Roth Conversion Noob

[pb4uski]

What about 401k assets that you left in your old 401k account?

Or would you have to transfer those to tIRA and then transfer again to Roth?

But these conversions only make sense if you have low taxable income right?

If you have relatively high income, then the 401k distributions just raise the taxable income. I understand the general strategy though, when you're forced to take RMDs at age 70, it's better to have as much retirement assets in Roth IRA, not tIRA or 401k.

I rolled my 401k into an tIRA and then converted money into a Roth IRA... I'm not totally sure if you can go directly from a 401k to a Roth but you might be able to.

Yes, Roth conversions manke the most sense during periods of your life where your income tax rate is low.... especially lower than it will be in retirement once pensions, SS and RMDs are online.... commonly between when you retire and before pensions and SS start unless you need to keep your income low for ACA subsidies or other reasons.

If you're income/tax bracket excluding Roth conversions is higher than it will be in retirement then Roth conversions don't make sense.

 

[fh2000]

I rolled my 401k into an tIRA and then converted money into a Roth IRA... I'm not totally sure if you can go directly from a 401k to a Roth but you might be able to.

I have been doing Roth conversion directly from 401K to Roth IRA for few years now. I have done this in Vanguard as well as Fidelity. I have to open Roth IRA account first, then request the firms to do the conversion. I could not do it online. I had to be on the phone with both firms. I could not do in-kind conversion and I had to liquidate some funds and convert the cash.

What both firms had to check was if the company allows the conversion. In my case, my ex-employer does allow that.

 

[RetiredAndLovingIt]

You can do Roth Conversions from your Traditional IRA with no penalty regardless of your age.
The entire amount I convert goes into the Roth account. So 50K out of IRA and 50K into Roth IRA. While you are required to pay taxes on the amount converted, you are not obligated nor would you want to pay them from the conversion amount. The Conversion request form gives you 2 options for Federal Withholding or No Withholding. I check the No withholding box.
I also pay quarterly estimated taxes which includes the taxes on the conversion amount. These taxes are paid from my after tax savings and the 50K continues to grow tax free forever in the Roth Account.

 

[RetiredAndLovingIt]

Here is the IRS Rollover Chart for Rollovers of Retirement funds, see notes at bottom.

https://www.irs.gov/pub/irs-tege/rollover_chart.pdf

 

[SecondCor521]

So let's get this straight, if I am in the 12% tax bracket, under 59-1/2 and do a Roth conversion of 100K from the IRA and pay all taxes & penalties from that IRA. I start by taking 100K out of the IRA. Some of that is going to taxes. How much more than simple taxes is the penalty?

1st pass = 12% of the 100K is taxable, or 12K leaving 88K to go to the Roth. But wait, 10% of that 12K is a penalty 2nd pass = 10% of 12% is 1.2%. An additional 1.2% on top of 12% is 13.2%. This puts 86.8K to the Roth. That would be a nontaxed part of the IRA withdrawal.

Two problems with this math:

1. You'd have to repeat the calculation until the series converged, if it does. I'm not sure it does, because whenever you withhold $X from the conversion, you owe 10% of $X as a penalty. Thus X[n+1] = 1.1 * X[n]. $X will never converge with that sort of problem. So the series diverges, I think.

2. The penalty is only on the withheld amount, not the entire $100K.

I admit that I haven't gone through the tax forms. Are you saying that the entire 100K gets penalized? i.e. 22% of the IRA withdrawal goes to Uncle Sam? That doesn't sound right or fair.

It isn't correct.

One could debate "fair" but that is right. See Part I of Form 5329.

Nope. From the instructions for Form 5329 Part I:

"The additional tax on early distributions doesn’t apply to any of the following[:]
[...]
A distribution from a traditional or SIMPLE IRA that was converted to a Roth IRA."

-- https://www.irs.gov/pub/irs-pdf/i5329.pdf page 2 column 3

It's right.... that's why they call it a penalty, silly. They want to make it unattractive for people to withdraw money before they are 59-1/2. I think it is good... that way people are less inclined to take money out of their retirement plans for a new toy of some sort or splurge vacations or whatever which preserves that money for their retirement.

I agree with the penalty aspect, so it's "right" in that sense. But it's incorrect to say that the penalty applies to the entire amount.

