Roth conversion earlier in the year issues?

[JohnKeating]

We are planning on doing our first set of Roth conversions at the end of this year as this is our first year of limited to no income. We've done the calculations and have a good idea of how much we want to do going forward.

Given the recent market downturn was wondering if we should do some/all of the conversion now rather than wait? I understand we don't know what the future holds but given we were planning on doing the conversions regardless later this year seems reasonable to do some/all now. Thoughts?

Also, when we signed up for the ACA we hadn't decided to do the conversion so we have a pretty substantial subsidy. We knew if we did the conversion later in the year would basically erase the subsidy and we'd owe the difference on our taxes which is OK by us. We don't believe there is a penalty just simply pay back the difference.

But, if we were to convert earlier then I don't know if that changes when we have to pay back the difference. I know we can update our income in the ACA marketplace and start paying full price earlier but I'd rather not and simply pay back the difference at tax time. Is there an issue if we have large income earlier in the year for the Roth conversion but don't adjust our ACA subsidy until tax time?

 

[SecondCor521]

We are planning on doing our first set of Roth conversions at the end of this year as this is our first year of limited to no income. We've done the calculations and have a good idea of how much we want to do going forward.

Given the recent market downturn was wondering if we should do some/all of the conversion now rather than wait? I understand we don't know what the future holds but given we were planning on doing the conversions regardless later this year seems reasonable to do some/all now. Thoughts?

I do my Roth conversion in thirds based on a YouTube video on the topic from Safeguard wealth management (they don't manage my money; I just think some of their content is well thought out).

1. First third in January, because the stock market goes up on average.

2. Second third if the market drops by 10% to 15% during the year, for the same reasons you're thinking of doing it. If no drop, this third happens at the end of the year.

3. Third third at the end of the year to top things off, and I guess this is partly for the relatively uncommon case where the market drops the entire year.

(This is my variation on the "drawdown" strategy described by Safeguard Wealth Management at

).

I have already done my first third for the year. I'm aware of the current market drop and have considered pulling the trigger on my second third. However, my history has been to convert too soon during a market drop, so for now I'm waiting.

The main thing to understand is that there are no options to reverse a Roth conversion, so once you've done it it will be taxable income. This means that if your tax situation changes significantly later in the year, you're stuck with the income even if that significant change means you wish you hadn't.

Also, when we signed up for the ACA we hadn't decided to do the conversion so we have a pretty substantial subsidy. We knew if we did the conversion later in the year would basically erase the subsidy and we'd owe the difference on our taxes which is OK by us. We don't believe there is a penalty just simply pay back the difference.

Generally true, although there are two subtleties which might apply:

1. First, if your income is below 400% FPL, you may not have to pay back the entire amount. There is something called a repayment limitation. See Line 28 at the bottom of Form 8962.

2. Any repayment is considered an additional tax, and so could expose you to an underpayment penalty if you don't have enough withheld, paid in estimated taxes, or meet a safe harbor for your regular income taxes plus the repayment amount.

But, if we were to convert earlier then I don't know if that changes when we have to pay back the difference. I know we can update our income in the ACA marketplace and start paying full price earlier but I'd rather not and simply pay back the difference at tax time. Is there an issue if we have large income earlier in the year for the Roth conversion but don't adjust our ACA subsidy until tax time?

See item #2 above.

You are expected to update your income and any other applicable changes to the Marketplace according to the instructions for Form 8962. I am unaware of any penalty (again, other than a potential underpayment penalty) for not doing so. Keeping the monthly amounts the same does make preparing the tax return easier.

 

[RetireBy90]

Any attempt to time the market, selling or buying is suspect, IMHO. I would suggest since you sound confident of the conversion amount to split into quarters and do one each quarter. Same idea as dollar cost averaging. Full disclosure, I do mine in Dec when my tax situation is clear.

 

[Al18]

If the stocks/funds/ETF you are mostly stock based, you can convert more shares when the market is down. I would consider converting 1/3 to 1/2 of your funds within the next month, now that the SP500 entered into correction yesterday. Recommend you convert in-kind and you can have withholding done in November or December by having 100% of this conversion withheld for Federal and/or state taxes.

 

[JohnKeating]

Thanks for the replies. All were very helpful.

I like the idea of partial conversions/dollar cost averaging throughout the year as I've been doing that for years during accumulation and it make sense to do that for conversions as well. I like the ability to have a schedule but also the flexibility to change if required based on unexpected income or significantly down markets.

I'll also do a bit more research on the ACA repayments and run some tax scenarios to make sure I fully understand the consequences/requirements of doing periodic conversions.

Thanks all.

 

[OldShooter]

It's been a number of years since I finished doing Roth conversions but at that time (maybe still now) you could do a conversion early in the year and if the market ran against you it was possible to "un-do" the conversion near calendar year-end. I set up an isolated Roth account at Schwab and transferred the money ("Oldshooter Roth #2"). As it turned out I didn't need to un-do, but keeping the money isolated should have made things much easier. After the un-do possibility had passed, I just moved the money from the #2 account into the main account and closed #2.. It was totally friction-free with Schwab and totally finessed the "now or then" question.

Maybe someone can comment on whether the un-do option still exists.

 

[TheWizard]

It's been a number of years since I finished doing Roth conversions but at that time (maybe still now) you could do a conversion early in the year and if the market ran against you it was possible to "un-do" the conversion near calendar year-end. I set up an isolated Roth account at Schwab and transferred the money ("Oldshooter Roth #2"). As it turned out I didn't need to un-do, but keeping the money isolated should have made things much easier. After the un-do possibility had passed, I just moved the money from the #2 account into the main account and closed #2.. It was totally friction-free with Schwab and totally finessed the "now or then" question.

Maybe someone can comment on whether the un-do option still exists.

It does not...

 

[SecondCor521]

It does not...

+1.

Maybe someone can comment on whether the un-do option still exists.

Nope, which is why I wrote earlier (post #2 on this thread):

"The main thing to understand is that there are no options to reverse a Roth conversion, so once you've done it it will be taxable income. This means that if your tax situation changes significantly later in the year, you're stuck with the income even if that significant change means you wish you hadn't."

 

[SevenUp]

We knew if we did the conversion later in the year would basically erase the subsidy and we'd owe the difference on our taxes which is OK by us. We don't believe there is a penalty just simply pay back the difference.

If you haven't already, consider the Roth Conversion and Capital Gains On ACA Health Insurance article.