moving pre-tax money to after-tax for free?

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moving pre-tax money to after-tax for free?

Postby ghost9804 » Tue Feb 12, 2013 11:44 am

I just got an interesting thought, to move pre-tax money from traditional IRA/401K to after-tax money in Roth.

say we have some funds both in pretax and after tax account. when the market is right, we can sell the under performing fund in pretax account and buy back in after tax account. Also, we can sell over performing funds in after tax account and buy back in pretax account. of course, overall AA kept the same.
This way, we can always realize losses in pretax account and move the gain to the after tax account, tax free!!

have anyone tried this? is this a stupid idea?
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Re: moving pre-tax money to after-tax for free?

Postby Kosmo » Tue Feb 12, 2013 11:47 am

Wash sale?
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Re: moving pre-tax money to after-tax for free?

Postby ghost9804 » Tue Feb 12, 2013 11:50 am

I assume wash sale not applicable to tax sheltered account

Kosmo wrote:Wash sale?
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Re: moving pre-tax money to after-tax for free?

Postby Grt2bOutdoors » Tue Feb 12, 2013 11:52 am

ghost9804 wrote:I just got an interesting thought, to move pre-tax money from traditional IRA/401K to after-tax money in Roth.

say we have some funds both in pretax and after tax account. when the market is right, we can sell the under performing fund in pretax account and buy back in after tax account. Also, we can sell over performing funds in after tax account and buy back in pretax account. of course, overall AA kept the same.
This way, we can always realize losses in pretax account and move the gain to the after tax account, tax free!!

have anyone tried this? is this a stupid idea?


In your imaginary scenario, fine. In real life, the IRS will call you down and have you explain your idea before they start disallowing it and fining you silly. If you sell and buy the same funds, its a wash. If you sell the S&P 500 and buy the Large Cap Index - no wash, and you'd be fine under current regulations to do so.
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Re: moving pre-tax money to after-tax for free?

Postby ghost9804 » Tue Feb 12, 2013 11:56 am

Wash sale applies when sell for a loss in a taxable account to claim tax benefit
if I sell in traditional IRA and buy back in ROTH/taxable, there is no capital loss to claim, nothing reported to IRS, still considered a wash sale?

Grt2bOutdoors wrote:
ghost9804 wrote:I just got an interesting thought, to move pre-tax money from traditional IRA/401K to after-tax money in Roth.

say we have some funds both in pretax and after tax account. when the market is right, we can sell the under performing fund in pretax account and buy back in after tax account. Also, we can sell over performing funds in after tax account and buy back in pretax account. of course, overall AA kept the same.
This way, we can always realize losses in pretax account and move the gain to the after tax account, tax free!!

have anyone tried this? is this a stupid idea?


In your imaginary scenario, fine. In real life, the IRS will call you down and have you explain your idea before they start disallowing it and fining you silly. If you sell and buy the same funds, its a wash. If you sell the S&P 500 and buy the Large Cap Index - no wash, and you'd be fine under current regulations to do so.
Last edited by ghost9804 on Tue Feb 12, 2013 12:00 pm, edited 1 time in total.
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Re: moving pre-tax money to after-tax for free?

Postby BL » Tue Feb 12, 2013 11:58 am

Not sure if I understand your plan, but any dollars you move from tIRA to Roth IRA are taxed at your regular income rate, not at capital gain or loss amounts. Nothing to do with wash sales, which only apply to capital loss.
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Re: moving pre-tax money to after-tax for free?

Postby FordBiggs » Tue Feb 12, 2013 12:01 pm

Grt2bOutdoors wrote:In real life, the IRS will call you down and have you explain your idea before they start disallowing it and fining you silly. If you sell and buy the same funds, its a wash. If you sell the S&P 500 and buy the Large Cap Index - no wash, and you'd be fine under current regulations to do so.

Just to clarify, a wash is selling and buying the same stock within 30 days BUT it's legal to sell and wait for 30 days and then buy the same stock right? Isn't this exactly what Tax Loss harvesting is?
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Re: moving pre-tax money to after-tax for free?

