Roth... to convert or not to convert?

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Roth... to convert or not to convert?

Postby SteveNet » Thu May 16, 2013 5:58 pm

Greetings,

I have always been on the fence with this issue, No matter what Calc I use the answer always seems to be a wash (give or take a small amount).
Perhaps there is something I'm missing or not understanding that might be of benefit to me to actually do a conversion for the next 5 or 7 years.

Me Age 59-Retired, Spouse 59 never employed.
My current tax bracket 15%
Projected tax bracket going forward 15%
Tennessee, so no state tax on other than dividends from taxable accts, so no issue there.
Planning on SS at age 66.
My pension get cut in half at age 62, so I will have 4 years to convert and still stay within the 15% bracket. This year and the next 2 I could convert some as well.
Additional monies to make up for the pension loss will come from my taxable acct and as long as I stay within the 15% bracket will be 0% taxable. So no problem there, I can convert larger chunks age 62-65.
I could get the whole sum of IRA 220K converted by doing it a bit each year till age 66. Taxes for the conversion would come out of our taxable accounts by selling funds/etf's.
I would be selling equity fund/etfs to pay the taxes on converting my IRA bond holdings to a Roth.

The conundrum I see is to go through the process every year for the next 6 years for virtually no gain...
Just that we pay the taxes now rather than later, which I always held as a not so good thing.
I am aware of the age 70 mandatory withdrawal.
I know there is an inheritance advantage for our kids if it's in a Roth, but is there any other advantage I'm not considering?
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Re: Roth... to convert or not to convert?

Postby kmok » Thu May 16, 2013 6:32 pm

The general concept is if the marginal tax rate is the same right now and gong forward, it would be beneficial to convert, provided you have money outside of retirement accounts to pay taxes, as conversion means you can put more value in retirement accounts.
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Re: Roth... to convert or not to convert?

Postby SteveNet » Thu May 16, 2013 6:40 pm

kmok wrote:The general concept is if the marginal tax rate is the same right now and gong forward, it would be beneficial to convert, provided you have money outside of retirement accounts to pay taxes, as conversion means you can put more value in retirement accounts.


Thanks for the reply,
So if I'm understanding this correctly in this (my) case it would 'not' be beneficial to convert as I would be taking the money for taxes from retirement accounts?
Even though that retirement account that the tax money is coming from is separate from the account involved in the conversion.
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Re: Roth... to convert or not to convert?

Postby gerrym51 » Thu May 16, 2013 6:42 pm

Who's on first-watts on second :mrgreen:
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Re: Roth... to convert or not to convert?

Postby The Wizard » Thu May 16, 2013 7:03 pm

Do a comparison on what's going to happen once you hit age 70 and start RMDs.
The RMDs will be taxed at your marginal rate (and/or ABOVE) and the residual amount, if reinvested, will be all in taxable.
Decide if that's what you want; otherwise do something about it...
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Re: Roth... to convert or not to convert?

Postby kmok » Thu May 16, 2013 7:05 pm

SteveNet wrote:
kmok wrote:The general concept is if the marginal tax rate is the same right now and gong forward, it would be beneficial to convert, provided you have money outside of retirement accounts to pay taxes, as conversion means you can put more value in retirement accounts.


Thanks for the reply,
So if I'm understanding this correctly in this (my) case it would 'not' be beneficial to convert as I would be taking the money for taxes from retirement accounts?
Even though that retirement account that the tax money is coming from is separate from the account involved in the conversion.

No. I said retirement accounts, but what I meant was tax sheltered accounts. So in your case, since you are paying taxes from taxable accounts, it is most likely beneficial to convert.
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Re: Roth... to convert or not to convert?

Postby hq38sq43 » Thu May 16, 2013 7:07 pm

In weighing likely costs and benefits of Roth conversions I have concluded for my wife and myself that a tie or even near tie should go to the runner, i.e., conversion, especially since she is likely to outlive me by a good many years. But, as is often said on this forum, there are many roads to Dublin.

Best regards,
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Re: Roth... to convert or not to convert?

Postby Watty » Thu May 16, 2013 7:17 pm

....but is there any other advantage I'm not considering?


Did the numbers you ran include the taxation of social security?

http://www.bogleheads.org/wiki/Taxation ... y_benefits

If your income is in the range where each dollar of IRA withdrawals makes more of your social security taxable then you may end up in a higher effective tax bracket.

You also need to run the numbers to see what your tax bracket will be if one of your survives the other. Single people get to the 25% tax bracket pretty quickly.

One other thing to consider is that if your pension is not indexed for inflation then 20 or 30 years from now being in a high tax bracket might not be as much of a concern.

