Roth conversion question

[Plantman]

If a person can convert all of their traditional IRA to their Roth IRA over time without paying any taxes, are there any considerations why one would not want to do that? Is having all your IRA funds in a Roth the ultimate goal or is there a better solution?

 

[SecondCor521]

First, the premise is questionable.

While a person might be able to avoid federal income tax on Roth conversions, there are quite often other effects. Conversions always add to AGI, and AGI is a key figure in determining a lot of other things, such as ACA subsidy amounts, eligibility for other credits (such as EIC, CTC, AOTC, and others). Conversions might push otherwise 0%-bracket capital gains into the 15% bracket. Federal AGI is often the starting point for state income taxes, so conversions are often taxable at the state level.

Second, yes, there are other considerations.

Funds left in a traditional IRA can be left to charity at zero tax cost. If the traditional IRA balance is small enough, QCDs can completely eliminate the taxation of RMDs. QCDs are also better than traditional Schedule A charitable deductions.

Some people intend to use their traditional IRA as a form of LTC insurance, figuring that withdrawals used for medical expenses (above the 7.5% of AGI and itemized deduction floors) will be lightly taxed.

There are some exceptions to the penalties for early withdrawal from traditional IRAs. Keeping funds in a traditional IRA may appeal for that reason.

Some people are concerned that Roth IRAs may eventually be taxed somehow. This is a potential risk because Roth conversions are usually made based on the assumption that all future Roth withdrawals will be tax free.

As for your second question, I don't think of it as an ultimate "goal" to Roth convert all of my traditional IRA. I view annual partial conversions as a way to hopefully reduce my lifetime tax bill and end up with more after-tax wealth for me and my children. I basically figure out what my maximum marginal rate will be between now and about age 83, then each year I convert up to the point where my current year marginal rate would exceed that number. For this analysis, I try to include all of the tax effects mentioned in the first paragraph above.

 

[Time2]

Under what conditions can "a person can convert all of their traditional IRA to their Roth IRA over time without paying any taxes" "
I'm sure not in that, box, boat, container, bracket!

How is that done?

 

[FlaGator]

Substantial outside losses from a business would be one way.

 

[Time2]

I have to wonder if the OP has a misunderstanding of of the Roth conversion rules. Plantman, can you give us some more detail?

 

[CRLLS]

Given the hypothetical premise of a no-tax conversion, I don't think there is a downside to converting. However, be very sure that that can be accomplished without being taxed, or affecting IRMMA, or ACA subsidy, or .......

It might be a good situation for a paying professional expert for confirmation of your plan instead of SGOTI.

 

[Time2]

It might be a good situation for a paying professional expert for confirmation of your plan instead of SGOTI.

Hey, I resemble that remark!

 

[Sunset]

OP - Please tell us HOW you think you can convert IRA to Roth taxfree.

I can see it if the IRA is very tiny and you have zero income, otherwise I'm concerned you are being sold/told something by some sales person/advisor that is false.

 

[Time2]

OP - Please tell us HOW you think you can convert IRA to Roth taxfree.

I can see it if the IRA is very tiny and you have zero income, otherwise I'm concerned you are being sold/told something by some sales person/advisor that is false.

Inquiring minds want to know!

 

[RunningBum]

First, the premise is questionable.

While a person might be able to avoid federal income tax on Roth conversions, there are quite often other effects. Conversions always add to AGI, and AGI is a key figure in determining a lot of other things, such as ACA subsidy amounts, eligibility for other credits (such as EIC, CTC, AOTC, and others). Conversions might push otherwise 0%-bracket capital gains into the 15% bracket. Federal AGI is often the starting point for state income taxes, so conversions are often taxable at the state level.

Second, yes, there are other considerations.

Funds left in a traditional IRA can be left to charity at zero tax cost. If the traditional IRA balance is small enough, QCDs can completely eliminate the taxation of RMDs. QCDs are also better than traditional Schedule A charitable deductions.

Some people intend to use their traditional IRA as a form of LTC insurance, figuring that withdrawals used for medical expenses (above the 7.5% of AGI and itemized deduction floors) will be lightly taxed.

There are some exceptions to the penalties for early withdrawal from traditional IRAs. Keeping funds in a traditional IRA may appeal for that reason.

Some people are concerned that Roth IRAs may eventually be taxed somehow. This is a potential risk because Roth conversions are usually made based on the assumption that all future Roth withdrawals will be tax free.

As for your second question, I don't think of it as an ultimate "goal" to Roth convert all of my traditional IRA. I view annual partial conversions as a way to hopefully reduce my lifetime tax bill and end up with more after-tax wealth for me and my children. I basically figure out what my maximum marginal rate will be between now and about age 83, then each year I convert up to the point where my current year marginal rate would exceed that number. For this analysis, I try to include all of the tax effects mentioned in the first paragraph above.

Oh, come on!

I'll give you the first part. We don't know the mechanism the OP has for being able to convert with no taxes, but it may raise the MAGI to undesirable levels.