Postby cheese_breath » Tue Feb 12, 2013 12:04 pm

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Re: moving pre-tax money to after-tax for free?

Postby ghost9804 » Tue Feb 12, 2013 12:09 pm

The key here is not to claim any capital loss and tax benefit to IRS, so it is not a tax loss harvesting.
The key is to realize some capital loss in pretax account, and get the same amount capital gain in after tax account.
So it looks like rolling over money from pretax account to after tax account for free.
If both accounts are tax sheltered, IRS would not know any of the transactions.

FordBiggs wrote:
Grt2bOutdoors wrote:In real life, the IRS will call you down and have you explain your idea before they start disallowing it and fining you silly. If you sell and buy the same funds, its a wash. If you sell the S&P 500 and buy the Large Cap Index - no wash, and you'd be fine under current regulations to do so.

Just to clarify, a wash is selling and buying the same stock within 30 days BUT it's legal to sell and wait for 30 days and then buy the same stock right? Isn't this exactly what Tax Loss harvesting is?
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Re: moving pre-tax money to after-tax for free?

Postby ghost9804 » Tue Feb 12, 2013 12:11 pm

the purpose is to NOT paying any conversion tax.

cheese_breath wrote:Sell? Buy? Aren't we just talking a Roth conversion here? There is no selling or buying. Just converting and paying the tax.
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Re: moving pre-tax money to after-tax for free?

Postby cheese_breath » Tue Feb 12, 2013 12:12 pm

ghost9804 wrote:the purpose is to NOT paying any conversion tax.

cheese_breath wrote:Sell? Buy? Aren't we just talking a Roth conversion here? There is no selling or buying. Just converting and paying the tax.

I deleted my previous comment.
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Re: moving pre-tax money to after-tax for free?

Postby Doc » Tue Feb 12, 2013 12:14 pm

Grt2bOutdoors wrote: If you sell and buy the same funds, its a wash. If you sell the S&P 500 and buy the Large Cap Index - no wash, and you'd be fine under current regulations to do so.


Wash sales apply to capital losses that you take to offset capital gains or as a credit on your tax return. Sales made within a tax sheltered account when the money remains in the account are not taxable events and the wash sale rules don't apply.

In the OP ghost suggested to "buy back in after tax account". If the money for that buy came from the pre-tax account the act of transferring the money to the ROTH is a ROTH conversion and the value of the transfer is a taxable event subject to ordinary income rates and maybe penalties if the rest of the rules are not followed.

At Fido they even have an on line procedure for such a ROTH conversion and you can even move shares to the ROTH. Even the cost basis of the lots is retained. But you also get a 1099 R at the end of the year showing the value of the shares transferred at the time of the transaction.

The only way you can "win" with this type of transaction is to somehow lower the tax rate at the time of the original or later withdrawals. Lowering the tax rate by more than ~3% on part of the withdrawal is probably not relevant to the vast majority of investors by my estimate.

ghost9804 wrote:the purpose is to NOT paying any conversion tax.


Ghost, it's a conversion, period.
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Re: moving pre-tax money to after-tax for free?

Postby DSInvestor » Tue Feb 12, 2013 12:15 pm

ghost9804 wrote:say we have some funds both in pretax and after tax account. when the market is right, we can sell the under performing fund in pretax account and buy back in after tax account. Also, we can sell over performing funds in after tax account and buy back in pretax account. of course, overall AA kept the same.
This way, we can always realize losses in pretax account and move the gain to the after tax account, tax free!!


Are you moving any $ from the pre-tax accounts to the Roth accounts? If yes, that's a Roth conversion and it will be taxable.

If you're not moving money, you will sell losing funds in the pre-tax account. What will you do with the proceeds of those sales in the pre-tax account? Assuming you're fully invested in the after-tax account, what will you sell to raise cash to allow you to buy?

If you're adding new money to both accounts, wouldn't be easier just to direct the new money to those asset classes that are below your target AA?
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Re: moving pre-tax money to after-tax for free?