 

[CRLLS]

SecondCor521, YOu have pointed to the paragraph that explains my position. Thank you. Later in that paragraph it says "

Note. Any related IRA earnings withdrawn
with excess IRA contributions are subject
to the 10% additional tax on early distributions if you were under age 591/2 at
the time of the distribution.

"

I get the repeating of the calculations.... part too. I was trying to keep the analysis simple. Sorry if that confused some.

I'm note sure if pb4uski was calling me names or commenting on the obvious part of the penalty part. I'll assume the latter.

Your posting makes me feel a bit better about our tax system. I couldn't understand how a Roth conversion would not create a penalty if 100% of the withdrawal (conversion) was moved while if 90% ended up in the Roth, that 90% was also penalized 10%. Again thanks.

 

[SevenUp]

Are you saying that the entire 100K gets penalized? i.e. 22% of the IRA withdrawal goes to Uncle Sam? That doesn't sound right or fair.

One could debate "fair" but that is right. See Part I of Form 5329.

Nope. From the instructions for Form 5329 Part I:

"The additional tax on early distributions doesn’t apply to any of the following[:]
[...]
A distribution from a traditional or SIMPLE IRA that was converted to a Roth IRA."

Semantics, but when dealing with the IRS and taxes the words do matter: the amount withdrawn is subject to the penalty, but not the amount converted.

 

[pb4uski]

....I agree with the penalty aspect, so it's "right" in that sense. But it's incorrect to say that the penalty applies to the entire amount.

You are correct and I agree, the penalty is on the withdrawal, which is the taxes withheld, not on the entire conversion amount.

So for example, if $100k is taken out of the tIRA, $20k withheld and $80k put into the Roth, then the tax is on the $100k conversion and the 10% penalty is on the $20k withheld which is a withdrawal. So if the conversion is taxed at 12% then the taxpayer would owe $14k... $12k of tax ($100k *12%) and $2k penalty ($20k * 10%).... and would be due a $6k refund. Sorry for the confusion.

 

[explanade]

Why would there be any penalty if you're rolling over to another retirement account?

Also if you're over 59.5, you don't have any penalties?

 

[pb4uski]

^^^ Penalty is only on the amount of income taxes withheld if you are not yet 59-1/2... since the taxes withheld are a benefit to you it is like a withdrawal so is subject to the 10% early withdrawal penalty.

 

[samcat]

www.newretirement.com has a new roth conversion calculator. I played with it today. You might want to check it out.

 

[rrs26ja]

pb4uski is correct, you will have to pay federal and state income tax on this money but it doesn't effect your Social Security earned income. I just went through this at the end of last year and 1Q of this year doing a $40k and $60k Roth conversion. My plan is to convert as much as I can to keep me in the 22% fed tax bracket until RMD starts which I believe is now going to be 75.

 

[Exchme]

With only $300K in tax deferred to last from age 49 to 65 to stay off Medicaid, the challenge will be to mete that out carefully and not use it too fast. That greatly simplifies the problem, just use the Medicaid income eligibility maximum for your state as your total target for the sum of the conversion + taxes + early withdrawal penalty. Then use a tax program to figure the taxes & penalties on that target income and the rest is the Roth conversion.

So to make up an example, if your state's income limit is $30,000 (I'll assume no state income tax):

Then the tax on that for MFJ is $413 + the 10% penalty (say $42) = $435 in taxes. So Roth convert the rest, $29,565.

 

[Phroig]

You are correct and I agree, the penalty is on the withdrawal, which is the taxes withheld, not on the entire conversion amount.

So for example, if $100k is taken out of the tIRA, $20k withheld and $80k put into the Roth, then the tax is on the $100k conversion and the 10% penalty is on the $20k withheld which is a withdrawal. So if the conversion is taxed at 12% then the taxpayer would owe $14k... $12k of tax ($100k *12%) and $2k penalty ($20k * 10%).... and would be due a $6k refund. Sorry for the confusion.

A withholding of $13,333 gets it just right, I think. Tax of $12K plus a penalty of $1,333 equals $13,333. State taxes extra, of course.
($X = $12K + 10%*$X)

 

[Al18]

You should use a tax calculator or your tax program to create a separate file to get a better estimate of the Federal Taxes that need to be withheld. In my situation (12% tax bracket), I determined I only need to withhold 8% to convert $48K. I am older, so there is no penalty.