Roth Conversion/Recharacterization strategy finally sunk in

[RunningBum]

I've been whittling away at my tIRA for a few years with partial conversions, trying to smooth out my income tax rate over the years, and avoid RMDs later which would probably push me into a higher income tax, especially with more SS benefits getting taxed.

Every year I try to get the conversion amount just right, to the top of the 15% bracket or the edge of the ACA cliff. It's very tough to do since I don't know exactly what my dividends and interest income will be. But I slave to try to get it as close as possible, but every year I either fall short or have to do a small (or not-so-small) recharacterization--usually the latter.

I kept seeing posts here from people who'd convert a larger amount than they know would work, and then recharacterize after doing their taxes. I always dismissed this, thinking recharacterizations are too much trouble. But I inevitably do one anyway, so why go to all the effort.

So this year I finally wised up and converted a larger amount and I know for sure I'll be recharacterizing. It's not that big of a deal and I'm going to do it anyway, so what's the big deal with $10 or $10K on the form? I don't know if it matters but I kept it as simple as possible by converting a holding from the tIRA that I don't already have in the Roth, so I can just rechar part of that holding back. Vanguard will figure it all out anyway.

I love the things you learn here by just opening your eyes and being willing to consider doing something different. I'm going to both optimize my conversion and simplify my life by not tracking my tax situation throughout the year to try to get it perfect in advance. Rather than trying to hit the bulls-eye from a distance, I can shoot an arrow at a huge target, and draw the bulls-eye circle around it after doing taxes next spring.

Withholding taxes is a potential issue as one might have to pay estimated taxes on the worst case, but I can use safe harbor from last year.

 

[Midpack]

I love the things you learn here by just opening your eyes and being willing to consider doing something different.

+1. More a general observation, but the biggest reason I participate in this forum, and I assume many others. That and the relative civility and intelligence here vs most other forums I am a part of [-]online shouting matches I wade through 90% garbage looking for the 10% insights and pearls of wisdom[/-].

 

[zinger1457]

I'm planning on starting Roth conversions this year and probably for the next few years until I turn 62 and my pension kicks in and will likely need to recharacterize. I would expect to get a 1099-R showing the IRA distribution that was converted to a ROTH but it probably won't include the amount that was recharacterized. When you do your tax returns how do you subtract the amount that was recharacterized from what the 1099-R indicates was converted?

 

[RunningBum]

I just subtract it, making sure to use the right number. If I initially converted $25K, and recharacterize $20K many months later, Vanguard (or whoever you use) will calculate what that $20K earned in the Roth and transfer that back, but that's not the number to use. If you made 5% on the funds in that time, they will transfer $21K back, but $5.25K is left (if my math is correct). So I subtract $20K from $25K for a net $5K conversion even though the transfer back amount was more.


I think eventually you get another 1099-R that reflects the recharacterization, but it may not come for another year and you don't need to wait for it. Made me uneasy the first year but I could easily show the transaction history on the accounts if audited.

 

[Fedup]

But you also have to do amended tax return right?

 

[kaneohe]

I'm planning on starting Roth conversions this year and probably for the next few years until I turn 62 and my pension kicks in and will likely need to recharacterize. I would expect to get a 1099-R showing the IRA distribution that was converted to a ROTH but it probably won't include the amount that was recharacterized. When you do your tax returns how do you subtract the amount that was recharacterized from what the 1099-R indicates was converted?

You also attach a descriptive narrative that describes the recharacterization.

 

[RunningBum]

But you also have to do amended tax return right?

No, I'll prepare my return, see where I'm at, then play with recharacterization numbers until I get what I want. Then I'll recharacterize exactly that amount, and file my return, probably waiting to make sure the transfer goes through.

 

[Retireatee1]

I was hoping to do a Roth conversion this year, but I'm waiting to see what if any changes will be made to the tax brackets by this administration. From what I've gathered so far, the bottom of that 33% bracket could be pulled down into the "danger zone".

 

[Sunset]

I'm waiting (for this year) until the stock market tanks, and then convert in kind, so I move more shares than doing it today.
Of course I could be waiting all year only to find the market keeps going up, but that is a nice problem.

 

[user5027]

I'm waiting (for this year) until the stock market tanks, and then convert in kind, so I move more shares than doing it today.
Of course I could be waiting all year only to find the market keeps going up, but that is a nice problem.