Postby Faith20879 » Tue Feb 12, 2013 12:20 pm

Is this anything to do with TLH? I failed to see what you are trying to achive.

If your goal is to simply shift shares between pre- and post- accounts then okay I see what you are saying. But you are by no means
... move pre-tax money from traditional IRA/401K to after-tax money in Roth.
as stated in your post.

Let's say you sold 10 sh of ABC in your 401K(proceeds=$451) and bought 10 sh ABC in your Roth(paid=%449). The $451 does not leave your 401K, it is still there.

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Re: moving pre-tax money to after-tax for free?

Postby Userdc » Tue Feb 12, 2013 12:23 pm

Here's what I think ghost is saying:

In a pre-tax IRA, you have $100 in fund A and $100 in fund B.
In a Roth IRA, you also have $100 in fund A and $100 in fund B.

Lets say fund A's value drops by 50% and fund B's value doubles.

Within the pre-tax, you sell your $50 of Fund A and buy $50 of fund B. You have $250 in fund B.
Within the Roth, you sell $50 of Fund B and buy $50 of fund A. You have $100 in fund A and $150 in fund B.

Now lets assume that both funds reverse their gains/losses. Fund A doubles and fund B it cut in half.

You now have $125 in your pre-tax and $275 in your Roth with the same asset allocation.

There shouldn't be any tax consideration with any of this as they are just independent transactions done inside IRAs and no capital losses are bing claimed.

Of course this only works if we believe that losers will be outsized winners in the future.
Last edited by Userdc on Tue Feb 12, 2013 12:24 pm, edited 1 time in total.
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Re: moving pre-tax money to after-tax for free?

Postby ghost9804 » Tue Feb 12, 2013 12:24 pm

no money moving between pre-tax and ROTH account
say we have 2 funds A and B both in pre-tax and ROTH account. A is winning, B is losing.
we sell B, buy A in pre-tax
sell A, buy B in Roth
AA for funds A and B still kept the same after the transaction.
later on we can reverse the transaction if B is winning while A is losing.
so little by little, the money is "moved" from pre-tax to ROTH.

DSInvestor wrote:
ghost9804 wrote:say we have some funds both in pretax and after tax account. when the market is right, we can sell the under performing fund in pretax account and buy back in after tax account. Also, we can sell over performing funds in after tax account and buy back in pretax account. of course, overall AA kept the same.
This way, we can always realize losses in pretax account and move the gain to the after tax account, tax free!!


Are you moving any $ from the pre-tax accounts to the Roth accounts? If yes, that's a Roth conversion and it will be taxable.

If you're not moving money, you will sell losing funds in the pre-tax account. What will you do with the proceeds of those sales in the pre-tax account? Assuming you're fully invested in the after-tax account, what will you sell to raise cash to allow you to buy?

If you're adding new money to both accounts, wouldn't be easier just to direct the new money to those asset classes that are below your target AA?
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Re: moving pre-tax money to after-tax for free?

Postby ghost9804 » Tue Feb 12, 2013 12:26 pm

Thanks. That's exactly what I means

Userdc wrote:Here's what I think ghost is saying:

In a pre-tax IRA, you have $100 in fund A and $100 in fund B.
In a Roth IRA, you also have $100 in fund A and $100 in fund B.

Lets say fund A's value drops by 50% and fund B's value doubles.

Within the pre-tax, you sell your $50 of Fund A and buy $50 of fund B. You have $250 in fund B.
Within the Roth, you sell $50 of Fund B and buy $50 of fund A. You have $100 in fund A and $150 in fund B.

Now lets assume that both funds reverse their gains/losses. Fund A doubles and fund B it cut in half.

You now have $125 in your pre-tax and $275 in your Roth with the same asset allocation.

There shouldn't be any tax consideration with any of this as they are just independent transactions done inside IRAs and no capital losses are bing claimed.

Of course this only works if we believe that losers will be outsized winners in the future.
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Re: moving pre-tax money to after-tax for free?

