Roth Conversion & Taxes

[DektolMan]

This might seem like a stupid question but here goes.

If my wife & I are in the 15% tax bracket and I do a Roth conversion this year of 50k will the 50k be taxed in the 15% bracket we're in or will we be bumped into the next bracket which would be the 25% bracket?

Thanks in advance.

ADUM

 

[tjon72]

The taxable amt is added to your AGI and where that falls is where your tax due is calculated. I guess you realize that you can split the tax half and half between 2001/2012

 

[kaneohe]

Looks like the 15% bracket goes from17 to 69K this yr
Reference Room
so if all the stars aligned you might just fit 50K of conversion in but since it seems unlikely
that you'd just be at the bottom of the 15% bracket w/o conversion, it seems more likely that part will be at 15% and the rest at 25%. Best to use some tax software and see...
you could do a partial and tune it for just 15%.

 

[haha]

This might seem like a stupid question but here goes.

If my wife & I are in the 15% tax bracket and I do a Roth conversion this year of 50k will the 50k be taxed in the 15% bracket we're in or will we be bumped into the next bracket which would be the 25% bracket?

Thanks in advance.

ADUM

There is not enough information to answer your question. If your 2011 income will be similar to your 2010 income except for the Roth Conversion, then you need to subtract your 2010 taxable income other than capital gains and qualified dividends from the upper limit of the 15% bracket for MFJs. I believe that is limit is $68,000. That number minus income as defined above gives you as estimate of the room you have for a Roth conversion at the 15% tax level. $50,000 minus that room tells you the amount that will be converted at 25%.

Ha

 

[DektolMan]

that's what I thought. Thank you for your replys.

ADUM

 

[jimnjana]

The taxable amt is added to your AGI and where that falls is where your tax due is calculated. I guess you realize that you can split the tax half and half between 2001/2012

Not really, what matters is "taxable income" which is the AGI reduced by exemptions and standard or itemized deductions. also he has to keep in mind that only the portion of "taxable income" that is above 69k is taxed at 25%.

 

[Nords]

This might seem like a stupid question but here goes.
If my wife & I are in the 15% tax bracket and I do a Roth conversion this year of 50k will the 50k be taxed in the 15% bracket we're in or will we be bumped into the next bracket which would be the 25% bracket?
Thanks in advance.

What other posters are alluding to is that your IRA is a combination of deductible contributions, non-deductible contributions, and (hopefully) gains. When you do the conversion, only the deductible contributions and the gains are taxed. So you're converting an IRA that has a $50K balance but perhaps only $20K of that is taxable.

The way to figure this out is to go to your IRS Form 8606 from last year's tax returns. (It tracks the cost basis of your conventional IRA. You [and your spouse, if applicable] filed a Form 8606 with every previous non-deductible contribution to a conventional IRA. Just nod your head for now as if you know what I'm talking about.) Then download a blank copy of Form 8606 from the IRS.gov website and follow the instructions for taxing a conversion to a Roth IRA. The details of that are in IRS Pub 590 but the instructions for the form are also next to its link on the IRS website. Completing the form gives you a number to add to the rest of your adjusted gross income as the taxable amount of your IRA conversion.

If you don't have any forms 8606 in previous tax returns then you either (1) didn't do it right or (2) the basis of your conventional IRA is considered to be zero-- all deductible contributions + gains, and all taxable. In that case you'd be converting a $50K conventional IRA and adding all $50K of it to the rest of your adjusted gross income.

And as another poster has mentioned, only the amount that exceeds the top end of the 15% bracket is taxed at 25%. If you fiddle around with the conversion amount on Form 8606 then you can figure out how much of the IRA you want to convert to a Roth IRA (for example, a "partial conversion" of $20K or $30K) to remain within the 15% bracket. Spouse and I have been doing this for at least six years now.

 

[kaneohe]

haha has introduced an interesting wrinkle which makes the use of tax software even more inportant in order to avoid running into the "phantom" 30% bracket if you have signficant amounts of qualified dividends/cap gains. Assume your
taxable income was 59K and included 20K of QDIV/CG. The boundary between 15% and 25% brackets is 69K. You have 10K (69K - 59K) left in the 15% bracket for the taxable part of your Roth conversion (Nord's wrinkle).
If the taxable part of your Roth conversion increased even more ,the next 20K would would displace the 20K of QDIV/CG (in the 15% bracket and taxed at 0%) into the 25% bracket (and taxed at 15%). Effectively , adding 20K of taxable Roth conversion (after the initial 10K), would be taxed at 30%.