You can do it now and if the market tanks do it again into a separate Roth and recharacterize the first one.

 

[pb4uski]

No, I'll prepare my return, see where I'm at, then play with recharacterization numbers until I get what I want. Then I'll recharacterize exactly that amount, and file my return, probably waiting to make sure the transfer goes through.

+1 I convert an amount that I think will be more than what I need in December. When I finalize my return in February or March, I determine how much we are over the top of the 15% tax bracket and recharacterize that amount. I enter the amount that was NOT recharacterized on line C3 of the 1099-R that I received for the conversion, which effectively reduces the conversion to the amount that I input (with the recharacterization being the difference). Then I do a final check that the taxable income is exactly equal to the top of the 15% tax bracket (the target in my case) and file my return. I also wait until the recharacterization is processed before filing my return.

The following year I get a 1099-R that has the amount that was recharacterized in box 1 and a R code (for recharacterization) in box 7 and put that in my subsequent year's return. Because of the R code it does not actually get included in the subsequent year return... in fact, if I didn't input it it probably would not affect the subsequent year return but it comes in automatically when I download from Vanguard.

 

[Trooper]

You also attach a descriptive narrative that describes the recharacterization.

And Form 8606 if the conversion was a partial one; i.e. not the full amount of the tIRA was converted to a Roth.

 

[NgineER]

Consider making super sized conversions while staying within your sectors and asset allocations (Roth IRA horse race). That way you can leave the sector with the best return and recharacterize the worse performing ones. That way you will only pay taxes on the highest performing sector.
Just my $0.02

 

[2017ish]

Consider making super sized conversions while staying within your sectors and asset allocations (Roth IRA horse race). That way you can leave the sector with the best return and recharacterize the worse performing ones. That way you will only pay taxes on the highest performing sector.
Just my $0.02

Good idea. OP, the horse race concept has been frequently discussed on bogleheads--here, however, is a good overview in a single blogpost at White Coat Investor's site: Roth Conversion Horse Race

 

[Trooper]

+1 I convert an amount that I think will be more than what I need in December. When I finalize my return in February or March, I determine how much we are over the top of the 15% tax bracket and recharacterize that amount. I enter the amount that was NOT recharacterized on line C3 of the 1099-R that I received for the conversion, which effectively reduces the conversion to the amount that I input (with the recharacterization being the difference). Then I do a final check that the taxable income is exactly equal to the top of the 15% tax bracket (the target in my case) and file my return. I also wait until the recharacterization is processed before filing my return.

Exactly how I transacted my first-ever tIRA => Roth conversion last December. I also plan to do more conversions in the future, as I didn't ever contribute to Roths while w*rking due to taxes.

I have a question about the accessibility of the converted money. I did some research on Bogleheads and other places and got confused. Do I need to wait for 5 years prior to withdrawing the money from the Roth? And does each annual conversion have its own 5 year waiting period? I just turned 59 this year. Thanks.

 

[Fedup]

One Roth account. As long as the account is 5 years old.

 

[RunningBum]

Good idea. OP, the horse race concept has been frequently discussed on bogleheads--here, however, is a good overview in a single blogpost at White Coat Investor's site: Roth Conversion Horse Race

I haven't gotten over the complexity of that yet, but I probably should. One in bonds and one in stocks makes really good sense. Can I open two Roths at Vanguard, or do they have to be at different places?

 

[2017ish]

I haven't gotten over the complexity of that yet, but I probably should. One in bonds and one in stocks makes really good sense. Can I open two Roths at Vanguard, or do they have to be at different places?

I believe you can open multiple Roths at Vanguard or the like without a problem. (We won't be doing big conversions until 2018 tax year, so I don't have personal knowledge yet.)

 

[user5027]

Can I open two Roths at Vanguard, or do they have to be at different places?

Yes you can open two Roths at Vanguard.

 

[RunningBum]

Thanks to both of you. It was very easy to do, and I've already done the second conversion to this new account. Not sure it's that worthwhile as my final conversion for 2017 is likely to be around $5K, but it seems like a risk free way to invest in equities or whatever I want.

 

[kaneohe]

......................
I have a question about the accessibility of the converted money. I did some research on Bogleheads and other places and got confused. Do I need to wait for 5 years prior to withdrawing the money from the Roth? And does each annual conversion have its own 5 year waiting period? I just turned 59 this year. Thanks.

check out this useful table by kawill of the fairmark.com site:
Fairmark Forum :: Retirement Savings and Benefits :: Roth early withdrawal question

Each conversion has its own 5 yr clock......however note at 59.5, the clock changes from conversion clock to age of the oldest Roth (even if you don't have it anymore) . At that point the only thing you have to worry about is tax on earnings which come out last.