Postby cheese_breath » Tue Feb 12, 2013 1:06 pm

If you take anything out of an IRA or 401K (I don't care whether you call it a sale or conversion) you will pay taxes on it. Any withdrawal is taxed as ordinary income, and there is no such thing as gain or loss. If it is worth less when you withdraw in than when you bought it, tough luck. It's not a loss.
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Re: moving pre-tax money to after-tax for free?

Postby SSSS » Tue Feb 12, 2013 1:13 pm

ghost9804 wrote:I assume wash sale not applicable to tax sheltered account

Kosmo wrote:Wash sale?


You're half right and half wrong. Technically it's a wash sale (selling at a loss in a taxable account, buying replacement shares after OR before even if in a tax-advantaged account), and the IRS expects you to self-report. However, your brokerage will not report this to the IRS as a wash sale.
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Re: moving pre-tax money to after-tax for free?

Postby Doc » Tue Feb 12, 2013 1:27 pm

SSSS wrote:
ghost9804 wrote:I assume wash sale not applicable to tax sheltered account

Kosmo wrote:Wash sale?


You're half right and half wrong. Technically it's a wash sale (selling at a loss in a taxable account, buying replacement shares after OR before even if in a tax-advantaged account), and the IRS expects you to self-report. However, your brokerage will not report this to the IRS as a wash sale.


To clarify, if you sell at a loss in a taxable account and repurchase in a tax advantaged account within the 30 day period it's a wash sale even if not reported to the IRS. Since the disallowed loss is used to adjust the basis of the new purchase and the basis doesn't matter in the tax advantaged account you lose your tax loss forever. Not a good idea.

Is the IRS still doing random "compliance" audits? They are not fun even if you have no tax issues.
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Re: moving pre-tax money to after-tax for free?

Postby Default User BR » Tue Feb 12, 2013 2:18 pm

People are getting hung up on the semantics. The "move" of money is a virtual one, in the form of gains and losses. No actual money goes from one account to another. No conversions or withdrawals are performed.

By "after-tax", the OP means Roth, not taxable. Wash sales will not be a factor at all.


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Re: moving pre-tax money to after-tax for free?

Postby Ketawa » Tue Feb 12, 2013 2:30 pm

Use tax-adjusted asset allocation, and you'll see that you're not beating the system by doing this. You are just fooling yourself about how much risk you have in each account.

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Re: moving pre-tax money to after-tax for free?

Postby cheese_breath » Tue Feb 12, 2013 3:21 pm

Default User BR wrote:People are getting hung up on the semantics. The "move" of money is a virtual one, in the form of gains and losses. No actual money goes from one account to another. No conversions or withdrawals are performed.

By "after-tax", the OP means Roth, not taxable. Wash sales will not be a factor at all.


Brian

So all we're talking about is realigning the investments in his accounts so that the poor performing ones are in the TIRA and the better performing ones in the Roth? And visa-versa? At the instant of realignment the values of the TIRA and Roth are unchanged. Whether this is a good strategy or not depends on the future performance of the investments. If he guesses right he wins. If he guesses wrong he loses. Hope he realizes past performance is no guarantee of future results.
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Re: moving pre-tax money to after-tax for free?

Postby ghost9804 » Tue Feb 12, 2013 3:42 pm

You are right. When AA is tax-adjusted, everything is the same

Ketawa wrote:Use tax-adjusted asset allocation, and you'll see that you're not beating the system by doing this. You are just fooling yourself about how much risk you have in each account.

Tax-Adjusted Asset Allocation
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Re: moving pre-tax money to after-tax for free?

Postby winger » Tue Feb 12, 2013 4:49 pm

ghost9804 wrote:...
say we have 2 funds A and B both in pre-tax and ROTH account. A is winning, B is losing.
we sell B, buy A in pre-tax
sell A, buy B in Roth
AA for funds A and B still kept the same after the transaction.
...

In this case, you do have a reportable loss when you sell B. I do not believe that buying B in a Roth account will exempt you from wash sale rule. Review IRS 550 and google Revenue Ruling 2008-05.
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Re: moving pre-tax money to after-tax for free?

