Roth conversion for dummies

[pb4uski]

Wouldnt RetireAge50's situation of multiple IRA's fall under the prorata rule i mentioned?...

The pro-rata rule only applies to tIRAs that are a mix of pre-tax/deductible and post-tax/nondeductible contributions.

The vast majority of tIRAs are only pre-tax/deductible contributions so in most cases the prorate rule isn't in play.

But you make a fair point that if your tIRA is a mix then a portion of the conversion would not be taxable.

The pro-rata rule is in play for backdoor Roths which was the subject of the article that you linked, but here we are talking about plain Roth conversions.

 

[lordjust]

The pro-rata rule only applies to tIRAs that are a mix of pre-tax/deductible and post-tax/nondeductible contributions.

The vast majority of tIRAs are only pre-tax/deductible contributions so in most cases the prorate rule isn't in play.

But you make a fair point that if your tIRA is a mix then a portion of the conversion would not be taxable.

The pro-rata rule is in play for backdoor Roths which was the subject of the article that you linked, but here we are talking about plain Roth conversions.

I took the link from camfused prior comments ... but I didnt catch that this was strictly plain Roth conversions. thanks for the feedback pb.

 

[kaneohe]

"You’ll need the money in five years or less. Money converted from an IRA to a Roth IRA falls under a Roth five-year rule: If you don’t wait five years to withdraw it, you could owe taxes and a 10% penalty."

.................

How old will you be when you want to withdraw? If > 59.5, you will be able to access the conversion funds w/o taxes/penalty (but not necessarily the earnings).

 

[Truckinalong]

How old will you be when you want to withdraw? If > 59.5, you will be able to access the conversion funds w/o taxes/penalty (but not necessarily the earnings).

47-50? Plan is to spend down taxable bucket and use ROth conversion to manage income to ACA threshold.

The way I read this I am in trouble in year 1 thru 5.

 

[pb4uski]

"You’ll need the money in five years or less. Money converted from an IRA to a Roth IRA falls under a Roth five-year rule: If you don’t wait five years to withdraw it, you could owe taxes and a 10% penalty."

This throws a kink in my plan I think? I planned on pulling plug in a couple years. I intended to manage ACA subsidies with rolling my 401K to IRA and converting to Roth and using roth distributions as my income in combination with some bond fund income.

This makes it sound like I would need to wait 5 years and the income I generate alone from bond fund would kick me to medicaid?

47-50? Plan is to spend down taxable bucket and use ROth conversion to manage income to ACA threshold.

The way I read this I am in trouble in year 1 thru 5.

You can withdraw contributions without penalty anytime... so it depends on how much of your Roth represents contributions in relation to how much you need to withdraw.

After 59 1/2 you can withdraw without penalty.

 

[Truckinalong]

And the contribution withdrawal would count as the income to ACA then?

 

[camfused]

^^^ Yes. Hence the awkward years before you turn 65, when you want to qualify for ACA subsidies (by keeping your income low), yet you also want to be doing Roth conversions (and you are taxed on those amounts you pull out to do that as normal income).

 

[Animorph]

DW is five years younger than me. I Roth converted all of my tIRA/401k accounts before starting on hers. We'll still have a little left in her tIRA, but the RMD's for her start five years after mine would have. I don't think there's any reason to file separately.

We were able to Roth convert some of DW's 401k by transferring directly to a Roth account. So you don't have to funnel it through a tIRA first. The hassle there was working around the stupid withdrawal rules of her 401k. We were limited to quarterly withdrawals/rollovers and we had a Roth 401k component that they wouldn't initially separate out for us to roll into a Roth. Moving to a Vanguard tIRA might be easier.

Think of your HSA's as a slightly limited Roth account. You may be able to find an ACA plan that is HSA eligible as well, allowing more contributions. I would only withdraw from them if you need to control your taxable income. Normally it is good to withdraw from the Roth as your last source of funds. If you save your medical receipts you should be able to reimburse yourself for those expenses at any time in the future. That said, we'll be withdrawing from our HSA's first, before using the Roths.

