Gradual Roth Conversion

[SteveL]

Helllo,
I've been reading this forum since I took ER in Aug of 2001. It is always interesting. Anyway, on to my issue....
I will be eligible to start taking funds from my fairly large IRA next year. (I don't need to do this, and hadn't planned to take funds out until forced to by the manditory with. rules.) However, I have done some forcasts of how much my IRA will be worth in 12 years, and then what my req. dists. might have to be. I'm using http://72t.net/MD_Planner.aspx
for this purpose. Based on this, I'm certain to be in a much higher tax bracket then...31+ compared to 25% today.
So one option would be to begin next year taking withdrawals up to the max which would put me into the next bracket, pay the tax and roll the funds into a ROTH. I'd gain having a portion of my IRA in a place where I wouldn't have to make withdrawals, but this would be at the cost of a reduction in the ultimate value of the IRA plus ROTH IRA value compared to just leaving it all alone. To make it more complicated, there is the possibility, however slim, that Bush might be able to make some switch in the tax rules from taxing income to taxing consumption......and some compllications depending on what happens to the estate tax too.
If I do the gradual thing, I'd reinvest in a way that mirrored my current 60/35/5 stock,bond, cash split so that I expect similar returns from the ROTH.
I'd welcome any thoughts, great or otherwise...
SteveL

 

[Patrick]

If you can get $$ out in a lower tax bracket, do so.  If not, leave it where it is. Over time you will be ahead, after taxes. If you want to leave the maximim amount to your heirs, leave it in the original IRA.

 

[TromboneAl]

If you haven't already, Google "Roth Conversion Calculators" and plug in your numbers.

One thing I plan to do is this: The first years of retirement, I'll be using money from my taxable accounts. So, my income will be zero. I could then convert $14,600 per year at the 10% tax rate. Yes?

 

[73ss454]

Al,
Thanks for the info, great idea.
But I am a little confused, why did Patrick say that leaving the money in a traditional IRA would leave more for the family?
What are the benefits either way?
Thanks,
JOE

 

[maddythebeagle]

I am curious Al on your planning. Why would you start by taking money out of your "taxable accounts" only. Is it an age issue? I would think it would be in your interests to tap your tax deferred accounts (iras/401ks) at least a little each year (at least in the 15k range) so that you can take enough close to tax free out of your deferred accounts (with the standard deduction and 2 exemptions). I would even add a little more so that you can take some of it out in the 10% bracket if you had a huge account? Then your investment income from your taxable accounts (dividends, etc.) and Roth IRAs can supplement. At least that is what I have in my plan.

 

[Nords]

Helllo,
I've been reading this forum since I took ER in Aug of 2001.  It is always interesting.  Anyway, on to my issue....
I will be eligible to start taking funds from my fairly large IRA next year. (I don't need to do this, and hadn't planned to take funds out until forced to by the manditory with. rules.)  However, I have done some forcasts of how much my IRA will be worth in 12 years, and then what my req. dists. might have to be.  I'm using http://72t.net/MD_Planner.aspx
for this purpose.  Based on this, I'm certain to be in a much higher tax bracket then...31+ compared to 25% today.  
So one option would be to begin next year taking withdrawals up to the max which would put me into the next bracket, pay the tax and roll the funds into a ROTH.  I'd gain having a portion of my IRA in a place where I wouldn't have to make withdrawals, but this would be at the cost of a reduction in the ultimate value of the IRA plus ROTH IRA value compared to just leaving it all alone.  To make it more complicated, there is the possibility, however slim, that Bush might be able to make some switch in the tax rules from taxing income to taxing consumption......and some compllications depending on what happens to the estate tax too.
If I do the gradual thing, I'd reinvest in a way that mirrored my current 60/35/5 stock,bond, cash split so that I expect similar returns from the ROTH.
I'd welcome any thoughts, great or otherwise...SteveL

We've started a multi-year Roth conversion to the top of the 15% bracket.  Only seven or eight more years to go.

First, an excellent discussion board for all obscure IRA questions is Ed Slott's IRA Help Forum.  It has several CPAs (Mary Kay Foss, Bruce Steiner, & Alan S.) who seem to compete for the best answers to the most difficult questions.  Fairmark also has a good guide to Roth conversions.  

I think the vocabulary is "conversion" instead of "withdrawal".  That way the funds can be rolled from one account to another (perhaps even the same custodian) without touching your hands.  You can certainly take a withdrawal from a conventional IRA after age 59 & 1/2, but contributions to a Roth (not conversions) would be limited to your earned income & that year's contribution limits.  All you HAVE to do in a conversion is pay the taxes.

