Tax Planning and RMD

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills

Tax Planning and RMD

Postby LarryG » Wed Nov 04, 2009 1:38 pm

I am retired, age 78, and our income is entirely from my IRA and SS. This year with the RMD withdrawal suspended, I am looking at the optimum amount to withdraw from the IRA. Because I had sufficient funds from 2008 withdrawal, I have not withdrawn anything in 2009 and could go into 2010 before withdrawing anything.

With the assumption that income taxes will rise in the future, I wonder whether I should withdraw an amount that will put me in a tax bracket just below what the full RMD amount would be taxed. The advantage of withdrawing that amount would be that there would be a lower balance at the end of the year. Obviously withdrawing anything results in having that much less to grow tax deferred.

Any ideas about appropriate withdrawal from IRA this year will be appreciated.

Thank you

LarryG
User avatar
LarryG
 
Posts: 250
Joined: Sun Mar 11, 2007 12:10 pm

Postby Horatio » Wed Nov 04, 2009 2:33 pm

On a related note, are you considering conversion to Roth IRA next year?
Horatio
 
Posts: 156
Joined: Fri Dec 19, 2008 11:33 pm

Postby DSInvestor » Wed Nov 04, 2009 3:00 pm

Hi Larry,

Horatio is on to something. She asked if you were considering ROTH conversion next year, but if your only income for 2009 was social security, you'd qualify for ROTH conversion in 2009. If you don't need the money in 2009 and are willing to pay some tax, ROTH conversion may be an excellent option for you. The taxes due for a ROTH conversion will depend on your tax bracket and type of income you have. Roth conversion is a distribution from your IRA so the taxes are the same as if you had taken an RMD. If you make 20K ROTH conversion, the tax is exactly the same as 20K RMD.

The difference with ROTH conversion is that the amount converted will grow tax free. Withdrawals from ROTH IRA are tax free for you and your heirs. ROTH-IRA is not subject to RMD. IMO, ROTH conversion would be a better option than taking a voluntary IRA withdrawal and investing in taxable account.

2009 is a great year for conversion because the RMD was suspended for 2009. If you wait until 2010 to do ROTH conversions, you'd have to make your RMD first and then do the ROTH conversion. It would be much more expensive to convert in 2010 and beyond. IRS does not allow you to direct the proceeds of RMD into a ROTH account.
DSInvestor
 
Posts: 6541
Joined: Sat Oct 04, 2008 12:42 pm

Postby pshonore » Wed Nov 04, 2009 3:20 pm

If Larry's only income is SS and IRA, he might want to consider withdrawing (or converting) just enough so as to keep his SS tax free and stay within the 0% tax bracket (roughly $20900 MFJ status or $10750 Sgl)

edit: He can increase those 0% bracket numbers by $1000 MFJ or $500 Sgl if he 's paying property taxes and not itemizing
pshonore
 
Posts: 3088
Joined: Sun Jun 28, 2009 3:21 pm

Postby LongDistanceRunner » Wed Nov 04, 2009 5:58 pm

Hi Larry,

I agree with the idea of converting to a Roth this year (2009) for whatever amount keeps you in a reasonable tax bracket this year.

If you have after-tax savings from which you can pay the tax on the Roth conversion, I would suggest to you to pay the taxes with those funds, and not have it come out of your TIRA. This would allow you to shelter more future growth from income taxes than if you reduced the Roth conversion by the income tax on it.

LDR
LDR | | "Work like you don't need the money. | Love like you've never been hurt. | Dance like nobody's watching." - Satchel Paige
User avatar
LongDistanceRunner
 
Posts: 128
Joined: Fri Sep 25, 2009 1:00 pm

Postby GG » Wed Nov 04, 2009 6:26 pm

I also vote to convert some $$ to Roth instead of withdrawing to put in the bank for example.