Roth conversions are mostly a way to get money out of your tIRA/401k accounts at the lowest tax rate. Secondarily, paying the conversion taxes from a taxable account means you have that much more tax-free money in your retirement accounts. You need to estimate what your RMD taxes will look like in the future and what they will look like in the coming years. Because of that secondary effect, the Roth conversion benefit will be greater early on in the process. Only you can figure out your taxes and subsidies, but there might be a small chance that a larger Roth conversion in the first year might be worth giving up the ACA subsidy that year. Then go with the ACA subsidies after that. Those are the things that make it so hard to fully optimize.

 

[pb4uski]

And the contribution withdrawal would count as the income to ACA then?

^^^ Yes. Hence the awkward years before you turn 65, when you want to qualify for ACA subsidies (by keeping your income low), yet you also want to be doing Roth conversions (and you are taxed on those amounts you pull out to do that as normal income).

NO! Withdrawal of Roth contributions are not income, for ACA nor for tax.

 

[RetireBy90]

^^^ or was Truckingalong speaking of "contribution withdrawal" as the withdrawal from tIRA to convert to Roth. My original thought.

 

[pb4uski]

^^^ or was Truckingalong speaking of "contribution withdrawal" as the withdrawal from tIRA to convert to Roth. My original thought.

I interpreted it as him asking if a withdrawal of contributions from a Roth was included in ACA income... and it is not.

But you are right that the Roth conversion itself would be taxable and ACA income, though if the tIRA included nondeductible contributions then only a portion of the Roth conversion would be income for tax and ACA.

 

[camfused]

^^^ Yes, that is what I meant. Sorry for the confusion. Withdrawals from Roth are never taxable, as far as I know (if the money is more than 5 years old).

 

[pb4uski]

^^^ Yes, that is what I meant. Sorry for the confusion. Withdrawals from Roth are never taxable, as far as I know (if the money is more than 5 years old).

No, not that either. See below, its complicated. In many cases withdrawal of earnings are subject to tax. If you had said "Withdrawals of contributions from Roth are never taxable" then that would have been right.

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)
Earnings: Tax-Yes; Penalty-No

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

All Distributions Are Qualified

 

[camfused]

^^^ Ok, i'll be quite now.

 

[Truckinalong]

I interpreted it as him asking if a withdrawal of contributions from a Roth was included in ACA income... and it is not.

But you are right that the Roth conversion itself would be taxable and ACA income, though if the tIRA included nondeductible contributions then only a portion of the Roth conversion would be income for tax and ACA.

My situation

Retire in a couple years. Roll company 401k into IRA. Bond fund income from taxable fund $30G a year, but need $50G to live. Plan is to convert $20G IRA to Roth IRA per year to obtain said $50G.

That should then be $50G in income as I see it for ACA purposes?

 

[pb4uski]

My situation

Retire in a couple years. Roll company 401k into IRA. Bond fund income from taxable fund $30G a year, but need $50G to live. Plan is to convert $20G IRA to Roth IRA per year to obtain said $50G.

That should then be $50G in income as I see it for ACA purposes?

Yes, $50k of income for ACA... $30k bond interest and $20k Roth conversion.

However, Roth conversions don't give you money to live on... it just transfers $20k from your tIRA pocket to your Roth IRA pocket. But you can probably get that extra $20k you need for spending from redemptions of your taxable portfolio.

As an aside, you might want to look at how your portfolio is positioned for tax efficiency.... having bonds in a taxable portfolio is very tax inefficient... especially if it means that as a result you end up with equities in yout tIRA which effectively converts qualified dividend income and long-term capital gains that is taxed at preferential rates into ordinary income that is subject to higher tax rates.... but that is a whole different discussion.

 

[Truckinalong]

I have taxable in muni bond fund (VWAHX) now to manage high tax bracket while working. That said, I am in at a good cost basis and will likely just keep it and live off interest plus principal reductions before 59.5. Convert just enough IRA to roth each year to manage ACA income while IRA balance continues to grow and tap that when 59.5. Overall it all shakes out to about a 50/50 allocation.

Is it most efficient, probably not, but seems to work for me and my risk tolerance.

 

[pb4uski]

Thanks for the clarification.... munis make sense... not taxed but counts for ACA... wasn't clear before.... sounds like you are on top of it.

