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01-01-2012, 07:33 PM
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#21
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Thinks s/he gets paid by the post
Join Date: Mar 2004
Posts: 3,433
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Quote:
Originally Posted by Alan
DW also has a SEP-IRA plus a roll-over IRA from her old company that she left in 2004. As such she can't convert just the tIRA to a ROTH.
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Alan,
I have this situation also. I'm not clear on how this impacts conversions to Roth. Would you be willing to explain, please?
omni
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01-01-2012, 08:50 PM
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#22
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Thinks s/he gets paid by the post
Join Date: Jan 2006
Posts: 4,172
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Quote:
Originally Posted by omni550
Alan,
I have this situation also. I'm not clear on how this impacts conversions to Roth. Would you be willing to explain, please?
omni
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read this Conversion Consequences
I think that what Alan meant is that while you can physically convert specific parts, for tax purposes all of the TIRAs (including rollovers , regular contributory, and perhaps SEPs) are considered one single mixed up IRA and the tax consequences might be different from what you might intuitively think.
As an example if you had a non-deductible TIRA w/ 50K and a rollover IRA with deductible contributions of 50K, and you convert the non-deductible TIRA, you might think you would pay no taxes because you've already paid taxes on those contributions. However by the single pot theory, you are considered as having converted 25K of non-deductible contributions and 25K of deductible contributions so you will pay taxes on 25K.
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01-01-2012, 09:00 PM
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#23
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Administrator
Join Date: Jul 2005
Location: N. Yorkshire
Posts: 34,124
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Quote:
Originally Posted by omni550
Alan,
I have this situation also. I'm not clear on how this impacts conversions to Roth. Would you be willing to explain, please?
omni
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When you convert to a ROTH, all of your IRA's are taken into account, you cannot target any particular IRA. When I retired I had most of my retirement savings in my 401(k) which are not included in the calculations. When I converted my IRA I only had to pay tax on the gains.
In DW's case she had 3 IRA's.
A tIRA made up of after tax contributions + gains
A SEP-IRA made up entirely of before tax contributions + gains
A Roll-over IRA from a previous employer 401k, made up of before tax contributions + gains.
I'll now make up some numbers to illustrate.
My tIRA had a cost basis of $40k + $10k gains, so taxes paid only on $10k of the $50k conversion.
DW's tIRA had a cost basis of $40k +$10k gains.
Her other 2 IRA's had a total of before tax money of $200k.
If DW were to convert her tIRA, the proportion of not-taxed money is 50/250 of the cost basis.
1/5 of $40k would not be taxed so she would pay taxes on $42k and the cost basis going forward would now be $32k.
I may have the math slightly wrong but you get the idea.
The year after I converted my tIRA I rolled over my 401k into a roll-over IRA so my cost basis going forward is 0.
__________________
Retired in Jan, 2010 at 55, moved to England in May 2016
Enough private pension and SS income to cover all needs
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01-01-2012, 09:48 PM
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#24
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Thinks s/he gets paid by the post
Join Date: Jan 2006
Posts: 1,012
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i fixed your example list (and added to it). see my comments in red below
Quote:
Originally Posted by GrayHare
Hmm, after trying some math, I see if all the IRA contribs are pre-tax then IRA does come out ahead. However, if half the IRA contribs are post-tax, as is roughly true for me and perhaps others, and ordinary rates are the same pre- and post-FIRE, then the numbers end about the same as the outside IRA investment:
1) If all IRA contribs are pre-tax, then all $100k goes into IRA. In 40 years it grows 4x to $400k. Full $400k is subject to 30% tax of $120k, leaving $280k after tax.
2) If half of IRA contribs are after tax dollars, IRA is funded with $50k pre-tax and $35k after-tax, $85k total. In 40 years it grows 4x to $340k. $305k is subject to 30% tax of $91.5k; $340k-$91.5k leaves $248.5k after tax.
2) should actually look like this: If half of IRA contribs are after tax dollars, TIRA is funded with the $50k pre-tax and Roth IRA funded with the $35k after-tax, $85k total. In 40 years both grow 4x. The TIRA grows to $200k, all of which is subject to 30% tax of $60k; $200k-$60k leaves $140k after tax from the TIRA. The Roth IRA will also have grown 4x to $140k, all of which is tax free. the total is $280k.
