Another beginners questions. Converting to Roth IRA

[bclover]

Hello All,
Would someone explain the reasoning behind converting regular IRA"s into roth ira's prior to retiring for income?

Why is it a good thing?

So if I have an IRA with 440K in it, wouldn't I pay a penalty for withdrawing it before 59 1/2 to convert it to a roth?

would the money I take out of the IRA be considered ordinary income. I'm still working so I definitely don't want to bump up my tax bill.

Thanks,
BC

 

[hnzw_rui]

Would someone explain the reasoning behind converting regular IRA"s into roth ira's prior to retiring for income?

Why is it a good thing?

So if I have an IRA with 440K in it, wouldn't I pay a penalty for withdrawing it before 59 1/2 to convert it to a roth?

would the money I take out of the IRA be considered ordinary income. I'm still working so I definitely don't want to bump up my tax bill.

If you're taking money out of a traditional IRA pre-59 1/2 and converting the entire amount of the distribution to Roth (paying taxes with after tax money), then no, there's no penalty.

I don't quite understand the first question though. In general, I think you wouldn't want to do Roth conversions while you're still working because you're probably still in a higher tax bracket than when you retire unless it's just for a backdoor Roth (can make non-deductible traditional IRA contributions but too high income to make normal Roth contributions).

 

[growing_older]

There is no penalty for doing a conversion, although you do have to pay the tax as if the entire converted amount is regular income. If you have a very big IRA and anticipate RMDs will bump you into a higher tax bracket getting some of that into a Roth may be advantageous. Also if you do retire early, you may have some years with no income before SS or RMDs kick in. If so, you may be able to convert at low income tax rates during those years your income is low.

 

[bclover]

I
I don't quite understand the first question though. In general, I think you wouldn't want to do Roth conversions while you're still working because you're probably still in a higher tax bracket than when you retire unless it's just for a backdoor Roth (can make non-deductible traditional IRA contributions but too high income to make normal Roth contributions).

Actually my question was basically why do it? either now while I'm working or later when I retire.

I was watchng Ed Slott on PBS and I may have heard him incorrectly, but I thought he was advising folks to transfer their regular IRA's into roth's and I could not understand why. He's got a book called "parlay your ira into a family fortune" that I may pick up to read.


I'm 55, I have about 800K in a couple of IRAs. I basically thought I could not touch them until I'm 59 1/2 without paying a 10% penalty plus getting hit with a tax bill so I'm just trying to figure out how risking all that would be advantageous.

I plan on retiring at 56 but I do have enough savings to use until I hit 62,

I don't understand the tax savings for doing it at all.

 

[bclover]

There is no penalty for doing a conversion, although you do have to pay the tax as if the entire converted amount is regular income. If you have a very big IRA and anticipate RMDs will bump you into a higher tax bracket getting some of that into a Roth may be advantageous. Also if you do retire early, you may have some years with no income before SS or RMDs kick in. If so, you may be able to convert at low income tax rates during those years your income is low.

so if I convert it to a roth I won't get that 10% penalty for withdrawing prior to 59 1/2? Just the tax bill?

Thanks,

 

[RE2Boys]

so if I convert it to a roth I won't get that 10% penalty for withdrawing prior to 59 1/2? Just the tax bill?

Thanks,

Yes.

Many early retirees are concerned that RMDs starting at age 70.5, along with SS and other income streams, will push them into a higher tax bracket. Unless your working income is low, most do not due conversions while working unless their TIRA was not deductilble. One way to help avoid this is to convert TIRA to Roth before RMDs and presumably while in a lower tax bracket. I convert partial TIRA to Roth each year but only as long as I can stay in the 15% marginal tax bracket......that also insures that cap gains and Qualified dividends are taxed at 0%

I won't get all of my TIRAs converted by 70, but will have put a dent in it. Once converted, all growth based on these funds is tax free.

 

[aaronc879]

Yes.

Many early retirees are concerned that RMDs starting at age 70.5, along with SS and other income streams, will push them into a higher tax bracket. Unless your working income is low, most do not due conversions while working unless their TIRA was not deductilble. One way to help avoid this is to convert TIRA to Roth before RMDs and presumably while in a lower tax bracket. I convert partial TIRA to Roth each year but only as long as I can stay in the 15% marginal tax bracket......that also insures that cap gains and Qualified dividends are taxed at 0%

I won't get all of my TIRAs converted by 70, but will have put a dent in it. Once converted, all growth based on these funds is tax free.

This was a good explanation. You only do it if you can stay in the 15% tax bracket. Some people end up with well over a million in their tax deferred accounts by the time they reach 70 1/2. Say they have $1.5MM and a life expectancy of 15 years, that means the minimum they can take out of their tax deferred account is $100K. That puts them in a higher tax bracket. That is what people are trying to avoid.

 

[bclover]

Yes.

