Should I convert Traditional IRA to Roth?

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Should I convert Traditional IRA to Roth?

Postby squidler4 » Tue Apr 02, 2013 11:17 pm

I am new to this forum have been reading a lot about converting IRA's and backdoor Roth's. I wasn't aware that the limitations were lifted in 2010 to be able to convert a traditional IRA to a Roth IRA until I read this forum.

My wife and I have $190,000 combined in separate Traditional IRA's at Vanguard. We have maxed out our IRA's for at least 15 years with after tax income. We cannot directly contribute to a Roth (our income level is too high). We are both 48 yrs old and both have local gov. pension's and approximately $1mil combined in 457b accounts. We can comfortably live on our pension and 457b withdrawals. Our taxable income will be roughly the same after retirement. We do not plan on touching the IRA's until later in life or possibly pass them on to our two kids.

Our tax rates are Fed: 33%/ State 9.3% (CA)

Does it make sense to convert all or some of the traditional IRA's to Roths? I assume we would have to pay taxes on gains in the account. We could stretch this out over several years to spread the taxes out.

Should we do the backdoor method of putting money into our Roths in the future? Is it too late for 2012?

Would it be better to take withdrawals from the IRA's before the 457b's?

Thanks in advance.
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Re: Should I convert Traditional IRA to Roth?

Postby tfb » Wed Apr 03, 2013 1:06 am

squidler4 wrote:Our tax rates are Fed: 33%/ State 9.3% (CA)

Does it make sense to convert all or some of the traditional IRA's to Roths? I assume we would have to pay taxes on gains in the account.

Standard procedure. "Hide" the gains and then convert.
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Re: Should I convert Traditional IRA to Roth?

Postby trasmuss » Wed Apr 03, 2013 6:37 am

Personally I would not see any benefit to converting your IRA to a Roth at this time. If there is a chance that your rates could drop before you begin taking retirement pensions; then that may be a good time.

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Re: Should I convert Traditional IRA to Roth?

Postby JW Nearly Retired » Wed Apr 03, 2013 7:25 am

squidler4 wrote: I am new to this forum have been reading a lot about converting IRA's and backdoor Roth's. I wasn't aware that the limitations were lifted in 2010 to be able to convert a traditional IRA to a Roth IRA until I read this forum.

My wife and I have $190,000 combined in separate Traditional IRA's at Vanguard. We have maxed out our IRA's for at least 15 years with after tax income. We cannot directly contribute to a Roth (our income level is too high). We are both 48 yrs old and both have local gov. pension's and approximately $1mil combined in 457b accounts. We can comfortably live on our pension and 457b withdrawals. Our taxable income will be roughly the same after retirement. We do not plan on touching the IRA's until later in life or possibly pass them on to our two kids.

Our tax rates are Fed: 33%/ State 9.3% (CA)

Does it make sense to convert all or some of the traditional IRA's to Roths? I assume we would have to pay taxes on gains in the account. We could stretch this out over several years to spread the taxes out.

Should we do the backdoor method of putting money into our Roths in the future? Is it too late for 2012?


Once you are 70 you must take RMDs except from Roth IRAs.

Did you file IRS forms 8606 with your tax returns documenting your basis in non-deductible contributions over the year? If not, do them all now. The 8606 is what you and IRS use to keep track of your non-deductinble contribution basis. 15 years of them probably means they are a good percentage of the $190k. You can't do back door without paying tax since taxes are always pro-rata on the sum total basis in all your IRAs. You just have one big IRA in IRS eyes. If your after tax contribution basis is 50% of all IRA accounts then you pay tax on only 50% of the Roth converted money.

If you are certain your tax rate in retirement is going to be the same, and you have no way to "hide" the after-tax money in a 401k, then I would just start converting whatever yearly amount you have enough extra money to pay the tax on. Keep making non-deductible contributions and eventually the before-tax money should be pretty diluted so you can afford to convert the balance.

Disclosure: We waited and waited for a good time to convert my modest IRA and it never came. I converted it all this year because 401k RMDs start next year and my tax rate will get worse.
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Re: Should I convert Traditional IRA to Roth?

Postby bUU » Wed Apr 03, 2013 7:40 am

I've gone back and forth (and probably will continue to do so) regarding Roth conversions for my spouse and I, starting out ignorant, switching to being inclined towards Roth conversions (getting ready to rollover tIRAs into current-employer 401ks), then switching to inclined against Roth conversions (getting ready to rollover tax-deferred 401ks into tIRAs). The newest wrinkle causing me to reconsider again is the ACA subsidy, and how keeping AGI after we stop working below (in today's dollars) ~$64k could have some significant positive impact. We're going to have at least five years, if not ten years, between when I stop working and when I can file for Medicare, so that's at least that long buying individual (non-group) health insurance. Previously, the implications of Roth were mostly how it lowered AGI at the time of contribution and controlled taxation at the time of distribution. Now, I think we have to factor in much more how much Roth contributes to keeping AGI low at the time of distribution and how that impacts the ability to capitalize on ACA subsidies.
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Re: Should I convert Traditional IRA to Roth?