 

[2017ish]

check out this useful table by kawill of the fairmark.com site:
Fairmark Forum :: Retirement Savings and Benefits :: Roth early withdrawal question

Each conversion has its own 5 yr clock......however note at 59.5, the clock changes from conversion clock to age of the oldest Roth (even if you don't have it anymore) . At that point the only thing you have to worry about is tax on earnings which come out last.

If you are over 59.5 and your oldest Roth is more than 5 years old, you don't owe taxes on earnings either, I believe. From your link:

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

All Distributions Are Qualified

No Taxes
No Penalties

There is a lot of detail in this kitces article on the two 5 year clocks and the impact of age 59.5: https://www.kitces.com/blog/underst...s-for-roth-ira-contributions-and-conversions/

(We converted a nominal amount each at ages 53 & 54 for this reason; just in case we need to tap Roths for some currently inexplicable reason)

 

[Trooper]

If you are over 59.5 and your oldest Roth is more than 5 years old, you don't owe taxes on earnings either, I believe. From your link:



There is a lot of detail in this kitces article on the two 5 year clocks and the impact of age 59.5: https://www.kitces.com/blog/underst...s-for-roth-ira-contributions-and-conversions/

(We converted a nominal amount each at ages 53 & 54 for this reason; just in case we need to tap Roths for some currently inexplicable reason)

Thanks kaneohe and 2017ish. After reading both links I still feel I don't have a definitive answer for my particular situation.

I first thought my conversions would carry a single 5 year clock, starting with the date in which the Roth account was initially opened. However Kitces says:

Unlike the 5-year rule for contributions, in the case of conversions, each conversion amount has its own 5-year time period (Treasury Regulation 1.408A-6, Q&A-5(c)), and thus with multiple conversions there may be multiple different 5-year periods underway at once.

Perhaps it would help if I detailed my prior/planned transactions below:

Nov 2016 - Created Roth IRA (my first and only) with Vanguard
Dec 2016 - Performed a partial conversion from my Vanguard tIRA to the Roth IRA.
Feb 2017 - Partially recharacterized above conversion to fit into 15% bracket
Aug 2017 - I will turn 59 1/2
Dec 2017 - I will perform a partial conversion of my Vanguard tIRA to the same Roth IRA.
Dec 2018 - I will perform a partial conversion of my Vanguard tIRA to the same Roth IRA.
Dec 2019 - I will perform a partial conversion of my Vanguard tIRA to the same Roth IRA.
Dec 2020 - I will perform a partial conversion of my Vanguard tIRA to the same Roth IRA.

My question is: Starting in January 2021, am I able to withdraw any/all Roth monies (although I don't plan on needing to) tax-free and penalty-free, on both conversion principal and income earned, since I have satisfied the 5 year waiting period on the Vanguard Roth account?

Thanks again

 

[zinger1457]

I believe the Treasury Regulation you referenced (1.408A-6, Q&A-5(c)) deals with taking distributions from a ROTH before 59.5. Since you will be over 59.5 when you start taking distributions from your ROTH that wouldn't apply.

 

[kaneohe]

One of the beauties of the kawill table is that somebody else has worried about it and has distilled the wisdom into a few words....compare that to the article you are citing which has several orders of magnitude (or more) words more and it still doesn't cover taxable vs. non-taxable conversion plus more words = more opportunity for confusing those trying to learn. Try creating such a table or flow chart sometime and you will appreciate the skill/knowledge involved in creating something of few words but much wisdom.
**************************************************
The relevant section since you will be > 59.5:

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
************************************************
You now only have to worry about whether your oldest Roth is 5 yrs old or not.
Man on the street would say no since 5 yrs from Nov 2016 is Nov 2021. However due to the peculiar thinking of the creators (you may wish to verify),
the month goes back to January of the yr you created it. .......so , yes, in Jan 2021 no more taxes/penalty on any withdrawals......that is the last section of the chart applies and all distributions are qualified.

Note that the clock changes from a conversion clock on each conversion in the first half of the chart (age < 59.5) to a single clock on age of oldest Roth
in the second half of chart (age > 59/5).