RMD's only start out at about 3.5% at the age of 70.5 so you need to look at the actual numbers. I would suspect that they will not be a big concern until you are well into your 90's. Even if your IRA balance grows to $500K, a 10% RMD is only $50K so you could likely stay in a moderate tax bracket at that level.

If you will be capital gains taxes on the assets you sell to pay the 15% taxes on the conversion then your effective tax rate will be higher than 15%.

You mentioned the Roth advantages for your heirs, but you need to remember that they would not get the money from the taxable account which might be worth more to them. For example if you converted $100K and paid $15K in taxes from a taxable account then you could have had $15K in a mutual fund that could grow for decades then eventually go to the estate at a stepped up cost basis.

Without know more of you details there is no clear answer but I would suspect that converting maybe $50K might be a good choice so that you would have some tax free money to cover expenses without pushing your into a higher tax bracket if you have a year with unusually high expenses.
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Re: Roth... to convert or not to convert?

Postby SteveNet » Thu May 16, 2013 7:27 pm

kmok wrote:
SteveNet wrote:
kmok wrote:The general concept is if the marginal tax rate is the same right now and gong forward, it would be beneficial to convert, provided you have money outside of retirement accounts to pay taxes, as conversion means you can put more value in retirement accounts.


Thanks for the reply,
So if I'm understanding this correctly in this (my) case it would 'not' be beneficial to convert as I would be taking the money for taxes from retirement accounts?
Even though that retirement account that the tax money is coming from is separate from the account involved in the conversion.

No. I said retirement accounts, but what I meant was tax sheltered accounts. So in your case, since you are paying taxes from taxable accounts, it is most likely beneficial to convert.


Ok thanks for the clarification, noob that I am, I considered all my accounts as retirement accounts as I am retired.
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Re: Roth... to convert or not to convert?

Postby The Wizard » Thu May 16, 2013 7:39 pm

kmok wrote:The general concept is if the marginal tax rate is the same right now and gong forward, it would be beneficial to convert, provided you have money outside of retirement accounts to pay taxes, as conversion means you can put more value in retirement accounts.

This is actually NOT a prerequisite for doing a Roth conversion.
Some of us have 90+% of our assets in tax-sheltered accounts and it has to come out of tax-shelter one way or another, sooner or later.
It's quite permissible to convert $10K from sheltered to Roth, incurring a Federal tax of $2500 (for those of us in the 25% bracket.
To pay the $2500, you then take an additional $3333 out of tax-shelter and give the whole amount to the IRS.
"Pretending" that excess $$ that you took out of tax-shelter two years ago that's still sitting in your checking account unspent is different is just playing mental games with the taxman...
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Re: Roth... to convert or not to convert?

Postby SteveNet » Thu May 16, 2013 7:55 pm

Watty wrote:
....but is there any other advantage I'm not considering?


Did the numbers you ran include the taxation of social security?

http://www.bogleheads.org/wiki/Taxation ... y_benefits

If your income is in the range where each dollar of IRA withdrawals makes more of your social security taxable then you may end up in a higher effective tax bracket.

You also need to run the numbers to see what your tax bracket will be if one of your survives the other. Single people get to the 25% tax bracket pretty quickly.

One other thing to consider is that if your pension is not indexed for inflation then 20 or 30 years from now being in a high tax bracket might not be as much of a concern.

RMD's only start out at about 3.5% at the age of 70.5 so you need to look at the actual numbers. I would suspect that they will not be a big concern until you are well into your 90's. Even if your IRA balance grows to $500K, a 10% RMD is only $50K so you could likely stay in a moderate tax bracket at that level.

If you will be capital gains taxes on the assets you sell to pay the 15% taxes on the conversion then your effective tax rate will be higher than 15%.

You mentioned the Roth advantages for your heirs, but you need to remember that they would not get the money from the taxable account which might be worth more to them. For example if you converted $100K and paid $15K in taxes from a taxable account then you could have had $15K in a mutual fund that could grow for decades then eventually go to the estate at a stepped up cost basis.

Without know more of you details there is no clear answer but I would suspect that converting maybe $50K might be a good choice so that you would have some tax free money to cover expenses without pushing your into a higher tax bracket if you have a year with unusually high expenses.


No I have not looked into the SS taxation on this issue I will try to run some numbers.

As far as other information, I do already have a Roth of aprox 90K.
Taxable acct is aprox 280k
My Pension 32k will be cut in half at age 62 and it has NO cola, so it diminishes over time accordingly in real dollars.
That's One of the reasons I'm going to wait till 66 for SS, at that time I may postpone longer I'll make that determination when that time comes.

