

[corn18]

Well, I updated my RMD conversion spreadsheet to include 2% real growth. Wow, that changed things a lot.

Looks like I can do 100% to the top of the 12%/15% bracket from 55-70 and do just fine.

 

[imnontrad]

The money from a pre-tax retirement account, whether withdrawn for use or for Roth conversion is taxed as regular income.
the tax rate right now is expected to go up in a few years. So that, and time, is in your favor for converting to Rot.
Also, you want to time your pre-tax retirement account withdrawals based on a long term strategy to prevent any increases when you reach RMD plus you want to reduce the possibility of higher Medicare premium costs. Fore a married couple, they need to also look at the projected income each year to stay below 85K modified AGI so when one spouse dies, the surviving spouse will not have increased Medicare premiums.

 

[indiajust]

Sounds about right to me. Just remember to let it sit for 5 years after the last conversion tax year. No touch.

 

[Jim in PA]

Quote from CORN18
OVER AGE 59.5*
FIVE YEARS OR MORE SINCE OPENING FIRST ROTH IRA*

All Distributions Are Qualified*

No Taxes*
No Penalties*

———————
Quote from
SECONDCOR521
For Roths: Contributions can generally be withdrawn tax and penalty free. Conversions can be withdrawn tax and penalty free as long as the conversion was done five tax years ago or more. Earnings can be withdrawn tax and penalty free only after age 59.5.
———————
These two points seem to be in conflict for me.
I’m well over 59.5 and my Roth is well over 5 years old.
I’ve been converting pretty aggressively to Roth. If I end up needing more of the Roth money than I expect, do I need to consider a five-year clock running on each conversion? That’s what Secondcor’s post suggests, while Corn18’s post says that it’s all tax and penalty free.

 

[SecondCor521]

Quote from CORN18
OVER AGE 59.5*
FIVE YEARS OR MORE SINCE OPENING FIRST ROTH IRA*

All Distributions Are Qualified*

No Taxes*
No Penalties*

———————
Quote from
SECONDCOR521
For Roths: Contributions can generally be withdrawn tax and penalty free. Conversions can be withdrawn tax and penalty free as long as the conversion was done five tax years ago or more. Earnings can be withdrawn tax and penalty free only after age 59.5.
———————
These two points seem to be in conflict for me.
I’m well over 59.5 and my Roth is well over 5 years old.
I’ve been converting pretty aggressively to Roth. If I end up needing more of the Roth money than I expect, do I need to consider a five-year clock running on each conversion? That’s what Secondcor’s post suggests, while Corn18’s post says that it’s all tax and penalty free.

If you pay attention to my posts, you'll find that I'm not always precise or complete, and frequently I'll make comments that are true only for my particular situation (I'm 50).

The five year rule for conversions only applies before age 59.5. After 59.5, you can withdraw tax and penalty free any amount from a Roth as long as you've had a Roth for more than 5 years. So Corn's quote is more precise than mine.