However, I would not limit it to a low bracket, I would convert at least the amount you would have taken in RMDs since that's the bracket you'll be in forever. And possibly more if we agree taxes go up. And if you're usually in a high bracket like 33 or 35%, then I'd do even more becuase those brackets are guaranteed to go up
GG
 
Posts: 447
Joined: Mon Nov 17, 2008 9:09 pm

Postby MarkNYC » Wed Nov 04, 2009 6:40 pm

LarryG,

Converting some of your IRA to a Roth IRA in 2009 makes sense because, if your only income for 2009 thus far is Social Security , then a portion of your traditional IRA can be converted in 2009 with zero federal tax. The optimal amount for a 2009 conversion which keeps your federal tax at zero depends on your gross Social Security income and your total itemized deductions, or standard deduction, whichever applies.
MarkNYC
 
Posts: 779
Joined: Mon May 05, 2008 8:58 pm

Postby LarryG » Thu Nov 05, 2009 6:44 am

Thank you all for your suggestions.

I examined the effect of converting the entire IRA to a Roth compared to paying tax on annual RMD.

Assuming standard deduction, personal exemption, annual withdrawal, growth of balance of 5%, the amount remaining in the standard IRA after 10 years is much more than the balance in the Roth.
This also takes into account annual federal and state taxes and annual withdrawal from RMD.

The difference is even more striking if I add back interest (in tax exempt account) earned on balance of what I must withdraw in RMD after annual living expenses and taxes are subtracted.

I realize that intuitively the idea of converting to a Roth seems best and might be if I were 50 years old. Unless I made a mistake in my calculation
in my case the spread sheet rules over intuition.

I would welcome any questions or suggestions.

LarryG
User avatar
LarryG
 
Posts: 250
Joined: Sun Mar 11, 2007 12:10 pm

Postby livesoft » Thu Nov 05, 2009 8:50 am

1. If LarryG's income is not high, then he can convert some of the IRA to a Roth IRA at anytime. He doesn't have to wait until 2010.

2. There is no need to convert ALL the IRA to a Roth IRA.

Many retirees convert some of their tax-deferred IRA money to a Roth IRA each year. They usually try to convert an amount that puts them up to the top of their tax bracket since that money would be taxed at that rate in the future anyways.

So buy your 2009 copy of TurboTax over the Thanksgiving weekend when it comes out. Do a preliminary run of your taxes and then see how much of your IRA you can convert.

I am not versed in the 5-year rules for Roth IRA converted money, so read up on all that as well.

I also realize that I repeated some of the previous advice already given in this thread, but I will repeat it once more: 1) Convert some and 2) it is not necessary to convert all. One has to run the numbers to see how much to convert this year and each year going forward.
livesoft
 
Posts: 34303
Joined: Thu Mar 01, 2007 9:00 pm

Postby JW Nearly Retired » Thu Nov 05, 2009 9:17 am

I examined the effect of converting the entire IRA to a Roth compared to paying tax on annual RMD.

Nobody is saying to convert it all. However, if you have only SS and this IRA as income, then you can certainly convert some amount of it at a very low tax bracket. A single filer has to have about $15K of income in addition to their SS benefit before he pays any Federal taxes. Since Roth earnings will never be taxed, converting some of the IRA to a Roth is obviously better then just withdrawing some and putting it in a taxable account.

It might help us give more specific advice if you could tell us your marginal tax bracket with and without the IRA income.
JW
JW Nearly Retired
 
Posts: 4068
Joined: Sun Dec 16, 2007 1:25 pm

Postby LarryG » Thu Nov 05, 2009 2:57 pm

JW Nearly Retired,

I calculated the difference with an IRA of $2,000,000, SS $36,000, annual withdrawal for living expenses $55,000, State tax 6%, Standard deduction and exemption $21,900
Converting the entire IRA to Roth was in 35% tax bracket.
Annual RMD was in 25% tax bracket

I compared balances after 5 years. The Roth balance was $1,220,112
The IRA balance including annual surplus over $55,000 (reinvested at 2% yield) was $2,075,835.