"If you will be capital gains taxes on the assets you sell to pay the 15% taxes on the conversion then your effective tax rate will be higher than 15%."


I'm not understanding this, in the 15% bracket currently Cap gains taxes are 0% as long as I stay in the 15% bracket. (Long term cap gains)
The the tax rate of the conversion will be 15% as regular income, how would it be higher than 15%?

I will run some numbers on RMD and SS, and single survivor taxes, although my wife would get half of my pension (after it's already cut in half so say 25%) no cola and half of my SS. So I don't think she will get up too high in the tax brackets.
I will look into the numbers though.

Thanks for the replys so far :sharebeer
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Re: Roth... to convert or not to convert?

Postby Peter Foley » Thu May 16, 2013 8:15 pm

The following is from the Bogleheads Wiki:

The relevant income for Social Security taxation includes all items which are normally part of your adjusted gross income, plus tax-exempt interest income, plus 50% of your Social Security benefits. (Historically, the 50% represents the fact that half of your Social Security contributions were made by your employer and thus not taxed.) [2]

There are two relevant base amounts; unlike most income limits in the tax code, they are not adjusted for inflation. The lower base is $25,000 if you are single, $32,000 if married filing jointly. The upper base is $34,000 if you are single, $44,000 if married filing jointly.[3]

If your relevant income is below the lower base, none of your benefits are taxable. For every $1 of relevant income between the lower and upper bases, 50 cents of your Social Security benefits become taxable, up to 50% of your total benefits. For every $1 of relevant income above the upper bases, 85 cents of your Social Security benefits become taxable, up to a total taxable amount of 85% of your benefits.


OK. The relevant low base number for married filing jointly is $32,000. If you have income from your pension, your investments and your withdrawals from tax sheltered accounts in excess of $32,000, 50% of your SS benefits will be taxable. This creates an effective tax rate on your social security income of 15% + 7.5% or 22.5%. There is a table and more details on the Bogleheads Wiki.

You may be in a situation where you will be cutting it close with respect to SS taxation. If that is the case, it would be to your benefit to have funds in a Roth IRA so that in a given year you could choose to take withdrawals from taxable, tax deferred, or tax free. Staying in the 15% bracket has advantages including no taxation of long term capital gains.

Another way to look at this is from an income needs perspective: let's say you need $60,000 per year to cover your living expenses. What are the sources of that income prior to receiving SS and what are the sources after receiving SS?

I think it is likely that you are in a position where converting at least some of your tax deferred to Roth would be to your advantage. You didn't provide quite enough detail for the recomendation to be conclusive.
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Re: Roth... to convert or not to convert?

Postby kmok » Thu May 16, 2013 8:18 pm

The Wizard wrote:
kmok wrote:The general concept is if the marginal tax rate is the same right now and gong forward, it would be beneficial to convert, provided you have money outside of retirement accounts to pay taxes, as conversion means you can put more value in retirement accounts.

This is actually NOT a prerequisite for doing a Roth conversion.
Some of us have 90+% of our assets in tax-sheltered accounts and it has to come out of tax-shelter one way or another, sooner or later.
It's quite permissible to convert $10K from sheltered to Roth, incurring a Federal tax of $2500 (for those of us in the 25% bracket.
To pay the $2500, you then take an additional $3333 out of tax-shelter and give the whole amount to the IRS.


I don't know how 'general concept' would ever specified any 'prerequisite'.
It is also not a 'prerequiste' that your marginal tax rate can't be slightly higher right now than in the future and still be better off converting.

The Wizard wrote:"Pretending" that excess $$ that you took out of tax-shelter two years ago that's still sitting in your checking account unspent is different is just playing mental games with the taxman...

To be honest I don't quite understand what you meant by this.
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Re: Roth... to convert or not to convert?

Postby The Wizard » Thu May 16, 2013 8:35 pm

kmok wrote:
The Wizard wrote:"Pretending" that excess $$ that you took out of tax-shelter two years ago that's still sitting in your checking account unspent is different is just playing mental games with the taxman...

To be honest I don't quite understand what you meant by this.

Folks with no pension but with $2M in their 403b/401k/IRA are likely getting MOST of their retirement income from tax-sheltered assets and paying full taxes on that retirement income.
So if you decide to convert $10K into a Roth IRA, the taxes have to be paid from somewhere, and that somewhere is likely from tax-sheltered assets.
Someone else who has a good pension but only a smallish traditional IRA would be better served using $$ from the pension to eventually convert ALL of the tIRA to Roth IRA.
The approach varies depending on the details...
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Re: Roth... to convert or not to convert?