Postby Default User BR » Wed Apr 03, 2013 11:39 am

How much of the total is taxable? Do you have 401(k) or similar plans? If so, check to see if they will accept rollovers from IRAs. That's a way to move taxable amounts out of the way to perform tax-free conversions and backdoor Roth from that point on.


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Re: Should I convert Traditional IRA to Roth?

Postby bdpb » Wed Apr 03, 2013 6:09 pm

What's the breakdown of His vs Her IRA values? Might make sense to do a smaller one.

Do you have taxable accounts? Taxable investing in your tax bracket is relatively expensive, especially in CA. Would argue for doing conversions now.

Do you plan to retire in a different state? Many states exempt IRA withdrawals and/or conversions and pensions, too. Would argue for doing conversions in retirement.
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Re: Should I convert Traditional IRA to Roth?

Postby squidler4 » Thu Apr 04, 2013 8:22 pm

bdpb wrote:What's the breakdown of His vs Her IRA values? Might make sense to do a smaller one.

Do you have taxable accounts? Taxable investing in your tax bracket is relatively expensive, especially in CA. Would argue for doing conversions now.

Do you plan to retire in a different state? Many states exempt IRA withdrawals and/or conversions and pensions, too. Would argue for doing conversions in retirement.


There is a possibility we may move to PA but that is at least 8-10 years away so I am not sure how PA treats IRA's etc. I will have to research it. Thanks for the response.
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Re: Should I convert Traditional IRA to Roth?

Postby squidler4 » Thu Apr 04, 2013 8:25 pm

JW Nearly Retired wrote:
squidler4 wrote: I am new to this forum have been reading a lot about converting IRA's and backdoor Roth's. I wasn't aware that the limitations were lifted in 2010 to be able to convert a traditional IRA to a Roth IRA until I read this forum.

My wife and I have $190,000 combined in separate Traditional IRA's at Vanguard. We have maxed out our IRA's for at least 15 years with after tax income. We cannot directly contribute to a Roth (our income level is too high). We are both 48 yrs old and both have local gov. pension's and approximately $1mil combined in 457b accounts. We can comfortably live on our pension and 457b withdrawals. Our taxable income will be roughly the same after retirement. We do not plan on touching the IRA's until later in life or possibly pass them on to our two kids.

Our tax rates are Fed: 33%/ State 9.3% (CA)

Does it make sense to convert all or some of the traditional IRA's to Roths? I assume we would have to pay taxes on gains in the account. We could stretch this out over several years to spread the taxes out.

Should we do the backdoor method of putting money into our Roths in the future? Is it too late for 2012?


Once you are 70 you must take RMDs except from Roth IRAs.

Did you file IRS forms 8606 with your tax returns documenting your basis in non-deductible contributions over the year? If not, do them all now. The 8606 is what you and IRS use to keep track of your non-deductinble contribution basis. 15 years of them probably means they are a good percentage of the $190k. You can't do back door without paying tax since taxes are always pro-rata on the sum total basis in all your IRAs. You just have one big IRA in IRS eyes. If your after tax contribution basis is 50% of all IRA accounts then you pay tax on only 50% of the Roth converted money.

If you are certain your tax rate in retirement is going to be the same, and you have no way to "hide" the after-tax money in a 401k, then I would just start converting whatever yearly amount you have enough extra money to pay the tax on. Keep making non-deductible contributions and eventually the before-tax money should be pretty diluted so you can afford to convert the balance.

Disclosure: We waited and waited for a good time to convert my modest IRA and it never came. I converted it all this year because 401k RMDs start next year and my tax rate will get worse.
JW


Yes II have filed 8606 forms since the beginning but I have never accumulated them to determine how much I have contributed vs how much is gain. I will have to do this. Thanks for the advice after reading these posts I realize I need to do a lot more research. I downloaded Bogleheads guide to retirement and am going away for the weekend so I have plenty of time to read it.
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Re: Should I convert Traditional IRA to Roth?

Postby squidler4 » Thu Apr 04, 2013 8:28 pm

Default User BR wrote:How much of the total is taxable? Do you have 401(k) or similar plans? If so, check to see if they will accept rollovers from IRAs. That's a way to move taxable amounts out of the way to perform tax-free conversions and backdoor Roth from that point on.


Brian


Good question. I have a 457b through ICMA-RC so I will have to find out if I can roll the IRA into that account.

Thanks for the response.
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Re: Should I convert Traditional IRA to Roth?

Postby kaneohe » Fri Apr 05, 2013 10:51 am

squidler4 wrote:Yes II have filed 8606 forms since the beginning but I have never accumulated them to determine how much I have contributed vs how much is gain. I will have to do this.


I am not sure what you mean here.........each 8606 builds on the previous history so you should only have to look at the last one assuming the previous ones were done correctly.
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Re: Should I convert Traditional IRA to Roth?

Postby Peter Foley » Fri Apr 05, 2013 11:06 am

While this is very unbogleheadish advice, I think this is an instance where one can actually use market timing. If your contributions are after tax, you would pay tax only on the earnings when you convert. Why not wait until the market is down and the earnings are a lower percentage?