The rest though? Don't convert tax free because you might be able to take RMDs tax free, give it away with QCDs or write off medical expenses with? If one is able to convert tax free to begin with, why take the chance of getting taxed later? You can do charitable donations with appreciated stock (most easily done with a DAF), and you can write off medical expenses with appreciated stock sales. And if there's ever a notion of taking Roths, people will just withdraw from the Roth before it passes, so there's no sense in trying to tax Roths.

 

[Plantman]

Here's where I am at. We file jointly. Age 66. DW 71. Both collecting SSA. 24000 conversion keeps us at 0 taxes. SSA pretty much covers our expenses and if not I take from the Roth.

 

[SecondCor521]

Under what conditions can "a person can convert all of their traditional IRA to their Roth IRA over time without paying any taxes" "
I'm sure not in that, box, boat, container, bracket!

How is that done?

It could be done in very limited circumstances:

1. Convert only up to the standard deduction amount.
2. Live in a no-income tax state or in a state which does not tax Roth conversions.
3. Not be on the ACA, or be on the part of the FPL spectrum where the PTC is not affected.
4. Not have kids in college, or have an AGI such that Pell Grants and other federal aid are not affected (#1 would probably take care of this actually)

Also a consideration but technically not required for a zero tax scenario:

5. Not care about, or not be eligible for, any of the low-income tax credits such as the EITC and the retirement savings contribution credit.

6. One would also likely either need a very low cost of living, or be living off of savings or gifts or government assistance or an inheritance.

 

[SecondCor521]

The rest though? Don't convert tax free because you might be able to take RMDs tax free, give it away with QCDs or write off medical expenses with? If one is able to convert tax free to begin with, why take the chance of getting taxed later? You can do charitable donations with appreciated stock (most easily done with a DAF), and you can write off medical expenses with appreciated stock sales. And if there's ever a notion of taking Roths, people will just withdraw from the Roth before it passes, so there's no sense in trying to tax Roths.

I wasn't making the argument for any of the things I listed. I was just answering the OP's question which was asking about considerations that might apply.

I also did not say that the things I listed were the only way or even the best way to do things, so your response above seems to be reading something into what I wrote that isn't there.

...

As a side note, it's my understanding that you cannot do RMDs or QCDs into a DAF. I also don't understand your comment about "writing off medical expenses with appreciated stock sales" - the two are not particularly related as far as I can see offhand.

 

[Sunset]

Here's where I am at. We file jointly. Age 66. DW 71. Both collecting SSA. 24000 conversion keeps us at 0 taxes. SSA pretty much covers our expenses and if not I take from the Roth.

Then do your conversions, spreading it out over some years would work.

Remember enough income pushes the SS into a taxable level, if SS is low enough it's not taxable. If your income tax filing status is married-filing jointly and your combined income is over $32,000 then 50% of your Social Security benefits received during the tax year becomes part of your taxable income. At some point 85% of SS becomes taxable as income goes up.

I will say, if a person retired needs to take from the Roth now and then, in a year when that is going happen, taking from the IRA and doing less conversion is the same effect tax wise.

 

[RunningBum]

Here's where I am at. We file jointly. Age 66. DW 71. Both collecting SSA. 24000 conversion keeps us at 0 taxes. SSA pretty much covers our expenses and if not I take from the Roth.

Consider state taxes too. If they are 0 as well, yes, I would do the conversions. If not 0, it still probably is since you'd most likely pay the same state tax with RMDs, but I'd run the calculations to make sure.

 

[captain3d]

Rental property paper losses, no pensions yet etc make it possible to convert $50k chunks per year and stay on full ACA subsidy.

 

[RunningBum]

I wasn't making the argument for any of the things I listed. I was just answering the OP's question which was asking about considerations that might apply.

I also did not say that the things I listed were the only way or even the best way to do things, so your response above seems to be reading something into what I wrote that isn't there.

...

As a side note, it's my understanding that you cannot do RMDs or QCDs into a DAF. I also don't understand your comment about "writing off medical expenses with appreciated stock sales" - the two are not particularly related as far as I can see offhand.

Those things don't make any sense if the OP can convert with 0 taxes, so why bring them up for consideration? That's my point. If you think it's useful to give considerations that clearly don't give them any benefit is worthwhile, we'll just disagree.

I was not talking about doing RMDs or QCDs into a DAF, though you certainly could do RMDs into a DAF, after paying the taxes. I was talking about an alternative for someone who fully converted their tIRA, that they could donate appreciated taxable funds into a DAF (or directly to a charity) and still get some tax benefit, if one was needed.

Similarly, if one has major medical expenses later in life and no IRA, they could sell some of those appreciated funds and the income from that could be used to write off the medical expenses. This is my plan. I like it better than leaving an IRA balance (since I believe I can fully convert my tIRA at a favorable total tax cost, or at least come very close), because I don't know if I'll ever have those expenses, and I may have RMDs for many years before I might have those expenses.

 

[SecondCor521]

@RB: I have not quoted parts of your reply. I agree with, or at least understand, the parts that I have left out.