Postby kaneohe » Tue Feb 12, 2013 5:24 pm

wouldn't you have done better by just rebalancing to the original 50-50 allocation in the example given after each of the extreme moves?
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Re: moving pre-tax money to after-tax for free?

Postby ghost9804 » Tue Feb 12, 2013 6:04 pm

Wash sale is not the point. even it is a wash sale, it does not matter. IRS don't care what is the cost basis in your tax sheltered account, you are taxed by how much you withdraw, not how much you gain.

winger wrote:
ghost9804 wrote:...
say we have 2 funds A and B both in pre-tax and ROTH account. A is winning, B is losing.
we sell B, buy A in pre-tax
sell A, buy B in Roth
AA for funds A and B still kept the same after the transaction.
...

In this case, you do have a reportable loss when you sell B. I do not believe that buying B in a Roth account will exempt you from wash sale rule. Review IRS 550 and google Revenue Ruling 2008-05.
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Re: moving pre-tax money to after-tax for free?

Postby ghost9804 » Tue Feb 12, 2013 6:21 pm

That example only shows the tax benefit without considering rebalancing. With rebalancing, it can do even better.

kaneohe wrote:wouldn't you have done better by just rebalancing to the original 50-50 allocation in the example given after each of the extreme moves?
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Re: moving pre-tax money to after-tax for free?

Postby archbish99 » Tue Feb 12, 2013 8:02 pm

Yes, this is legitimate, though most people are missing the point of the question. This isn't actually much different than the wiki's advice to put the highest expected return assets in Roth, to maximize the amount that's withdrawn tax-free if the expected return materializes. The twist here is that "expected return" is projected from an asset class's recent losses, rather than being an absolute expectation regardless of the present value.

I doubt you'll win a great amount here, but it's certainly one way you can entertain yourself with a little gambling between asset classes. No wash sale, since both transactions are in tax-advantaged accounts, and no taxes since there are no actual transfers of money.
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Re: moving pre-tax money to after-tax for free?

Postby Ketawa » Tue Feb 12, 2013 8:16 pm

archbish99 wrote:Yes, this is legitimate, though most people are missing the point of the question. This isn't actually much different than the wiki's advice to put the highest expected return assets in Roth, to maximize the amount that's withdrawn tax-free if the expected return materializes. The twist here is that "expected return" is projected from an asset class's recent losses, rather than being an absolute expectation regardless of the present value.

I doubt you'll win a great amount here, but it's certainly one way you can entertain yourself with a little gambling between asset classes. No wash sale, since both transactions are in tax-advantaged accounts, and no taxes since there are no actual transfers of money.


This highlights the importance of tax-adjusting asset allocation. Putting the highest return asset in Roth makes a portfolio more risky than an investor realizes. There isn't any gambling involved, just a little unawareness about what is actually happening.

Edit - sorry, didn't want to say that putting highest return asset in Roth is a bad idea. Just want to make sure that the reason for doing so is correct. Not because you can make more money, but because Roths don't have RMDs, aren't counted as income for SS, etc.

Ketawa wrote:Use tax-adjusted asset allocation, and you'll see that you're not beating the system by doing this. You are just fooling yourself about how much risk you have in each account.

Tax-Adjusted Asset Allocation
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Re: moving pre-tax money to after-tax for free?

Postby Default User BR » Wed Feb 13, 2013 2:13 am

winger wrote:
ghost9804 wrote:...
say we have 2 funds A and B both in pre-tax and ROTH account. A is winning, B is losing.
we sell B, buy A in pre-tax
sell A, buy B in Roth
AA for funds A and B still kept the same after the transaction.

In this case, you do have a reportable loss when you sell B. I do not believe that buying B in a Roth account will exempt you from wash sale rule. Review IRS 550 and google Revenue Ruling 2008-05.

Both the buy and sell are in tax-advantaged accounts. There is no reportable loss. No wash sale.


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Re: moving pre-tax money to after-tax for free?