3) Instead, keep same $100k outside IRA, pay the 30% tax, leaving $70k for a buy-and-hold stock investment. In 40 years it grows to $280k. Gain is $210k, pay 15% CG tax of $31.5k, leaving $248.5k after tax.
4) Keep same $100k outside TIRA, pay the 30% tax, putting the $70k remainder in a Roth IRA. In 40 years it grows to $280k, all of which is tax free.
the following no longer applies because #2 and #3 dont result in about the same.
Since scenario #2 and #3 result in about the same, #3 is interesting since it has no RMDs. OK, so an IRA is not quite the trap I thought it was, but it's interesting to see a buy-and-hold approach like #3 can be competitive.
what is shown is that using (the appropriate) IRAs results is a higher after tax future amount.
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however, if you have investment money outside IRAs after maximizing your contributions to your IRAs, there is an even better approach. for the sake of this example i am assuming that the $100k in IRA mentioned in 1) was the max possible "contribution" so therefore the max possible "contribution" in 4) can also be $100k so instead of paying the taxes out of the contribition you pay the taxes from other funds (i am adding about $42,857). now all the examples change but for simplicity i am only going to change 1), 3) and 4).
1) If all IRA contribs are pre-tax, then $100k goes into IRA and the $42,857 that stays out gets taxed at the 30% rate and becomes $30k. In 40 years it all grows 4x, the IRA to $400k and the $30k to $120k . The full $400k is subject to 30% tax ($120k), leaving $280k after tax from the IRA and $90k of the rest is subject to 15% CG tax ($13.5k) leaving $106.5k. this results in a total of $280k + $106.5k = $386.5k after tax.
3) Instead, keep same $142,857k outside IRA, pay the 30% tax, leaving $100k for a buy-and-hold stock investment. In 40 years it grows to $400k. Gain is $300k, pay 15% CG tax of $45k, leaving $355k after tax.
4) Keep same $142,857k outside TIRA, pay the 30% tax, putting the $100k remainder in a Roth IRA. In 40 years it grows to $400k, all of which is after tax.
so, the bottom line is, using the Roth IRA is better than using the TIRA which is better than using no IRA.
BTW, the value of the Roth IRA is seen similarly when converting TIRAs(401Ks) to a Roth IRA, provided funds outside the IRAs are used to pay the taxes due on conversion.
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01-01-2012, 10:31 PM
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#25
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Moderator Emeritus
Join Date: Dec 2002
Location: Oahu
Posts: 26,860
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For me it's never been about the rewards-- I couldn't stop if I wanted to...
__________________
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Co-author (with my daughter) of “Raising Your Money-Savvy Family For Next Generation Financial Independence.”
Author of the book written on E-R.org: "The Military Guide to Financial Independence and Retirement."
I don't spend much time here— please send a PM.
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01-01-2012, 10:45 PM
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#26
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Thinks s/he gets paid by the post
Join Date: Jan 2006
Posts: 1,012
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Quote:
Originally Posted by Koolau
I would add 3) The ROTH IRA. If I had it to do over, I would have placed much less in tIRAs and 401(k) and put more in taxable accounts instead. I would have maxed out my ROTH contributions as well. Now, in my dotage, I must carefully figure out which pot of money to pull funds from to keep my current AND future taxable income within manageable limits. I'm sure a case can be made for the benefits of tIRAs/401(k) but it isn't as simple as "put all you can into these vehicles". It ain't that simple for most of us. I look at these vehicles as overeating a favorite food. It sure tastes good going down, but...
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sure its that simple, here is an outline. step 1) while you are making the big buck you "put all you can into these vehicles" (specifically 401ks and deductable IRAs) to get the tax benefits of these while you are earning at your peak. you also need to save in after tax accounts to prepare for step 2). step 2) retire early and live off the after tax accounts. while you are doing this you will be in very low tax brackets so now you also convert the money in pre tax accounts (eg. 401k) onto a roth IRA (via a TIRA) in a way that provides tax advantage (eg. convert enough to fill your lower tax brackets). you delay taking SS until you are age 70. 1 important rule: you dont convert any at a tax rate higher than you expect to be in at age 70 (after you have started to collect SS and RMDS). your goal here is to convert all pre tax money into a roth before you reach age 70 step 3) when you reach age 70 you start your SS and RMDs (if there is any pre tax money left).
these steps maybe more complicated or vary a bit depending on ur situation but like i said this is an outline.
