Roth conversion for dummies

[SevenUp]

It is to convert tIRA to Roth IRA (there is a max AROUND $17,500/year) and no taxes when staying within the limits.

There is no IRS-imposed limit on tIRA to Roth IRA conversions.

If you are trying to pay no federal tax, the sum of conversions plus all other ordinary income must stay below your standard deduction amount.

If you want to convert up to some marginal tax rate, that is also doable.

 

[whatnot]

It was my understanding that taxes need to be paid on the amount withdrawn from the 401k and converted to the Roth.

 

[RunningBum]

It was my understanding that taxes need to be paid on the amount withdrawn from the 401k and converted to the Roth.

Your understanding is correct. Technically you have to roll the 401K over to an IRA first. That is not a taxable event. Then you can convert as little or as much as you want. That is a taxable event. FIREarly is glossing over or ignoring that.

5 years after each conversion you can access that money penalty and tax-free, even if you are under 59.5. That's the ladder part. You convert some every year, and you withdraw from the conversion you did 5 years prior. But you have a 5 year starting gap, plus whatever taxes you owe on the conversion.

 

[RetireBy90]

Coup,e items to consider, if wife is 5 years younger, I would start with converting your tIRA and 401K first, then wife’s as she has additional 5 years to convert before RMDs.

Second, if your 401K has costs or investments that you wanted to keep, check with administrator to see if they have a Roth 401K and if they allow conversions. My old company had 401K administered by Fidelity that had a Roth option.

 

[SevenUp]

Technically you have to roll the 401K over to an IRA first.

Not necessarily. E.g., Megacorp's 401k allows partial withdrawals and Fidelity is happy to send those directly to a Roth IRA.

And yes, a 1099-R will be issued to document that amount of taxable income.

 

[Animorph]

Not necessarily. E.g., Megacorp's 401k allows partial withdrawals and Fidelity is happy to send those directly to a Roth IRA.

And yes, a 1099-R will be issued to document that amount of taxable income.

Yep. I rolled over some of DW's mixed 401k/Roth 401k to her Roth IRA. Megacorp wouldn't split them up at the time. I chose the Roth IRA because I didn't want Roth funds inside a tIRA, though Fidelity did say they would split it any way I wanted. And I was going to Roth convert at least that much anyway. The paperwork all worked out correctly. I only paid taxes on the non-Roth portion. That's not to say Megacorp might not allow that somehow, but it is OK with the IRS.

 

[bobbyr]

Your understanding is correct. Technically you have to roll the 401K over to an IRA first. That is not a taxable event. Then you can convert as little or as much as you want. That is a taxable event. FIREarly is glossing over or ignoring that.

5 years after each conversion you can access that money penalty and tax-free, even if you are under 59.5. That's the ladder part. You convert some every year, and you withdraw from the conversion you did 5 years prior. But you have a 5 year starting gap, plus whatever taxes you owe on the conversion.

thanks, this helps

 

[RetireBy90]

Just to better understand,

5 years after each conversion you can access that money penalty and tax-free, even if you are under 59.5. That's the ladder part. You convert some every year, and you withdraw from the conversion you did 5 years prior. But you have a 5 year starting gap, plus whatever taxes you owe on the conversion.

My understanding is that the 5 year clock starts when you open your first Roth IRA. So if you were to open a Roth today, and add funds (contribute or convert) in 2025 you could withdraw any or all funds without any tax or penalty.

Others can confirm or correct my understanding.

 

[RunningBum]

Just to better understand,
My understanding is that the 5 year clock starts when you open your first Roth IRA. So if you were to open a Roth today, and add funds (contribute or convert) in 2025 you could withdraw any or all funds without any tax or penalty.

Others can confirm or correct my understanding.

https://www.investopedia.com/ask/an...roth.asp#5-year-rule-for-roth-ira-conversions

Each conversion has its own five-year period. For instance, if you converted your traditional IRA to a Roth IRA in 2018, the five-year period for those converted assets began Jan. 1, 2018. If you later convert other traditional IRA assets to a Roth IRA in 2019, the five-year period for those assets begins Jan. 1, 2019.

 

[kaneohe]

This table by kawill from the fairmark.com site may help clarify:
There are 2 types of 5 yr clocks. When you are < 59.5
y.o., the clocks are on conversions. Each conversion has its own clock and within each conversion there may be tax/non-taxable parts of the conversion. The ordering rules say that contributions are withdrawn first, followed by conversion (oldest first and within each conversion, the taxable amount is first), and then finally earnings............like like the order in the table.

After 59.5, a different 5 yr clock comes into play........the age of the first Roth ever opened.

Re: Roth IRA Rules - Table Approach
Posted by: KAWill (IP Logged)
Date: October 14, 2010 11:57PM


Roth IRA Distribution Table

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD NOT MET

Contributions: Tax-No; Penalty-No
Conversions: Tax-No; Penalty-Yes (Taxable Portion)
Conversions: Tax-No ;Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-Yes

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD MET

Contributions: Tax-No; Penalty-No
Conversions: Tax-No; Penalty-No (Taxable Portion)
Conversions: Tax-No; Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-Yes

OVER AGE 59.5
LESS THAN FIVE YEARS SINCE OPENING FIRST ROTH IRA

Contributions: Tax-No ;Penalty-No
Conversions: Tax-No; Penalty-No (Taxable Portion)
Conversions: Tax-No; Penalty-No (Nontaxable Portion)
Earni :x ngs: Tax-Yes; Penalty-No

OVER AGE 59.5
FIVE YEARS OR MORE SINCE OPENING FIRST ROTH IRA

All Distributions Are Qualified

 

[pc95]

Wife and I both work and are in the 24% Fed tax bracket and 9.3% CA bracket (33.3% combined). We are in our mid-40s.
She changed jobs 2 years ago and had about $300k in 45/55 trad/roth 401k split that we rolled into t/roth IRAs because were getting hit with annoying percentage maintenance fees once she changed companies that was causing a drag (modest loss) on dividends. The combined tax bracket currently is historically low, and the earlier we convert the less amount we would need to convert in the future where I wonder if the brackets will be pushed up. I've done some back of the envelope calculations assuming a 5% average rate of return over time - if we allow to grow to age 59.5 without converting the traditional one may have double what what it has now. Currently the combined CA rate up to about $80,000 of income in is 21%. I don't foresee us moving, but who knows.

We expect both to have modest pensions by around 57. No children.

I'm wondering if its a good idea to pay the heftier tax rate early on (currently +13% difference) to increase the tax free holdings later. My tsp (401k) has a larger 80% portion in tax deferred that we cannot convert (yet), so I'm worried about having too much tax deferred income later. The unknown is tax rates at the lower end would get pushed up to current levels. We would pay more now, but try to nip the taxes owed later. Has anyone done these conversions earlier on before? I see most people are dealing with conversions upon retirement. Our situation is different than some (luckily in general) in which we expect pension money to fill up the lower tax brackets.
later. Thanks