Postby The Wizard » Thu May 16, 2013 8:36 pm

duplicate deleted.
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Re: Roth... to convert or not to convert?

Postby Watty » Thu May 16, 2013 8:42 pm

SteveNet wrote:
"If you will be capital gains taxes on the assets you sell to pay the 15% taxes on the conversion then your effective tax rate will be higher than 15%."


I'm not understanding this, in the 15% bracket currently Cap gains taxes are 0% as long as I stay in the 15% bracket. (Long term cap gains)
The the tax rate of the conversion will be 15% as regular income, how would it be higher than 15%?

You are correct that as long as you stay in the zero percent long term capital gains tax bracket than it would not make a difference.

I will run some numbers on RMD and SS, and single survivor taxes, although my wife would get half of my pension (after it's already cut in half so say 25%) no cola and half of my SS. So I don't think she will get up too high in the tax brackets.
I will look into the numbers though.

I am pretty sure that she would get your full SS benefit. You would also need to look at the numbers as if you survived her.

If you have not seen it yet you might check out taxcaster for running rough numbers.


http://turbotax.intuit.com/tax-tools/ca ... er&ven=gg&




Thanks for the replys so far :sharebeer
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Re: Roth... to convert or not to convert?

Postby BigFoot48 » Thu May 16, 2013 9:19 pm

SteveNet wrote:I will run some numbers on RMD and SS, and single survivor taxes, although my wife would get half of my pension (after it's already cut in half so say 25%) no cola and half of my SS. So I don't think she will get up too high in the tax brackets.
I will look into the numbers though.

Use my Roth Conversion Decision Model. It does all that stuff and more. http://www.bogleheads.org/forum/viewtopic.php?f=1&t=97352&p=1405885#p1405885
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Re: Roth... to convert or not to convert?

Postby grabiner » Thu May 16, 2013 9:55 pm

Wiki article link: Taxation of Social Security benefits

Peter Foley wrote:OK. The relevant low base number for married filing jointly is $32,000. If you have income from your pension, your investments and your withdrawals from tax sheltered accounts in excess of $32,000, 50% of your SS benefits will be taxable.


Also add in half your SS to that total; this makes it likely that you will be in the phase-in range.

This creates an effective tax rate on your social security income of 15% + 7.5% or 22.5%.


And 27.75% if you go over $40,000.

These tax rates are the reason that converting at 15% before taking SS may be a good idea; you pay 15% tax now to avoid paying 22.5% or 27.75% later. (But you have to check your own numbers as well; if your Roth gets too large, you might retire in the 10% tax bracket.)
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Re: Roth... to convert or not to convert?

Postby SteveNet » Thu May 16, 2013 10:23 pm

@ Watty

You are entirely correct...

"I am pretty sure that she would get your full SS benefit. You would also need to look at the numbers as if you survived her."

My typing speed exceeded my thinking when I posted that. :beer

Thanks to everyone for the replies and links I will get to them tomorrow with a sufficient amount of caffeine.
This topic has always eluded me, and the generalized (do it it's a good thing) never sat well with me in the past, as I really want to understand 'why' in my situation.
I know a Roth being tax exempt is a good thing no doubt, I just have to fit it into my situation as I know I'm kind of on the boarder if it pays to convert or not at this stage.
And it seems that I may actually get the answers or at least the direction to find that answer with the help of the Knowledgeable posters here. :sharebeer
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Re: Roth... to convert or not to convert?

Postby ddunca1944 » Thu May 16, 2013 11:09 pm

Oh this topic is a big one for me. I used Bigfoot's spreadsheet to help me decide. I've decided to convert as much as I can within the 15% marginal rate. (We have yet to reach the age for RMD's) because if our IRA accounts continue to do well, the RMD's will push us into the 25% bracket.

Now, if there was no chance that RMD's would put us into the next bracket and we'd fordver be in the 15% bracket, then I don't know that it would make any difference.

(Our SS is going to be taxed anyway because we have pensions)
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Re: Roth... to convert or not to convert?

Postby SteveNet » Fri May 17, 2013 10:50 am

Thanks to everyone for the input on my issue, I will be getting into BigFoot48's spreadsheet soon and thanks for that :beer
I will figure out how to use google docs to utilize it.

It would seem at first glance from the responses that I 'May' slip under the wire and not have to convert, however as it was posted even a tie should go to the runner, and if it's that close then perhaps it's better to convert than not too.

I will however read all the links provided and run the numbers, and then come to a decision.
Either way I will post my results of what I will do here and why.

Thanks to all for the enlightenment and expertise that simple online Calcs just don't provide. :sharebeer
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Re: Roth... to convert or not to convert?

