Converting RO IRA to ROTH

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Converting RO IRA to ROTH

Postby corner559 » Wed May 08, 2013 11:18 pm

I have about $150,000 sitting in a Rollover IRA. My US tax rate is currently 0% since I live overseas and I earn under the $90,000 or so threshold for taxable income outside of the US. I don't plan on returning to the States for some time, so would it make sense for me to convert all of my holdings in my RO IRA to my ROTH? Additionally, would it make sense for me to use money from the RO IRA to pay the tax bill? I do have cash on hand to pay it, but I'd rather not touch it since I will need a good chunk of that money for grad school soon.
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Re: Converting RO IRA to ROTH

Postby Alan S. » Wed May 08, 2013 11:36 pm

You should consider converting no more in any one year than the top of your 10% bracket if you plan on being overseas for around 5 years. That should minimize taxes taken from the conversion distribution since any amount distributed but not converted will be subject to tax and the 10% penalty.

Of course, any conversion decision should factor in other details regarding your overall tax situation and future earnings and saving potential. Converting at 0 tax is a no brainer, but without analyzing these other considerations it is not clear at which point conversions should stop due to the taxes you will pay.
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Re: Converting RO IRA to ROTH

Postby Epsilon Delta » Wed May 08, 2013 11:47 pm

corner559 wrote:I do have cash on hand to pay it, but I'd rather not touch it since I will need a good chunk of that money for grad school soon.

How soon is soon? If it's beyond Jan 1 2017 2018 you can convert this year and withdraw the converted amount tax and penalty free.

Edited because I can't add. :oops:
Last edited by Epsilon Delta on Thu May 09, 2013 9:06 am, edited 1 time in total.
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Re: Converting RO IRA to ROTH

Postby Bob's not my name » Thu May 09, 2013 3:33 am

Will you be in the 0% bracket in grad school too?
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Re: Converting RO IRA to ROTH

Postby Bob's not my name » Thu May 09, 2013 3:35 am

corner559 wrote:I have about $150,000 sitting in a Rollover IRA.
Why is "sitting" in this sentence? Will you use "sitting" to describe what your money will do in the Roth IRA?
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Re: Converting RO IRA to ROTH

Postby corner559 » Fri May 10, 2013 10:34 am

I'll be using the cash within the next 2-3 years for grad school. And while in school I have enough saved up to not have to work for the duration of my studies.

Should money from my RO IRA be used to pay the taxes or should I use the cash I have in hand to pay the taxes?
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Re: Converting RO IRA to ROTH

Postby Alan S. » Fri May 10, 2013 11:11 am

If you are sure that your cash needs will be limited to qualified higher education expenses, you could convert an amount to a Roth IRA and pay the taxes with your other funds. Later on if you need IRA money for expenses, you can distribute the conversion funds before the 5 year period is complete and file a 5329 to waive the 10% using the qualified higher education expense exception code. This is better than using withholding on your conversion for two reasons:
1) You won't have the higher education exception when you do the conversion meaning you will have to pay the 10% tax on the withheld amount as well as taxes on the withheld amount.
2) If you don't need the money from the Roth, you will have the money in the Roth sooner earning potentially tax free earnings.

This is not an "all or nothing" choice. If circumstances dictate you could withhold on only part of your conversion and pay the rest of the tax from your other money. This will result in not burning through your other money as fast.

But the real long term benefit will come from only converting an incremental portion of your TIRA to Roth such that the conversion does not trigger marginal taxes or is restricted to the lowest brackets. You also have the recharacterization option to utilize under which you could recharacterize part of your conversion if you find that you converted too much when you prepare your tax return. Extending this option, you could also convert much more than you intend to retain using two conversions invested in non correlated assets to two different Roth accounts and recharacterize the lower performing conversion.

Finally, if/when you are single and considering marriage to a much lower earning spouse, you could convert considerably more when filing jointly before your joint earnings penetrate the higher brackets. The higher education penalty exception can also apply to either spouse's distributions when used for the expenses of EITHER spouse.

You have considerable flexibility here, particularly with the "do over" option of recharacterization available to you.
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Re: Converting RO IRA to ROTH

Postby Sheepdog » Fri May 10, 2013 11:16 am

corner559 wrote:

Should money from my RO IRA be used to pay the taxes or should I use the cash I have in hand to pay the taxes?

If you use the money from your rollover to pay the tax, you will be reducing your IRA investment. To maintain it you should use available cash on hand to pay the tax.

As a side note, when I did my initial conversion from my rollover IRAs to Roth I converted the amount I wanted over a five year period while keeping my tax level within the 10% level. I had cash outside the IRAs to pay the tax.
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Re: Converting RO IRA to ROTH

Postby Bob's not my name » Fri May 10, 2013 1:47 pm

corner559 wrote:2-3 years for grad school. And while in school I have enough saved up to not have to work for the duration of my studies.
So you'll have several years to convert in the 0% bracket. Therefore there will be no taxes to pay. Be sure to convert school years to tax years and think about how much 0% bracket you'll have in the aggregate. Look at education credits and how they work.
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