 

[SevenUp]

1. Can I do roth conversion from 401k (first create IRA in Vanguard and roll 401k to it, then start doing conversions?) or do I have to move money to EJ?

No need to move money to EJ. May not need to use the 401k->tIRA step. Our Megacorp 401k with Fidelity allows directs 401k->Roth IRA conversions.

1a. If answer to 1 is yes, do I convert just the amount I want to roll over each year? (I think fees are a bit higher if I move out of 401k into ira with vanguard)

Yes, the marginal tax rate you will pay on the conversion (including ACA and/or IRMAA effects) should guide your conversion amount.

2. I have been reading about cost basis. Let's say I need my income to be below $50k/yr for health care considerations, that would mean I could convert $20k per year for the next 3 years?

https://thefinancebuff.com/tax-calculator-aca-obamacare-subsidy.html describes a tool that should be useful for you regarding this (and, for that matter, the generic marginal tax rate calculation).

3. Would I convert $20k exactly or would Vanguard or EJ provide me an adjusted amount based on cost basis?

That will be your choice - don't expect a broker to do those calculations for you.


I'll pass on #4....

 

[SecondCor521]

4. My wife is 5 yrs younger, so that would be five more years of keeping income low for her marketplace considerations I assume. Wondering if we should stop filing jointly at that point, so I could have a really low cost health option for her from the marketplace. Maybe I could hold off converting her traditional until this time and just focus on my conversions until I am 65.

Emphasis added.

This is not workable plan. If you file separately, your wife would not be eligible for an ACA subsidy, per:

https://www.healthinsurance.org/faq...-can-we-each-qualify-for-an-exchange-subsidy/

 

[bobbyr]

Emphasis added.

This is not workable plan. If you file separately, your wife would not be eligible for an ACA subsidy, per:

https://www.healthinsurance.org/faq...-can-we-each-qualify-for-an-exchange-subsidy/

Thank you

"the rules are clear that married couples must file a joint tax return in order to qualify for subsidies in the exchanges."

 

[2retireearly]

A 401K->tIRA rollover does not result in a tax hit. It's fine to do all of this at once.

The tIRA->Roth conversion is fully taxable, at regular income rates. Nowhere did the OP or anyone else suggest they do this all at once though.

And the tax is based on your entire taxable income for that year. So many people only convert a portion of the trad Ira to a Roth at a time, due to big taxes. Or...many don't do this conversion at all.

 

[sengsational]

Not to discount any of the intricate chess game that this stuff is, but even if you play a "perfect game", it's not going to make a really huge difference in your ability to spend or gift. A measurable difference, yes. Worth the trouble, probably. But, for example, moving from an income tax state to a non-income tax state (all else equal, which it never is, but if it were), would probably have a much larger impact than converting perfectly versus not converting. The i-orp modeling tool lets you turn off and on Roth conversions. The model isn't perfect, but can give you an idea about the magnitude of savings.

 

[BigMoneyJim]

I think I've heard of some that have a mix of tax-deferred and post-tax, but I don't know all the answers to that so I'm only answering the basic case.

Not related to OP's situation, but I somehow had some Roth 401k funds mixed in one of my Fidelity-held 401ks, and I just rolled it into IRAs. I had to open both a rollover IRA and a Roth, and they sorted it all out in the rollover.

 

[FIREarly]

Something to look into that might have already been discussed (did not read all of the pages of info) is a Roth Conversion Ladder. I am a rookie to this concept and might do it for the first time this year. It is to convert tIRA to Roth IRA (there is a max AROUND $17,500/year) and no taxes when staying within the limits. I believe this is one way to reach the triple tax savings of putting money in tax free, growing tax free, and converting within the limits so the money is taken out tax free from a Roth IRA.

You are talking about a 401k and not sure the process to moving your money to tIRA initially. There MIGHT be some kind of 401k Conversion Ladder (complete guess) or if you can move from 401k to tIRA and then tIRA to Roth IRA to avoid taxes.

This is all thoughts that have not been attempted yet. I am still growing investment/retirement income and studying for new certifications to increase income (to invest/save more).

Hope this provides you some added information to legally get your money tax free.