Granted the market may never be lower than it is today - but that is a good thing in its own right. Your 457's will have prospered.

You may also have a few years early in retirement where your income and tax rate are lower and could do it then.

In short, I would be in no rush to do it now at your current tax rate.
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Re: Should I convert Traditional IRA to Roth?

Postby squidler4 » Mon Apr 08, 2013 3:46 pm

kaneohe wrote:
squidler4 wrote:
Thanks Kaneohe for replying,

Yes II have filed 8606 forms since the beginning but I have never accumulated them to determine how much I have contributed vs how much is gain. I will have to do this.


I am not sure what you mean here.........each 8606 builds on the previous history so you should only have to look at the last one assuming the previous ones were done correctly.


Sorry Let me clarify, I just spent two hours looking through old tax returns and IRA statements and realized I screwed up a couple of times. I started our IRA's in 1995. It seems I never filed forms 8606 for 1995 and 1996 then started doing them in 1997. In 1999 we contributed to a Roth and not a traditional IRA but when I did my 8606 in 2000 I still added the amount to the basis of our traditional so I was $2,000 over per account. Then in 2006 for some reason I did not file an 8606 form so in 2007 Turbo Tax put my basis back to 0 for the prior year. From that point forward my 8606 reported basis was incorrect. So today I sent in my 2006 8606's with the now correct basis. I also corrected the basis on my 2012 tax return.

So the correct basis for our traditional IRA's is :

Mine: Basis $53,297 - Current Value $93,574 = Gain: $40,277
Hers: Basis $53,696 - Current Value $86,005 = Gain: $33,309

So converting them to a Roth would mean I would have to pay taxes (28% Fed/9.3% State) on the gain of $73,586 if I did it all at the same time?

Fed Tax: $20,604
State Tax: $6,843
Total: $27,447

If I did this, I could sell other Vanguard investments that are in taxable accounts to pay the taxes next year but from this point forward all gains would be non taxable because they would be in a Roth IRA. The negative part is the $27,447 would no longer be available to me. So the IRS either gets it now or gets it later.
Last edited by squidler4 on Mon Apr 08, 2013 3:48 pm, edited 1 time in total.
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Re: Should I convert Traditional IRA to Roth?

Postby squidler4 » Mon Apr 08, 2013 3:48 pm

Peter Foley wrote:While this is very unbogleheadish advice, I think this is an instance where one can actually use market timing. If your contributions are after tax, you would pay tax only on the earnings when you convert. Why not wait until the market is down and the earnings are a lower percentage?

Granted the market may never be lower than it is today - but that is a good thing in its own right. Your 457's will have prospered.

You may also have a few years early in retirement where your income and tax rate are lower and could do it then.

In short, I would be in no rush to do it now at your current tax rate.


Would you suggest keeping it in the traditional IRA but shifting it into a MM account until the market dips? Then convert it to a Roth? Or am I missing something?

Thanks
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Re: Should I convert Traditional IRA to Roth?

Postby grabiner » Mon Apr 08, 2013 9:44 pm

squidler4 wrote:Mine: Basis $53,297 - Current Value $93,574 = Gain: $40,277
Hers: Basis $53,696 - Current Value $86,005 = Gain: $33,309

So converting them to a Roth would mean I would have to pay taxes (28% Fed/9.3% State) on the gain of $73,586 if I did it all at the same time?

Fed Tax: $20,604
State Tax: $6,843
Total: $27,447


Reduce the federal tax by $1916 because the state tax is deductible from federal. (unless the 28% bracket is the result of AMT).

So you will pay $25,531 in tax to convert $179,579; that is 14%. If you keep the IRAs until you retire, you will lose much more than 14% of their value to taxes, as you will probably retire in a 25% or 28% bracket (due to your 457(b) income and pensions) and the IRAs will be mostly taxable by then. This makes the conversion a good deal.
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Re: Should I convert Traditional IRA to Roth?

Postby Watty » Mon Apr 08, 2013 11:14 pm

If your pension is not adjusted for inflation then the RMD's may increase as inflation decreases the value of your pension so that you may be increasing the amount you actually want to withdrawal from the IRA. It could be that having to take a RMD is a non-issue until you are much older since you could want to take that much money out anyway.

We do not plan on touching the IRA's until later in life or possibly pass them on to our two kids.

Our tax rates are Fed: 33%/ State 9.3% (CA)


I would think it likely that the kids will be in a lower tax bracket than you especially if they are living in state with lower state taxes.

If so then the there might not be much advantage in them inheriting a Roth instead of a larger amount in an IRA so you might want to focus on the advantages that you will get from any Roth conversion while you are still alive.

The negative part is the $27,447 would no longer be available to me.


If you did not use that money to pay the taxes for a Roth conversion then it could also be left in a stock investment and then eventually go to your estate at a stepped up cost basis.

If you will eventually leave the RMD money to your estate anyway then the advantages of being able to leave investments to your estate at a stepped up cost basis partially offset the taxes that are paid on an unneeded RMD. For example if you invest your RMD in an index fund when you are 71 and it is left there for 20 years then it is inherited at the stepped up cost basis then your heirs would get that without paying any taxes on it.
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