Postby archbish99 » Wed Feb 13, 2013 12:20 pm

Ketawa wrote:This highlights the importance of tax-adjusting asset allocation. Putting the highest return asset in Roth makes a portfolio more risky than an investor realizes. There isn't any gambling involved, just a little unawareness about what is actually happening.

Ketawa wrote:Use tax-adjusted asset allocation, and you'll see that you're not beating the system by doing this. You are just fooling yourself about how much risk you have in each account.

Tax-Adjusted Asset Allocation


I guess my ongoing issue with TAAA is that the rate at withdrawal is unknown. It has been demonstrated that reasonable planning (when to do Roth conversions) can lower substantially the tax rate at withdrawal, plus tax law can change in the intervening time. Sure, you can guess, and a guess of 15% may be more accurate than a guess of 0%, but the inherent uncertainty of that guess continues to make me wary of that idea.
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Re: moving pre-tax money to after-tax for free?

Postby Doc » Wed Feb 13, 2013 12:40 pm

archbish99 wrote: It has been demonstrated that reasonable planning (when to do Roth conversions) can lower substantially the tax rate at withdrawal ...


Do you have a source for this?

MFJ tax brackets for 2013 are ~$75k wide. If I'm doing my sums anywhere near correct that means on average a $75k lower RMD would move about $37k to a lower bracket for about a $1000 tax saving. I don't think that qualifies as "substantial" especially when you have some tax cost incurred on the conversion.

That is not to say that you shouldn't make the conversion when possible. I'm trying to do it while saving less than $100 a year potentially. But I'm doing it mostly so I don't screw up and miss taking my RMD when it becomes time.
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Re: moving pre-tax money to after-tax for free?

Postby ghost9804 » Wed Feb 13, 2013 12:51 pm

I agree it depends on the future performance, but analog to rebalancing, under the basic assumption of "reverse to mean", we should gain by this kind of transaction, right?

for rebalancing, we sell winners to buy losers, under the assumption that the winners will become losers and losers will become winners later. If the assumption is not valid, winner keeps winning and losers go bankrupt, then rebalancing would be a loser's game.

if we believe rebalancing, and the underlying assumption is correct. Then sell winners to buy losers in ROTH and sell losers to buy winners in pre-tax would definitely give us the rebalancing award, in terms of tax savings. right?

cheese_breath wrote:
Default User BR wrote:People are getting hung up on the semantics. The "move" of money is a virtual one, in the form of gains and losses. No actual money goes from one account to another. No conversions or withdrawals are performed.

By "after-tax", the OP means Roth, not taxable. Wash sales will not be a factor at all.


Brian

So all we're talking about is realigning the investments in his accounts so that the poor performing ones are in the TIRA and the better performing ones in the Roth? And visa-versa? At the instant of realignment the values of the TIRA and Roth are unchanged. Whether this is a good strategy or not depends on the future performance of the investments. If he guesses right he wins. If he guesses wrong he loses. Hope he realizes past performance is no guarantee of future results.
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Re: moving pre-tax money to after-tax for free?

Postby Doc » Wed Feb 13, 2013 1:11 pm

ghost9804 wrote: if we believe rebalancing, and the underlying assumption is correct. Then sell winners to buy losers in ROTH and sell losers to buy winners in pre-tax would definitely give us the rebalancing award, in terms of tax savings. right?


There is no difference between the after tax return of a traditional IRA/401K and a ROTH if the tax bracket is the same at the time of the contribution or conversion and the time of the withdrawal. With the difference in tax rates at adjacent brackets being ~3% on average it is hard to come out with significant savings. And any savings that you do achieve has to be offset by the lost income on the money you used to pay the conversion tax.

The big advantage you get with a conversion is that you get to effectivly shelter a larger piece of your portfolio by paying the conversion tax with outside money. But this has nothing to do with AA juggling between accounts.

BTW are you sure there is a rebalancing "reward" and not just a rebalancing "risk adjustment". If you don't rebalance your equity percent will increase over the long term and therefore you should expect more return for not rebalancing albeit with a riskier portfolio.
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Re: moving pre-tax money to after-tax for free?