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01-01-2012, 11:02 PM
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#27
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Full time employment: Posting here.
Join Date: May 2010
Posts: 862
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As this is my first partial year of ER, I calculated that my income was well within the 15% tax category, so I arranged to convert some shares from my Traditional IRA into my ROTH.
The conversion executed flawlessly, but now I have some questions.....
1. In future years, I hope to do this again. But from 2012 on, I have to send in Estimated Federal & States taxes. Must I allow for conversion income in calculating Estimated taxes, or can I wait and pay with my return without penalty?
2. Would such conversions affect ( increase ) Social Security tax by pushing the income beyond earnings limits? This is for future years when I start drawing Soc Sec.
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01-01-2012, 11:15 PM
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#28
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Moderator Emeritus
Join Date: Dec 2002
Location: Oahu
Posts: 26,860
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Quote:
Originally Posted by Coolius
1. In future years, I hope to do this again. But from 2012 on, I have to send in Estimated Federal & States taxes. Must I allow for conversion income in calculating Estimated taxes, or can I wait and pay with my return without penalty?
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You only have to pay the estimated tax after you incur the liability. So this quarter you go through the IRS flowchart and 1040ES form to determine your estimated taxes as though you are NOT doing a Roth IRA conversion, and make your first payment in April on that low-income assumption.
Then later on in 2012 you surprise yourself by deciding to do a Roth IRA conversion after all. You'd take that change (and that higher income) into account before the next estimated taxes are due. For most taxpayers that's with the Jan 2013 estimated payment.
Quote:
Originally Posted by Coolius
2. Would such conversions affect ( increase ) Social Security tax by pushing the income beyond earnings limits? This is for future years when I start drawing Soc Sec.
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If you did a Roth IRA conversion while also receiving Social Security benefits then yes, your income would probably exceed the threshold of SS taxation. However if you're old enough to be receiving SS benefits then you're possibly also old enough to just take an IRA withdrawal and able to delay SS benefits for a few more years.
__________________
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Co-author (with my daughter) of “Raising Your Money-Savvy Family For Next Generation Financial Independence.”
Author of the book written on E-R.org: "The Military Guide to Financial Independence and Retirement."
I don't spend much time here— please send a PM.
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01-02-2012, 08:42 AM
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#29
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
Join Date: Nov 2007
Posts: 7,746
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Quote:
Originally Posted by LOL!
It might be interesting to have a poll to figure out how common non-deductible traditional IRA contributions are for folks on this forum.
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Just based on a quick back of envelope calculation, I would say the great majority of people at large qualify for fully deductible IRA contributions, and even though active posters on this forum are probably higher earners than the average, I bet the majority of posters here are still eligible to fully deduct IRA contribs (of the traditional variety).
Our US average household income for a married couple is something like $70,000 per year. Taking the current IRS limits for full IRA deductibility for a married couple at around $91,000, and assuming this couple maxed out their 401ks as well, they could earn a total of $124,000 ($91000+$16,500+$16,500) and still deduct the trad IRA contribution in full.
We have only had 1 year during our working careers during which we were not eligible to fully deduct the IRA contrib, and we were still able to deduct about half of the limit IIRC (and contribute remainder to Roth).
__________________
Retired in 2013 at age 33. Keeping busy reading, blogging, relaxing, gaming, and enjoying the outdoors with my wife and 3 kids (8, 13, and 15).
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01-02-2012, 09:59 AM
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#30
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Thinks s/he gets paid by the post
Join Date: Nov 2011
Posts: 3,900
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Of course it's not just income level that can limit IRA contrib deductibility, but also participation (or spousal participation) in a retirement plan at w*rk.
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01-02-2012, 10:04 AM
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#31
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
Join Date: Nov 2010
Location: Sarasota, FL & Vermont
Posts: 36,361
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I'm late to this party, but I don't see IRAs as a tax trap at all. All of my IRA money will be taxable so I avoided taxes on that income and investment earnings during my working years at 28% to 32.5% marginal tax rates and will be converting from now until age 70 (before I start to draw SS) at 0% (or 15%). I wish there were more tax traps like this available to me when I was working.