Many early retirees are concerned that RMDs starting at age 70.5, along with SS and other income streams, will push them into a higher tax bracket. Unless your working income is low, most do not due conversions while working unless their TIRA was not deductilble. One way to help avoid this is to convert TIRA to Roth before RMDs and presumably while in a lower tax bracket. I convert partial TIRA to Roth each year but only as long as I can stay in the 15% marginal tax bracket......that also insures that cap gains and Qualified dividends are taxed at 0%

I won't get all of my TIRAs converted by 70, but will have put a dent in it. Once converted, all growth based on these funds is tax free.

Ok, I think I got it, so last question.

So now you are retired. you take let's say 100K (because I work well with round numbers. ) now while you are in a 15% tax bracket and stick it in a roth. You pay taxes on the 100K now as ordinary income.

Do I have that right? and you can convert part of your IRA, you don't have to churn over the entire thing?

 

[aaronc879]

When you transfer money from tax deferred to Roth it needs to be a direct transfer if you're under 59.5. You can't make a withdrawal and put it in your checking then a couple months later put it in a Roth. As long as you transfer directly from one account to another then it can be any amount, does not need to be the entire account.

 

[pb4uski]

BC, the ideal time for Roth conversions is after you stop working and before pensions, SS and other forms of retirement income come online. During that period, many of us are living off of savings (taxable accounts) and our income is very low, so there is plenty of headroom within the 15% tax bracket to do Roth conversions. IIRC, I paid about 7% in taxes on my Roth conversions tha last two years, vs saving 28% or more when I deferred that income.

There is not early penalty on Roth conversions and any converted amount is ordinary income, so you would NOT want to do this while you are still working.

Finally, Roth conversions are best where your current tax rate is low and you expect your tax rate to be the same or higher once SS, pensions, RMDs, etc are online.

 

[bclover]

thank you all so much.

I got it.

darn it, I spent 11.00 bucks on that book.

 

[aaronc879]

Ok, I think I got it, so last question.

So now you are retired. you take let's say 100K (because I work well with round numbers. ) now while you are in a 15% tax bracket and stick it in a roth. You pay taxes on the 100K now as ordinary income.

Do I have that right? and you can convert part of your IRA, you don't have to churn over the entire thing?

If you're in the 15% tax bracket then take out the $100K that will put you in a higher tax bracket. You will have to pay most of that 100K at a higher rate. You'll probably take closer to 10K per year rather than 100K per year because your income can't be that high and still be in the 15% tax bracket.

 

[pb4uski]

...Do I have that right? and you can convert part of your IRA, you don't have to churn over the entire thing?

Yes, you can do it a little at a time. And best of all, if you overconvert you can recharacterize (undo) any excess before you file your tax return.

 

[pb4uski]

If you're in the 15% tax bracket then take out the $100K that will put you in a higher tax bracket. You will have to pay most of that 100K at a higher rate. You'll probably take closer to 10K per year rather than 100K per year because your income can't be that high and still be in the 15% tax bracket.

For MFJ, under 65 with standard deduction it works out like this:

Standard deduction...............$12,600
Personal exemptions.................8,000
Top of 15% tax bracket...........73,800

Total income..........................94,400

Now subtract any income you have before any Roth conversions and that is the amount you can convert. If you itemize deductions, it might be even more.

 

[Jimmer25]

What about converting aftertax money in a TIRA to a Roth IRA? Is there a limit and are there tax or penalty implications?

 

[48Fire]

Actually my question was basically why do it? either now while I'm working or later when I retire.

I was watchng Ed Slott on PBS and I may have heard him incorrectly, but I thought he was advising folks to transfer their regular IRA's into roth's and I could not understand why. He's got a book called "parlay your ira into a family fortune" that I may pick up to read.


I'm 55, I have about 800K in a couple of IRAs. I basically thought I could not touch them until I'm 59 1/2 without paying a 10% penalty plus getting hit with a tax bill so I'm just trying to figure out how risking all that would be advantageous.

I plan on retiring at 56 but I do have enough savings to use until I hit 62,

I don't understand the tax savings for doing it at all.

Have you looked at a 72t?

 

[kaneohe]

What about converting aftertax money in a TIRA to a Roth IRA? Is there a limit and are there tax or penalty implications?

You can't just convert the aftertax money alone; it has to be converted in the same proportion as exists in all the TIRAs combined. See Form 8606. No limits.

Possible workaround: if you have an accepting 401K that will take your pretax money, you can isolate the basis and then convert that separately.

 

[bclover]

Have you looked at a 72t?

See just when I was beginning to understand. What is a 72t?

Sent from my SPH-L710 using Early Retirement Forum mobile app

 

[48Fire]

You can withdraw from your IRA before 59 1/2, as long as you take out the same amount each year. Go to 72t.net for more details. I am in my third year of withdraws.

 

[harley]

See just when I was beginning to understand. What is a 72t?