Postby ghost9804 » Wed Feb 13, 2013 1:57 pm

of course there is a difference between after tax return. Not using tax adjusted asset allocation, assume now your money grow $1000 across your both pre-tax and after tax accounts, which scenario do you prefer?
1. ROTH grow $0, pre-tax grow $1000
2. ROTH grow $1000, pre-tax grow $0
3. ROTH grow $10000, pre-tax lose $9000

what I'm proposing is trying to achieve scenario 3, to "move" money from pre-tax to ROTH without paying any taxes.


Doc wrote:
ghost9804 wrote: if we believe rebalancing, and the underlying assumption is correct. Then sell winners to buy losers in ROTH and sell losers to buy winners in pre-tax would definitely give us the rebalancing award, in terms of tax savings. right?


There is no difference between the after tax return of a traditional IRA/401K and a ROTH if the tax bracket is the same at the time of the contribution or conversion and the time of the withdrawal. With the difference in tax rates at adjacent brackets being ~3% on average it is hard to come out with significant savings. And any savings that you do achieve has to be offset by the lost income on the money you used to pay the conversion tax.

The big advantage you get with a conversion is that you get to effectivly shelter a larger piece of your portfolio by paying the conversion tax with outside money. But this has nothing to do with AA juggling between accounts.

BTW are you sure there is a rebalancing "reward" and not just a rebalancing "risk adjustment". If you don't rebalance your equity percent will increase over the long term and therefore you should expect more return for not rebalancing albeit with a riskier portfolio.
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Re: moving pre-tax money to after-tax for free?

Postby Doc » Wed Feb 13, 2013 2:20 pm

Ghost,

Google ROTH,tIRA,"your share" on this site.
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Re: moving pre-tax money to after-tax for free?

Postby archbish99 » Wed Feb 13, 2013 2:29 pm

Doc wrote:
archbish99 wrote: It has been demonstrated that reasonable planning (when to do Roth conversions) can lower substantially the tax rate at withdrawal ...


Do you have a source for this?

MFJ tax brackets for 2013 are ~$75k wide. If I'm doing my sums anywhere near correct that means on average a $75k lower RMD would move about $37k to a lower bracket for about a $1000 tax saving. I don't think that qualifies as "substantial" especially when you have some tax cost incurred on the conversion.

That is not to say that you shouldn't make the conversion when possible. I'm trying to do it while saving less than $100 a year potentially. But I'm doing it mostly so I don't screw up and miss taking my RMD when it becomes time.


How does a $75k lower RMD move only $37k to a lower bracket? A $75k lower RMD makes $75k less per year taxable, so the taxes on that amount would be pure savings. The cost is paying the taxes (hopefully at a lower rate) up front.

See the perennial zero-taxes-in-retirement thread. Your amount of tax savings assumes that money is being converted at a tax bracket which is only 3% lower. I'm envisioning a scenario where a retiree knows they'll be in the 25% or higher bracket once they start receiving SS, and so does annual Roth conversions before starting SS, thus converting at 0%, 10%, or 15%. The effective tax rate on those conversions would be under 11%, assuming just the standard deduction. By doing the conversions at 11%, they avoid being taxed at 15-25% on the RMDs, and potentially avoiding the Social Security taxability phase-in which magnifies brackets to as high as 46%. In my parents' case, they're converting at ~16% to avoid paying the 28% (SS phase-in times 15% bracket) they pay on their RMDs every year. We haven't converted further into 25% because (as you point out) the 3% savings is less persuasive given the up-front cost.

But all of that's current law, which will surely change drastically by the time I get there. Still, I think the general principle of planning for a few years of low taxable income living off a taxable portfolio in which Roth conversions are worthwhile is at least a possibility, and makes me uncertain what tax rate I should use to discount the tax-deferred accounts this far out. Probably not less than 11%, but going as high as 25% or 28% seems dubious. Once one has hit their retirement steady-state (SS and any pensions have kicked in), it's easier to get an accurate estimate and then the strategy makes a little more sense.
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Re: moving pre-tax money to after-tax for free?