It's always better to pay lower taxes now, and today's tax rates are the lowest of the 20th & 21st centuries.  I don't think Bush will get a chance to mess with the system (quack, quack) but Hilary & Kerry scare me even more.  I suspect that any conversion done today (especially before 2008) will be grandfathered into whatever new changes to IRAs are passed.  So if you can pay 25% to avoid 31% (or possibly even higher?) then I'd jump all over it.  My brother-in-law the CPA and I used to have this debate because he hates paying taxes before they're actually due.  But after EGTERRA 2003 accelerated the rate reductions, he agrees that it makes sense to convert when it can be done in a lower bracket.

Converting actually gives you an opportunity to shift even more assets to the tax-free category if you use non-IRA funds to pay the taxes.  You know today that you'll only keep 69% of your IRA after paying taxes, so today's $100K conventional IRA is only $69K of after-tax withdrawals.  When you convert that $100K conventional IRA to a Roth, if you roll all of the $100K to the Roth and pay the taxes with funds from some other source, then the Roth is compounding $100K instead of $69K-- and now it's ALL tax-free.  The net effect is that you've made a $31K contribution to your IRA and reduced your taxable accounts by at least that much.  

To be technically correct, you probably had to sell something from a taxable account to pay the conversion taxes, so you probably actually paid a little more in taxes on the sale.  But you probably also paid taxes on that taxable-account sale at the cap gains rates instead of the higher income rates.

Let's not forget the effect of IRA distributions on Social Security income. Distributions from conventional IRAs raise your taxable income, so your SS is also subject to tax. You're really getting pummeled in the 31% bracket. If you had to pay a little in cap gains taxes to raise funds from taxable accounts to pay for the IRA conversion, then you're still probably ahead on tax costs.

Al,
Thanks for the info, great idea.
But I am a little confused, why did Patrick say that leaving the money in a traditional IRA would leave more for the family?
What are the benefits either way?  Thanks,  JOE

Well, one way to do it is to die before you make any withdrawals.  You didn't have to pay any withdrawal taxes so the heirs get more.

Usually this situation arises when taxes are paid from the IRA during the conversion (instead of from separate funds).  Ed Slott also has a couple books on the subject that go into excrutiating detail on how to maximize Roth IRA distributions for your heirs.  It's all good advice, but we're going to focus on spending the distributions first...

 

[SteveL]

Thanks to Nords, and other responders. I hadn't thought of paying the tax on the converted amount from my taxable account. I've got a ladder that I could tap each year to fund this extra tax allowing the whole amount to go to the Roth. Unfortunately(or fortunately depending on your point of view), in the time between now and 70.5 there is no way to put much of a dent in the IRA balance. It will continue to grow no matter what I do. I will take a look at the IRA Forum you mentioned. I did an Excel spreadsheet forcasting the level of the 25% tax bracket for the next 12 years using 3% inflation, and the 2004 $117,250 upper end will rise quite a bit. Speaking of inflation or the lack of it, wejust bought a replacement refridgerator almost identical to the last one from 12 years ago, and it was a little less. Must be do to all the parts made in China and shipped over. Not sure if I should worry about the SS benefit effect on taxes. SS goes into negative cash flow about the time I will have to start manditory withdrawals.

 

[HFWR]

Bring up the subject of refrigerators, and you just might get TH out of hiding...

 

[unclemick]

The subject drives me nuts - single 62 - no heirs - 85% trad IRA - 12k pension - 6k divs. Playing with ORP for me - the conversion is not clear cut - especially using the 85 IRS default life expectancy.

Th can can use my old 14 year old 'girl from Missoula' personna if he wishes.

Anywise - a little of this and a little of that - and putz on. Did a mini conversion last year up to 15% bracket. Toss early SS into the mix - and I may say the heck with cute - take the money and watch football this fall.

 

[Patrick]

Al,
Thanks for the info, great idea.
But I am a little confused, why did Patrick say that leaving the money in a traditional IRA would leave more for the family?
What are the benefits either way?
Thanks,
JOE

There will be more for your heirs in the traditional IRA because you haven't paid any tax on it yet.  $100 in the IRA becomes $69 in the Roth (assuming the 31% tax bracket), so less is there for your heirs.  Hopefully they would be in a lower tax bracket and would pay less taxes than you would have.