Postby BigFoot48 » Fri May 17, 2013 11:27 am

SteveNet wrote:I will figure out how to use google docs to utilize it.

It can also be run using LibreOffice Calc, which is a free program available here: http://www.libreoffice.org/default/
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Re: Roth... to convert or not to convert?

Postby SteveNet » Fri May 17, 2013 11:39 am

BigFoot48 wrote:
SteveNet wrote:I will figure out how to use google docs to utilize it.

It can also be run using LibreOffice Calc, which is a free program available here: http://www.libreoffice.org/default/


I will try that, as I downloaded google drive and put it into my account in docs in my gmail and I cannot see how to input any information.

EDIT... LibreOffice Calc seems to do the trick, downloaded and installed and I can now see how to input info and the links also now work in the spreadsheet.
Got a Dr.s appt in a bit so I will get to this later on today (eye dr) no biggie.

Thanks BigFoot48! :sharebeer
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Re: Roth... to convert or not to convert?

Postby Watty » Fri May 17, 2013 11:57 am

One thing that hasn't been mentioned is that that the consequences of making an incorrect choice are not really equal.

By this I mean that if you choose to keep the money in an IRA and eventually end up in a higher tax bracket then you are doing pretty well financially and paying more taxes than you could have could mean that you would have to take a shorter cruise each year.

On the flip side if you convert to a Roth and pay the taxes now but end up short of money and in a lower tax bracket then you are likely not doing very well financially so not having the extra funds could force a reduction in your lifestyle.

Once all the numbers are crunched then if it is still a close call as to which is best then I would favor not converting most of the money to a Roth because the consequences of being incorrect are less severe.
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Re: Roth... to convert or not to convert?

Postby SteveNet » Fri May 17, 2013 1:05 pm

Watty wrote:One thing that hasn't been mentioned is that that the consequences of making an incorrect choice are not really equal.

By this I mean that if you choose to keep the money in an IRA and eventually end up in a higher tax bracket then you are doing pretty well financially and paying more taxes than you could have could mean that you would have to take a shorter cruise each year.

On the flip side if you convert to a Roth and pay the taxes now but end up short of money and in a lower tax bracket then you are likely not doing very well financially so not having the extra funds could force a reduction in your lifestyle.

Once all the numbers are crunched then if it is still a close call as to which is best then I would favor not converting most of the money to a Roth because the consequences of being incorrect are less severe.


Interesting take on the situation, certainly one to consider after I wade thru the spreadsheet and get the results.
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Re: Roth... to convert or not to convert?

Postby Electron » Fri May 17, 2013 1:14 pm

The benefits of a Roth conversion are not really known until years later since we don't know future tax rates. Many people just hedge their bets and convert a portion of their Traditional IRA. Holding an IRA of both types may be an excellent strategy.

I modeled two cases of Roth Conversions in a spreadsheet and one can learn a lot. Case 1 involves paying Roth conversion taxes from the Traditional IRA and winding up with a smaller Roth IRA. The two IRA accounts are actually identical after tax if the effective tax rate is the same in the future. The smaller Roth IRA comes out ahead after tax if tax rates rise.

Case 2 involves paying the Roth conversion taxes from taxable accounts. This becomes a very complicated analysis, because you now have to compare a Traditional IRA plus a taxable side account to the Roth IRA. You now need to consider the investment results in the taxable side account. If the after tax return is less than the return in the IRA investments, the Roth conversion will come out ahead. If the taxable side account happens to perform very well, the Roth conversion would not come out ahead. However, note that you may need to adjust your overall asset allocation after any conversion.

The analysis is further complicated because once RMDs start, you may choose to also withdraw from the taxable side account.

Note also that every Traditional IRA has a Tax Free IRA hidden inside. We own a portion of the IRA tax free and the other portion is owned by the taxing authorities. As an example, a $100K IRA is effectively an $85K tax free IRA for an individual who pays 15% every year in taxes.

There is one other consideration for anyone who might pay estate taxes in the future. The taxes paid for a Roth conversion reduces net worth which could in some cases lower or eliminate estate taxes.
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Re: Roth... to convert or not to convert?

Postby SteveNet » Fri May 17, 2013 5:49 pm

@ BigFoot48,

That is some spreadsheet!
Certainly not for the faint of heart or knowledge to use it.
I find however that I may be somewhere in between, just enough to input the information and read the results but for me it's way to complicated and I fear that by my muddling thru it I may come up with results that are incorrect or I read them incorrectly, causing me to not do the right thing.

I may just opt for a middle of the road approach and balance out my Roth and Ira thru conversions in my most tax favored years so that each are about the same size 50/50 and just have done with it.
Current 90k aprox Roth, 215K Ira, convert 62.5K.