Postby Doc » Wed Feb 13, 2013 8:22 pm

archbish99 wrote:How does a $75k lower RMD move only $37k to a lower bracket? A $75k lower RMD makes $75k less per year taxable, so the taxes on that amount would be pure savings. The cost is paying the taxes (hopefully at a lower rate) up front.


The $37k is the one half of the $75k. There are going to be very few who start at the top of the bracket so all the savings are in that bracket. On average 1/2 of the RMD will be in the upper bracket and 1/2 in the lower bracket which will not have the savings.

See the perennial zero-taxes-in-retirement thread. Your amount of tax savings assumes that money is being converted at a tax bracket which is only 3% lower. I'm envisioning a scenario where a retiree knows they'll be in the 25% or higher bracket once they start receiving SS, and so does annual Roth conversions before starting SS, thus converting at 0%, 10%, or 15%.


I don't know if starting SS later is widely applicable. Many people need that SS at the start or are in poor health and predict lower longevity for them to make up the deferral. The low brackets also ignore income from taxable sources and defined benefit plans which still exist in a number of industries - teaching comes to mind.

If one is taking SS that 10% bracket often becomes 15% and the 15% bracket often becomes 27.75% because of the SS phaseout. I have been told that the phase occurs even in the 25% for some. Certainly if you can convert in the 0% or 10% bracket it makes sense and I indeed did this in the past when I wasn't taking a salary. I just question how widespread the low bracket conversion is.

This concept is very sensitive to individuals personal situation and one should be very careful in accepting "convention wisdom" type statements in this situation.

In our personal situation we can take very little conversion before getting ourselves in a higher or at least the same bracket as what it will be when the RMD's kick in. :(

I just don't know what a "typical" situation is or even if there is such a thing in this instance which is why I asked if you had a source. (The zero bracket thread makes a lot of asumptions as I recall.)
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Re: moving pre-tax money to after-tax for free?

Postby archbish99 » Wed Feb 13, 2013 10:06 pm

Yes, it does -- it's more a proof of concept than an applicable-to-everyone. However, I'll also point out that someone who has minimal resources and needs to take SS ASAP isn't likely to be stressing about their $75k/year RMDs. They're going to be in a lower tax bracket to begin with. Also, deferral by itself makes more sense in a couple than a single, so health and life expectancy becomes less relevant because you're thinking about survivor benefits.

Certainly, for my parents, Dad's pension and the SS that makes taxable already means their IRA withdrawals start at the top edge of the 10% bracket, so nearly everything is in the 15% bracket. However, they would certainly have had the option to defer SS if they had wanted to. They chose not to, though had I known then what I know now, I would probably have counseled them to. (Of course, in the situation where I'd known then what I know now and been in a position to advise them, they might also have survived the two bear markets of the 2000s better, so that's a highly hypothetical scenario. :wink:)
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Re: moving pre-tax money to after-tax for free?

Postby Doc » Thu Feb 14, 2013 12:13 pm

archbish99 wrote:Certainly, for my parents, Dad's pension and the SS that makes taxable already means their IRA withdrawals start at the top edge of the 10% bracket, so nearly everything is in the 15% bracket. However, they would certainly have had the option to defer SS if they had wanted to. They chose not to, though had I known then what I know now, I would probably have counseled them to. (Of course, in the situation where I'd known then what I know now and been in a position to advise them, they might also have survived the two bear markets of the 2000s better, so that's a highly hypothetical scenario. :wink:)


1) I tried to avoid the top of bracket scenario because it seems contrived. If you are near the top of a bracket you can't convert enough to make much of a difference and you have to pay the taxes early and lose the deferral.

2) The bear market factor is probably impossible to quantify. Thinking in terms of "safe withdrawal rates" delaying SS and therefore withdrawing more in early retirement increases the chance of serious depleting your portfolio early.

In any case, doing a ROTH conversion when your rates are low is a good idea. Delaying SS to get those low rates needs a lot of thought based on one's personal situation.

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