Those things don't make any sense if the OP can convert with 0 taxes, so why bring them up for consideration? That's my point. If you think it's useful to give considerations that clearly don't give them any benefit is worthwhile, we'll just disagree.

Well, as the Spartans famously said, "If."

Yes, if the OP can convert with zero taxes, then the considerations I listed may be moot.

I think the situations where actually doing so are quite limited, so I hope the OP will reconsider the premise.

If they do and decide that converting with zero taxes isn't actually possible for them, then the considerations I listed might then become important.

I guess I'm fairly confident that OP will figure out that it's not actually zero tax impact for them.

And even if it does turn out to be zero tax impact for OP, there are other people who are reading this thread for which my comments may be relevant. I write for the world, my friend.

Similarly, if one has major medical expenses later in life and no IRA, they could sell some of those appreciated funds and the income from that could be used to write off the medical expenses.

Emphasis added. I still don't fully understand.

Selling appreciated funds does create income.

One can deduct medical expenses beyond 7.5% of AGI, and also subject to the usual limitation that itemization would need to make sense.

But selling appreciated funds is also generally going to increase AGI. This is generally going to increase the 7.5% of AGI limitation and is generally going to reduce the amount of the medical expense deduction.

If you mean that you're going to use the proceeds from the sales of the appreciated funds to pay the medical expenses, then sure, that makes sense.

 

[Plantman]

I appreciate all the responses. Not only for my particular situation but covering others for those who may have had the same type of questions regarding IRA accounts.

 

[RunningBum]

Emphasis added. I still don't fully understand.

Selling appreciated funds does create income.

One can deduct medical expenses beyond 7.5% of AGI, and also subject to the usual limitation that itemization would need to make sense.

But selling appreciated funds is also generally going to increase AGI. This is generally going to increase the 7.5% of AGI limitation and is generally going to reduce the amount of the medical expense deduction.

If you mean that you're going to use the proceeds from the sales of the appreciated funds to pay the medical expenses, then sure, that makes sense.

You said earlier:

Some people intend to use their traditional IRA as a form of LTC insurance, figuring that withdrawals used for medical expenses (above the 7.5% of AGI and itemized deduction floors) will be lightly taxed.

I am looking to sell appreciated funds for the same purpose, if needed. My way has the advantage that only the gains from the proceeds are taxable income, counting as part of the 7.5%, though using capital gains income may not be as efficient overall as regular income from an IRA distribution.

 

[Harris4crna]

Rental property paper losses, no pensions yet etc make it possible to convert $50k chunks per year and stay on full ACA subsidy.

Planned to make conversions, but yes, that pension gets in the way. Wife and I will be in the 24% tax bracket until the day we die unless of course they change the tax bracket, which they will. Perhaps there is a way.

 

[SecondCor521]

I am looking to sell appreciated funds for the same purpose, if needed. My way has the advantage that only the gains from the proceeds are taxable income, counting as part of the 7.5%, though using capital gains income may not be as efficient overall as regular income from an IRA distribution.

Ah, gotcha. Thanks for the clarification.

 

[copyright1997reloaded]

It could be done in very limited circumstances:

1. Convert only up to the standard deduction amount.
2. Live in a no-income tax state or in a state which does not tax Roth conversions.
3. Not be on the ACA, or be on the part of the FPL spectrum where the PTC is not affected.
4. Not have kids in college, or have an AGI such that Pell Grants and other federal aid are not affected (#1 would probably take care of this actually)

Also a consideration but technically not required for a zero tax scenario:

5. Not care about, or not be eligible for, any of the low-income tax credits such as the EITC and the retirement savings contribution credit.

6. One would also likely either need a very low cost of living, or be living off of savings or gifts or government assistance or an inheritance.

#2 is giving me about 126,000 reasons to leave NY and move to PA (no tax on IRA withdraws/conversions) or FL/TN/... (no state income tax).

 

[SecondCor521]

#2 is giving me about 126,000 reasons to leave NY and move to PA (no tax on IRA withdraws/conversions) or FL/TN/... (no state income tax).

Check the inheritance taxes before choosing PA (or anywhere else, actually, but it seems PA is pretty awful from what I can surmise).

 

[EastWest Gal]

Check the inheritance taxes before choosing PA (or anywhere else, actually, but it seems PA is pretty awful from what I can surmise).

Pennsylvania has an inheritance tax. However, for a spouse, it is zero, and for direct descendants it is 4.5%. For siblings it’s 12% and all others it’s 15%. If 90% of the tax is paid within 3 months of death, there is a discount of 5%. Our state income tax is a flat 3.07% and SS and IRA withdrawals, including Roth conversions after age 59-1/2 are not taxed at all. Farm land and equipment are excluded from our inheritance tax.

To me that does not seem draconian, especially since New York’s lowest tax rate is 4%. Also…you can’t take it with you. It’s free money to your heirs. And a little bit to the state.

I started doing Roth conversions at age 61, and my inherited IRA withdrawals are no longer taxed by the state.