To anyone...
I can see that where you get the dollars to pay the taxes might matter for the conversion.
I see 2 feasible options... (I'm sure there are more)
Pay the taxes thru conversion from the IRA acct. at the time of conversion.
Pay the taxes from my Taxable acct via selling equity funds/etf's while staying within the 15% tax bracket so that gains are taxed at 0%.

If I pay from the taxable acct I believe I would then rebalance so that the shares I sold for taxes are repurchased at that time in the Ira/Roth accts by selling bond shares.
Keeping my allocation the same.

Question... If the taxes for the conversion(s) are paid from the IRA at the time of the conversion(s) is that amount (taxes) also taxed as regular income for that/those years?
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Re: Roth... to convert or not to convert?

Postby House Blend » Fri May 17, 2013 8:31 pm

SteveNet wrote:To anyone...
I can see that where you get the dollars to pay the taxes might matter for the conversion.
I see 2 feasible options... (I'm sure there are more)
Pay the taxes thru conversion from the IRA acct. at the time of conversion.


Better:
Do it in two steps. Say you've got $10K left in the 15% bracket.
Convert $10K in 2013.
Then when you determine your exact tax bill for 2013 (perhaps in April 2014), withdraw from the IRA the amount you need to pay that bill. Note that it will increase your AGI for 2014, but not 2013.

(This assumes you have paid enough 2013 income tax in advance to avoid penalties.)

Pay the taxes from my Taxable acct via selling equity funds/etf's while staying within the 15% tax bracket so that gains are taxed at 0%.

IMO, this is the better option, because it is generally better to spend down taxable accounts before tax-advantaged ones.

Note that you can do it in two steps as above--convert in 2013, sell stocks in taxable to pay the bill in 2014, but it should increase your 2014 AGI less because part of your sale of stock will include return of capital. If you have enough carryover losses, it might not increase your AGI at all. Lower AGI means more room for further Roth conversions in 2014.
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Re: Roth... to convert or not to convert?

Postby SteveNet » Fri May 17, 2013 11:11 pm

House Blend wrote:
SteveNet wrote:To anyone...
I can see that where you get the dollars to pay the taxes might matter for the conversion.
I see 2 feasible options... (I'm sure there are more)
Pay the taxes thru conversion from the IRA acct. at the time of conversion.


Better:
Do it in two steps. Say you've got $10K left in the 15% bracket.
Convert $10K in 2013.
Then when you determine your exact tax bill for 2013 (perhaps in April 2014), withdraw from the IRA the amount you need to pay that bill. Note that it will increase your AGI for 2014, but not 2013.

(This assumes you have paid enough 2013 income tax in advance to avoid penalties.)

Pay the taxes from my Taxable acct via selling equity funds/etf's while staying within the 15% tax bracket so that gains are taxed at 0%.

IMO, this is the better option, because it is generally better to spend down taxable accounts before tax-advantaged ones.

Note that you can do it in two steps as above--convert in 2013, sell stocks in taxable to pay the bill in 2014, but it should increase your 2014 AGI less because part of your sale of stock will include return of capital. If you have enough carryover losses, it might not increase your AGI at all. Lower AGI means more room for further Roth conversions in 2014.


Thanks House Blend,
I'm leaning towards the reducing the taxable acct as well for the taxes on the conversion. Carry over losses have been burned up so to speak from the 2008 debacle, but on the bright side of that now 90% of my taxable acct. is now my basis with only a 10% as cap gain, so the LT cap gain hit would be minimal to help keep me in the 15% bracket, which would actually become LT at the end of Feb 2014.
Sounds like a plan. :beer
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Re: Roth... to convert or not to convert?

Postby acr123 » Sat May 18, 2013 7:15 am

Just a clarification. Gabiner wrote ".....if your Roth gets too large, you might retire in the 10% tax bracket. Does this just mean pay small amount of taxes ???

Assume virtually no taxable retirement income and all retirement income were split Roth 70% and Traditional IRA 30% , and at FRA SS for husband and wife ~ 3,000 total. Since 36,000 yearly SS is under floor for married couple does this mean you could (1) take out all Roth to live in a year and pay Zero taxes. (2) Exactly determine amount of taxes by varying how much traditional IRA you take out and (3) since Traditional IRA is not that large the RMD in the future is not a factor.

Thanks,

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Re: Roth... to convert or not to convert?

Postby Electron » Sat May 18, 2013 1:12 pm

SteveNet wrote:Question... If the taxes for the conversion(s) are paid from the IRA at the time of the conversion(s) is that amount (taxes) also taxed as regular income for that/those years?