Don't worry about the 72t, since you've already stated that you have plenty of money to tide you over until 59 1/2. It's just a way to draw from your IRA early and without penalty, but it doesn't sound like you need it.

I got it.

darn it, I spent 11.00 bucks on that book.

It's a pretty good book and also has information in it about passing on the Roth to your heirs (if you have any). You'll still get your money's worth out of it. But next time check your library first.

 

[hnzw_rui]

I'm 55, I have about 800K in a couple of IRAs. I basically thought I could not touch them until I'm 59 1/2 without paying a 10% penalty plus getting hit with a tax bill so I'm just trying to figure out how risking all that would be advantageous.

I plan on retiring at 56 but I do have enough savings to use until I hit 62,

I don't understand the tax savings for doing it at all.

To be honest, I can't really think of any tax savings for doing Roth conversions while you're still working (unless you got a pay cut or something dropping you into a lower tax bracket). I can understand why someone with a large tax deferred balance and no taxable savings would like to do so for early retirement.

Here's an example:
Say someone is age 45 and would like to retire at age 50. He has $1M in a traditional 401k (all tax deferred) but no other savings. If he converts part of that $1M to Roth, he'll be able to withdraw the conversion amount (but not earnings) tax and penalty free when he hits age 50.

Since you're already 55, though, I don't think this strategy's going to work for you. You could, however, do a 72t/SEPP if you need to spend IRA money before 59 1/2. Traditional IRA to Roth IRA conversions, you can do at any age penalty-free (as long as it's done properly).

72t Distribution Rule: How to Retire Early (Calculation Methods)

 

[pb4uski]

Actually my question was basically why do it? either now while I'm working or later when I retire.

I was watchng Ed Slott on PBS and I may have heard him incorrectly, but I thought he was advising folks to transfer their regular IRA's into roth's and I could not understand why. He's got a book called "parlay your ira into a family fortune" that I may pick up to read.


I'm 55, I have about 800K in a couple of IRAs. I basically thought I could not touch them until I'm 59 1/2 without paying a 10% penalty plus getting hit with a tax bill so I'm just trying to figure out how risking all that would be advantageous.

I plan on retiring at 56 but I do have enough savings to use until I hit 62,

I don't understand the tax savings for doing it at all.

So from when you retire at 56 to you get to 62, you can convert if you want to. Presumably, your income before Roth conversions will be minimal since you'll be living from savings, so your income would likely just be dividends, interest and capital gains on taxable accounts. When you convert, the 10% penalty does not apply because you are not really getting the money... just shifting it from a tax-deferred account to a tax-free account. But any amount converted is pension income (which is ordinary income).

The tax savings are twofold. First, you deferred while you were working and I'm guessing avoided 25% or more on those tax-deferred savings. If you convert between 56 and 62 to the top of the 15% bracket, you'll likely pay somewhere between 5-10%, so you'll have saves 15-20% compared to having taken the income while you were working. Also, if you don't convert, you'll have to take those monies later as RMDs and once you factor in SS income and any pensions, you might well be in a 15% or higher tax bracket so it is better to pay 5-10% now than 15% or more later.

 

[kaneohe]

When you transfer money from tax deferred to Roth it needs to be a direct transfer if you're under 59.5. You can't make a withdrawal and put it in your checking then a couple months later put it in a Roth. .....................

aaron..........why ?? You can do indirect rollover to another TIRA as long as you redeposit within 60 days and then subsequently do the Roth conversion there......so why can't you do the Roth conversion "on the fly" bypassing the 2nd TIRA? You'd want to request no withholding and want to be aware of the one rollover every 12 mos so direct transfer would be preferable but not really necessary?

 

[aaronc879]

aaron..........why ?? You can do indirect rollover to another TIRA as long as you redeposit within 60 days and then subsequently do the Roth conversion there......so why can't you do the Roth conversion "on the fly" bypassing the 2nd TIRA? You'd want to request no withholding and want to be aware of the one rollover every 12 mos so direct transfer would be preferable but not really necessary?

I'm not entirely sure about the rules on that. I thought it couldn't touch your hands. I thought it had to go from one account direct to another but that may not be the case.

 

[Koolau]

I always mention one more advantage of Roth conversion - assuming you can pay the taxes from already taxed savings: If you have a TIRA of $1000, what is it actually worth? It's worth $1000 MINUS whatever taxes you will eventually pay. If you have a Roth of $1000 it's worth $1000 since you don't have to pay taxes on it. What if you could "magically" change your TIRA to a Roth? You would now have a MORE VALUABLE asset. The "magic" is to pay the taxes with already taxed savings. (So the magic is not free.) But once you have done so, your Roth has been upgraded in value by the amount you paid in taxes. That EXTRA value gets to grow in the Roth TAX FREE until you eventually cash it in. SO... By paying some taxes, you get a "larger" Roth than you used to have as a TIRA. If you don't follow this, read the book. I'm sure they explain it MUCH better than I have. YMMV