Backdoor Roth IRA question

[Omalley]

Question about the best time to convert an existing Traditional IRA (TIRA) to a Roth IRA. I have had a TIRA for 25 yrs, with a hypothetical balance of $50k of which $10k were previously taxed contributions. Currently, I am in the 37% tax rate bracket and expect the same for 2019-2021 tax years.

How do I analyze if I should begin converting the TIRA to Roth immediately or wait until the 2022 tax year when I expect to drop into the 24% tax bracket. Is there a tax calculator which would help with this analysis. I created a spreadsheet of the two scenarios, and unexpectedly it seems like slightly less taxes would be paid if I start converting immediately at the higher tax rate and continue later at the lower tax rate. However, the difference was negligible over the time it would take to convert the $50k balance.

Omalley

 

[braumeister]

As you've already seen, there are a lot of moving parts in that decision.

But here's one point to consider. When you transfer in kind, if you move individual items (stocks, funds, whatever) when they are at low price points, you can get more bang for your buck in the long run.

 

[gauss]

Does I-Orp model this and provide an optimal Roth conversion each year?

 

[bingybear]

I think the term backdoor is incorrect. It usually IIRC when you make a non-deductible TIRA contribution and immediately to a roth before any gains occur. You have the IRA already with mixed tax basis. I would say this is just a roth conversion with not backdoor.

Backdoor is likely easier to analyze. But look for tools for simulating roth conversions with non-zero tax basis.

I did a spreadsheet that calculate this, but includes growth in all assets/account types, determines tax and pays it out, keeps basis info, carry forward losses, ... pretty much everything. But it is not easy to split apart.

 

[FIREd_2015]

Question about the best time to convert an existing Traditional IRA (TIRA) to a Roth IRA. I have had a TIRA for 25 yrs, with a hypothetical balance of $50k of which $10k were previously taxed contributions. Currently, I am in the 37% tax rate bracket and expect the same for 2019-2021 tax years.

How do I analyze if I should begin converting the TIRA to Roth immediately or wait until the 2022 tax year when I expect to drop into the 24% tax bracket. Is there a tax calculator which would help with this analysis. I created a spreadsheet of the two scenarios, and unexpectedly it seems like slightly less taxes would be paid if I start converting immediately at the higher tax rate and continue later at the lower tax rate. However, the difference was negligible over the time it would take to convert the $50k balance.

Omalley

Here is a link to a calculator that I found that can help one decide if it's worth doing or not. There are a couple of assumptions like rate of return and tax rate at retirement that can swing the results one way or the other.

https://www.bankrate.com/calculators/retirement/convert-ira-roth-calculator.aspx

 

[Sunset]

So if you only have 50K in the IRA, why even convert it ? It's not like this is going to be a tax torpedo.

Why not wait until retired, and then withdraw from it when your income will be lower ?

 

[VanWinkle]

So if you only have 50K in the IRA, why even convert it ? It's not like this is going to be a tax torpedo.

Why not wait until retired, and then withdraw from it when your income will be lower ?

"with a hypothetical balance of $50k"

I am not sure that he was stating the IRA is 50K

 

[Omalley]

Thanks for all of the feedback. Based on my initial shot at an analysis spreadsheet, I realized it would be difficult to generate a quick one size fits all solution.

May decide to only have DW look into the Roth option, since my existing TIRA and an undiscussed Inherited IRA make my analysis more complicated. Originally, I had planned on letting my TIRA and InhIRA ride until age 60 then use funds up to the 24% tax bracket each year. I was concerned that I wasn't maximizing my tax advantages and thought I should investigate the Roth option. However, I have probably made many decisions over the years that didn't maximize the tax advantages available every time.

Omalley

 

[SecondCor521]

How do I analyze if I should begin converting the TIRA to Roth immediately or wait until the 2022 tax year when I expect to drop into the 24% tax bracket. Is there a tax calculator which would help with this analysis. I created a spreadsheet of the two scenarios, and unexpectedly it seems like slightly less taxes would be paid if I start converting immediately at the higher tax rate and continue later at the lower tax rate. However, the difference was negligible over the time it would take to convert the $50k balance.

Emphasis added.

Just pointing out that there are no annual limits on conversions from traditional to Roth IRAs. Even if your IRA had $100M in it, you could convert it all this year if you wanted to.

The only real governor on doing so is that it will generate ordinary taxable income on a pro-rata portion of the deductible / untaxed portion.

 

[Dash man]

If you’re not yet 59 1/2, wouldn’t there be a 10% penalty for a conversion from tIRA to Roth? There wouldn’t be for a back foot Roth, but any other move would be costly.

 

[38Chevy454]

If you’re not yet 59 1/2, wouldn’t there be a 10% penalty for a conversion from tIRA to Roth? There wouldn’t be for a back foot Roth, but any other move would be costly.

No 10% penalty the way I understand it. You are only responsible for the taxes, but since the switched money is staying in IRA territory, there is no penalty. In effect the funds are still in an IRA, just a different type.


Now the question that might come up is you can't use the switching funds to cover the taxes. If you remove money from the pre-tax funds to pay the taxes, that money is considered as taking out and the tax money is subject to the 10% penalty. Example, if you transfer $50K out of pre-tax IRA and move to Roth IRA, you would be responsible for the tax on that $50K. Assume 22% tax bracket, that is $11K of taxes. You can't transfer the $50K out of the per-tax and put $39K into the Roth, saving $11K out for taxes without also paying a 10% penalty on that $11K, or penalty would be $1.1K.


The way to do it is remove $50 K out of the pre-tax, and deposit $50K into Roth, and then use another source of funds (after tax money) to pay the $11K of tax liability. This saves the 10% penalty.

 

[retired1]

I'm in similar position having large TIRA balance rolled over from previous employers 401k. I keep chipping 10-15k every year converting into Roth.

 

[Dash man]

No 10% penalty the way I understand it. You are only responsible for the taxes, but since the switched money is staying in IRA territory, there is no penalty. In effect the funds are still in an IRA, just a different type.


Now the question that might come up is you can't use the switching funds to cover the taxes. If you remove money from the pre-tax funds to pay the taxes, that money is considered as taking out and the tax money is subject to the 10% penalty. Example, if you transfer $50K out of pre-tax IRA and move to Roth IRA, you would be responsible for the tax on that $50K. Assume 22% tax bracket, that is $11K of taxes. You can't transfer the $50K out of the per-tax and put $39K into the Roth, saving $11K out for taxes without also paying a 10% penalty on that $11K, or penalty would be $1.1K.


The way to do it is remove $50 K out of the pre-tax, and deposit $50K into Roth, and then use another source of funds (after tax money) to pay the $11K of tax liability. This saves the 10% penalty.

That makes sense. Thanks!