All withdrawals from a Traditional IRA other than after-tax contributions are taxed regardless of how the money is used. If you choose to pay Roth conversion taxes out of a Traditional IRA resulting in a smaller Roth IRA balance, it would be a two step process. One could convert x% of the Traditional IRA to Roth, and then withdraw y% separately to pay the conversion taxes. Both withdrawals would be taxable.

You also mentioned taking a long term capital gain and its effect on tax brackets. Your tax bracket for ordinary income should have little or no impact from taking a capital gain. Take a look at your tax forms and understand how everything works. Capital gains are broken out separately. However, there may be some cases where the tax on ordinary income is affected to a small degree. That might include a higher AGI that results in a reduced itemized deduction or personal exemption.

Note also that a marginal 15% bracket addresses the tax rate on additional income. The first dollars earned are taxed at lower rates and your overall tax rate on all income will be lower than the marginal rate.
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Re: Roth... to convert or not to convert?

Postby SteveNet » Sat May 18, 2013 1:21 pm

Electron wrote:
SteveNet wrote:Question... If the taxes for the conversion(s) are paid from the IRA at the time of the conversion(s) is that amount (taxes) also taxed as regular income for that/those years?

All withdrawals from a Traditional IRA other than after-tax contributions are taxed regardless of how the money is used. If you choose to pay Roth conversion taxes out of a Traditional IRA resulting in a smaller Roth IRA balance, it would be a two step process. One could convert x% of the Traditional IRA to Roth, and then withdraw y% separately to pay the conversion taxes. Both withdrawals would be taxable.

Thanks, then that is a no go imo.

You also mentioned taking a long term capital gain and its effect on tax brackets. Your tax bracket for ordinary income should have little or no impact from taking a capital gain. Take a look at your tax forms and understand how everything works. Capital gains are broken out separately. However, there may be some cases where the tax on ordinary income is affected to a small degree. That might include a higher AGI that results in a reduced itemized deduction or personal exemption.

Note also that a marginal 15% bracket addresses the tax rate on additional income. The first dollars earned are taxed at lower rates and your overall tax rate on all income will be lower than the marginal rate.


As I am in the 15% tax bracket, I am able to take LT cap gains in my taxable account at 0% tax consequence, as long as I stay within the 15% tax bracket, no?.
If my taxable income (line 43) exceeds the 15% tax bracket due to LT cap gains my taxes are increased because of it.
I just ran that thru Tax act tools for next yr and that was the result.

EDIT... I just reread what I posted in a previous post...
"I'm leaning towards the reducing the taxable acct as well for the taxes on the conversion. Carry over losses have been burned up so to speak from the 2008 debacle, but on the bright side of that now 90% of my taxable acct. is now my basis with only a 10% as cap gain, so the LT cap gain hit would be minimal to help keep me in the 15% bracket, which would actually become LT at the end of Feb 2014."

And I can see I didn't word that clearly enough along the lines of what I was thinking, I see what you were getting at based on my posting.
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Re: Roth... to convert or not to convert?

Postby Electron » Sat May 18, 2013 1:49 pm

SteveNet wrote:As I am in the 15% tax bracket, I am able to take LT cap gains in my taxable account at 0% tax consequence, as long as I stay within the 15% tax bracket, no?

If my taxable income (line 43) exceeds the 15% tax bracket due to LT cap gains my taxes are increased because of it. I just ran that thru Tax act tools for next yr and that was the result.

The 0% bracket for capital gains and qualified dividends only applies to unused space in the 15% bracket.

As an example, if you had $5K unused space in the 15% bracket, a $10K capital gain would be taxed half at 0% with the remainder taxed at 15%.

Your 15% bracket in this case is filled partly with ordinary income (after all deductions and exemptions) and partly with capital gains
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Re: Roth... to convert or not to convert?

Postby SteveNet » Sat May 18, 2013 3:21 pm

Electron wrote:
SteveNet wrote:As I am in the 15% tax bracket, I am able to take LT cap gains in my taxable account at 0% tax consequence, as long as I stay within the 15% tax bracket, no?

If my taxable income (line 43) exceeds the 15% tax bracket due to LT cap gains my taxes are increased because of it. I just ran that thru Tax act tools for next yr and that was the result.

The 0% bracket for capital gains and qualified dividends only applies to unused space in the 15% bracket.

As an example, if you had $5K unused space in the 15% bracket, a $10K capital gain would be taxed half at 0% with the remainder taxed at 15%.

Your 15% bracket in this case is filled partly with ordinary income (after all deductions and exemptions) and partly with capital gains


Yep, we are on the same page. :beer
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Re: Roth... to convert or not to convert?