BTW, I never saw the merit to non-deductible IRAs - that already taxed money goes into my taxable investment accounts which are mostly equities.
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01-02-2012, 10:41 AM
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#32
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Thinks s/he gets paid by the post
Join Date: Nov 2011
Posts: 3,900
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Per kaneohe's suggestion, below I've recalculated the same scenarios altered only to allow payment of taxes from another source so that the $100k of contribs are not reduced by tax. The other source has $30k of outside-tIRA funds. The outside funds are invested so as to be subject to capital gains tax only.
1) If all IRA contribs are pre-tax, then all $100k goes into IRA, and full $30k remains outside. In 40 years
the IRA grows 4x to $400k, and the outside to $120k. The $400k less 30% tax of $120k leaves $280k, and the outside fund gain of $90k is subject to 15% CG tax of $13.5k, leaving $106.5k This total after tax is $386.5k.
2) If half of IRA contribs are after-tax dollars, IRA is funded with $50k pre-tax and $50k after-tax, $100k total, but the outside fund is tapped to pay the $15k tax on the $50k of after-tax IRA contribs, reducing that fund to $15k. In 40 years the IRA grows 4x to $400K and the outside fund to $60k. In the IRA, only $350k is subject to 30% tax of $105k, leaving $295k. The outside fund gain of $45k is subject to 15% CG tax of $6.75k, leaving $53.25k. This total after tax is $348.25k.
3) Instead, keep same $100k outside IRA, pay the 30% tax from the $30k outside fund, reducing it to $0. Invest in a buy-and-hold growth stock investment. In 40 years it grows 4x to $400k. Of that, $300k is subject to CG tax, so pay 15% CG tax of $45k, leaving $355k after tax.
With this approach, the outside buy-and-hold growth stock investment of scenario #3 does better than the IRA of #2. Updated Conclusion: tIRAs are a trap if 1) funded with after-tax dollars, and 2) one's ordinary tax rate will not go down post-FIRE. Many people made after-tax contribs before Roth was invented, and some may still be doing so due to lack of eligibility. tIRAs holding after-tax dollars are candidates for Roth conversion.
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01-03-2012, 09:49 AM
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#33
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
Join Date: Nov 2007
Posts: 7,746
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Quote:
Originally Posted by GrayHare
Of course it's not just income level that can limit IRA contrib deductibility, but also participation (or spousal participation) in a retirement plan at w*rk.
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The income thresholds I quoted where deductibility of IRA contributions are limited assume both spouses are eligible to contribute to a 401k. I think you will find that a large slice of people are eligible to fully deduct IRA contributions and that only a relatively small proportion of high income earners are not eligible to deduct. For that small proportion, they are probably better off with a roth than a non-deductible traditional.
But to characterize deductible traditional IRAs as a trap somehow is certainly misleading for the large majority who are eligible to contribute to them.
__________________
Retired in 2013 at age 33. Keeping busy reading, blogging, relaxing, gaming, and enjoying the outdoors with my wife and 3 kids (8, 13, and 15).
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01-04-2012, 07:06 AM
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#34
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Thinks s/he gets paid by the post
Join Date: Feb 2009
Location: Cville
Posts: 1,602
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I think one important point is that you need to feed the beast, that is your retirement funds. The level of contributions can be more important than the vehicle. I agree you need to look at where you put cap gains and bonds, but first is feed your plan.
2nd, I find it much easier to leave the IRA and 401K funds alone than outside investments. Couple times I have snatched some cash from my cash stock account but never touched any of the funds from retirement accounts. Maybe this is just my problem. I'm not as disciplined as I should/could be.
3rd, I really wonder how many folks will really be in a higher income bracket after retirement than while W*rking. I am at my earnings peak now (at 55 with 4 left) so I should be making pretax investments, and with drawls at a lower rate later. Once SS kicks in (12 years) and tax rates go up to fix our problems, then I may rethink. But I'm making both trad 401k and roth 401k contributions so I'll have some options.
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01-04-2012, 07:20 AM
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#35
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
Join Date: Jun 2002
Location: Texas: No Country for Old Men
Posts: 50,021
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Quote:
Originally Posted by RetireBy90
I think one important point is that you need to feed the beast, that is your retirement funds. The level of contributions can be more important than the vehicle.
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+1
Just showing up is more than half the battle.
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Numbers is hard
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