 

[bcinvest]

The taxable amt is added to your AGI and where that falls is where your tax due is calculated. I guess you realize that you can split the tax half and half between 2001/2012

That train has left the station. To split the tax the rollover needed to be completed in 2010.

 

[tjon72]

That train has left the station. To split the tax the rollover needed to be completed in 2010.

Actually, I THINK it must be done before filing 2010 taxes, no ?

 

[kaneohe]

Actually, I THINK it must be done before filing 2010 taxes, no ?

......but if you didn't do the rollover in 2010, there would be nothing to claim on your 2010 taxes. A rollover in 2011 would be captured on 2011 taxes next yr.

 

[Nords]

Actually, I THINK it must be done before filing 2010 taxes, no ?

Unlike contributions, Roth IRA conversions need to be accomplished during the calendar year.

 

[ronin]

Not to belabor the point, but obviously one could split a 2011 conversion into two (the 2nd part in 2012) and effectively split one's tax burden over 2 yrs.

 

[haha]

Not to belabor the point, but obviously one could split a 2011 conversion into two (the 2nd part in 2012) and effectively split one's tax burden over 2 yrs.

How is that obvious? The only thing I have seen is that a 2010 conversion can be spit into 2-tax years 2011 and 2012. As far as I know, this splitting is not now part of the tax code for every year, or for any year other than 2010.

Ha

 

[tjon72]

Guess I was thinking of being able to un convert prior to filing the 2010 taxes.........oops !!

 

[ronin]

How is that obvious? The only thing I have seen is that a 2010 conversion can be spit into 2-tax years 2011 and 2012. As far as I know, this splitting is not now part of the tax code for every year, or for any year other than 2010.

Ha

I meant that rather than converting all in 2011, convert part this year and part next. If half is done on 12/31/11 and the other half 1/1/12, the tax would be due in spread across 2 yrs but conversions would only be 2 days apart. Sorry if I was unclear. It's a simple work-around with a fairly low negative impact assuming a long seasoning time until withdrawal.

 

[Aeowyn]

haha has introduced an interesting wrinkle which makes the use of tax software even more inportant in order to avoid running into the "phantom" 30% bracket if you have signficant amounts of qualified dividends/cap gains. Assume your
taxable income was 59K and included 20K of QDIV/CG. The boundary between 15% and 25% brackets is 69K. You have 10K (69K - 59K) left in the 15% bracket for the taxable part of your Roth conversion (Nord's wrinkle).
If the taxable part of your Roth conversion increased even more ,the next 20K would would displace the 20K of QDIV/CG (in the 15% bracket and taxed at 0%) into the 25% bracket (and taxed at 15%). Effectively , adding 20K of taxable Roth conversion (after the initial 10K), would be taxed at 30%.

I found that the phantom 30% bracket for 2010.

DH and I both contributed to Roth IRAs last year. I don't qualify for deductible contributions to a Traditional IRA (covered by retirement plan at work), but DH does. So I'm considering re-characterizing his IRA contribution to Traditional to get more of our LT Cap gains into the 15% bracket.

 

[kaneohe]

I found that the phantom 30% bracket for 2010.

DH and I both contributed to Roth IRAs last year. I don't qualify for deductible contributions to a Traditional IRA (covered by retirement plan at work), but DH does. So I'm considering re-characterizing his IRA contribution to Traditional to get more of our LT Cap gains into the 15% bracket.

well....if I didn't know what that face meant before, I do now. Software seems to translate when replying.

One of the benefits of stepping into doo, is that you'll probably never forget
.....and even if you remember, you might still fall into it. I waited until late Dec so I could get a good handle on the fund distributions and then converted to fill the rest of 15% bracket. Two days later HPQ decided to shift their quarterly dividend from January to Dec which along w/ some other surprises kicked me a few thousand over. The other surprise I got was that I converted a broker CD thinking it wouldn't change much, if at all, in value and not anticipating having to recharacterize. As it turns out, since you can't arbitrarily recharacterize specific amounts of the CD but they have to be in increments of 1K face so that would have meant giving up some of the 5%CD. I ended up recharacterizing a fund from my Roth instead of DW's CD. Still, I guess it's quite a nice technique over-converting and being able to take a second look months later to fine tune results, even if it is a bit more trouble.

 

[Nords]

Roth IRAs and tax deferral | Vanguard Blog

Vanguard had a pretty interesting set of assumptions in "proving" that a Roth IRA is a better deal than a non-deductible IRA.

I'll just be happy when all the conversion tax paperwork is finished. One or two more years...