Postby Electron » Sat May 18, 2013 3:38 pm

SteveNet wrote:
Electron wrote:
SteveNet wrote:Question... If the taxes for the conversion(s) are paid from the IRA at the time of the conversion(s) is that amount (taxes) also taxed as regular income for that/those years?

All withdrawals from a Traditional IRA other than after-tax contributions are taxed regardless of how the money is used. If you choose to pay Roth conversion taxes out of a Traditional IRA resulting in a smaller Roth IRA balance, it would be a two step process. One could convert x% of the Traditional IRA to Roth, and then withdraw y% separately to pay the conversion taxes. Both withdrawals would be taxable.

Thanks, then that is a no go imo.

There is actually nothing wrong with converting a Traditional IRA to a smaller Roth IRA and paying the taxes from the Traditional IRA. See my post from May 17.

The two IRAs are actually identical in after-tax value if the tax rate to convert is also the tax rate to withdraw. The two IRAs would remain identical after-tax if tax rates remain the same and that includes years of compounding in either IRA. The conversion pays off if tax rates rise in the future.

However, it's not clear if the tax rate to convert can also be the tax rate to withdraw since the relative amounts are different. In addition, we know that our average tax rate is less than the marginal tax rate with some money taxed at lower rates. The two IRAs could be essentially identical for conversions of a certain size.

Paying conversion taxes from taxable accounts can be better but it is a very complicated analysis and you don't know how things might actually turn out in the future. That includes investment gains and withdrawal amounts from the taxable account and future tax rates. However, there probably is the benefit of using low tax rate space in years where it is available rather than wasting it.
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Re: Roth... to convert or not to convert?

Postby grabiner » Sat May 18, 2013 6:03 pm

acr123 wrote:Just a clarification. Grabiner wrote ".....if your Roth gets too large, you might retire in the 10% tax bracket. Does this just mean pay small amount of taxes ???


The problem with falling into the 10% tax bracket is that you paid too much tax with the premature conversion. If you convert a $10,000 Traditional IRA to an S8500 Roth IRA, and the account doubles in value before you spend it, you will have $17,000 in the Roth. If you had kept it in a Traditional IRA, you would have $20,000 but would owe tax on the withdrawal.

Therefore, if you withdraw at a marginal tax rate of 15%, the conversion is break-even. If you withdraw at a marginal tax rate of less than 15%, the conversion is a mistake, as you would have had $18,000 in a 10% tax bracket without converting,

Assume virtually no taxable retirement income and all retirement income were split Roth 70% and Traditional IRA 30% , and at FRA SS for husband and wife ~ 3,000 total. Since 36,000 yearly SS is under floor for married couple does this mean you could (1) take out all Roth to live in a year and pay Zero taxes. (2) Exactly determine amount of taxes by varying how much traditional IRA you take out and (3) since Traditional IRA is not that large the RMD in the future is not a factor.


Strategy 2 is best. You probably don't want to pay zero tax, because you will burden your heirs with extra taxes. Your heirs are likely to pay 25% or higher tax (when they are still working) or 22.5% or 27.75% tax (when they are retired) on the inherited IRA. Therefore, it's better for you to pay 15% on the IRA withdrawals yourself.

The following examples are similar to the table in Taxation of Social Security benefits; that table assumes $40,000 rather than $36,000 in SS.

You should certainly take as much as possible out of the traditional IRA for a zero tax bill; if you don't need the money, use it to convert more of the traditional IRA to the Roth in order to save either yourself or your heirs in future tax. In 2013, a married couple over 65 can have adjusted gross income of $22,400 and owe no tax. With $36,000 in SS, you can have $14,000 of other income before the SS is taxed, and thus $19,600 of IRA withdrawals and $2800 of taxable SS would give you a zero tax bill.

The next dollars would have a 15% marginal tax rate (10% bracket plus SS phase-in), up to $26,000 of IRA withdrawals and $6000 of taxable SS for a $32,000 gross income; this should still be worth taking. Beyond that, you have an 18.5% marginal tax rate (10% bracket plus 18.5% SS phase-in), and that may also be worth taking. You don't want to go beyond $30,486 of IRA withdrawals, which would push you into the 15% tax bracket and 27.75% marginal tax rate.
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Re: Roth... to convert or not to convert?

Postby SteveNet » Fri May 24, 2013 2:03 pm

As a few of the last posts have been deleted somehow (including mine) , I have continued this here with some more information...

http://www.bogleheads.org/forum/viewtopic.php?f=2&t=116870

If the moderators want to combine these two topics I have no objection.
As posts disappeared I was reluctant to post here again.
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