I didn't continue the calculation for longer period.

My conclusion is that I should continue with the IRA and not convert.

Where am I wrong?

Thank you,

LarryG
User avatar
LarryG
 
Posts: 250
Joined: Sun Mar 11, 2007 12:10 pm

Postby livesoft » Thu Nov 05, 2009 3:08 pm

LarryG wrote:Where am I wrong?

What if you converted a little bit in each of the next 10 years? You would then have 2 IRAs: Your existing IRA and a Roth IRA.

The amount to convert might be the amount that keeps you in the 25% tax bracket after taking an RMD, but does not bump you into the 28% tax bracket. That way, you will not be paying 35% marginal income tax on such a large amount.

Note: Your RMD cannot be used as a conversion amount.
livesoft
 
Posts: 34303
Joined: Thu Mar 01, 2007 9:00 pm

Postby kaneohe » Thu Nov 05, 2009 4:39 pm

LarryG wrote:Where am I wrong?

Thank you,

LarryG


Larry, I believe you are comparing apples and oranges....which is unfair to one of them. The Roth, of course is smaller, immediately after conversion because it has already taken the tax hit where the TIRA has not yet. For a fair comparison, you need to figure out the after-tax value of the TIRA since you can't use those funds w/o withdrawing funds and being taxed on them. Of course, it is hard to know what scenario to use......
perhaps you will live forever; in that case you need to continue your model of RMDs forever and then find out what's left after you pay taxes in the taxable account from the IRA. Or perhaps you pass away soon, and a young grandchild in a low tax bracket inherits it and stretches it; or perhaps you kid inherits it and cashes it out immediately when he is already a high earner. All quite different results probably but unless you calculate the after tax results, the comparison is invalid.
kaneohe
 
Posts: 2608
Joined: Mon Sep 22, 2008 1:38 pm

Postby LarryG » Thu Nov 05, 2009 5:30 pm

Thank's Kaneohe,

I see the point of invalid comparison.

I looked at the value of a conversion to a Roth after 5 years of RMD withdrawals. The value of the Roth would be more than if I converted in 2010 and withdrew living expenses from the Roth.

I am inclined to continue with the IRA and will withdraw an amount this year that will be below what the suspended RMD would have been.
I will withdraw more than the minimum amount suggested by others but will stay within the tax bracket below what the full RMD withdrawal would have been.

Larry
User avatar
LarryG
 
Posts: 250
Joined: Sun Mar 11, 2007 12:10 pm

Postby Larry Y » Thu Nov 05, 2009 6:35 pm

I am in a very similar situation to Larry G - in fact we are the same age. I have decided to make a partial Roth conversion in both 2009 and 2010. By utilizing some substantial charitable giving I calculate a 22% tax rate on a conversion of $400,000. Don't think it will ever again be that inexpensive in my remaining years, given my expectations for tax increases. Larry Y
Larry Y
 
Posts: 5
Joined: Fri Jul 25, 2008 3:56 pm

Postby DickBenson » Fri Nov 06, 2009 3:41 am

You said: "I am retired, age 78, and our income is entirely from my IRA and SS".

Does this mean that you do not have any other savings or taxable investments, or is SS your only source of funds to pay the tax on a Roth conversion?

The usual plan is to use taxable savings to pay for the conversion of an IRA to Roth status in order to "freeze" its size by avoiding any RMDs (and thus avoiding tax on those RMDs).

Dick
DickBenson
 
Posts: 809
Joined: Sun Apr 08, 2007 8:27 pm

Postby LarryG » Fri Nov 06, 2009 12:02 pm

Dick,

That is correct. I have no other savings or investments. Our entire annual income is from my IRA and our SS.

Any tax due on a conversion would come from the IRA.

I gifted all other investments to our children years ago.

LarryG
User avatar
LarryG
 
Posts: 250
Joined: Sun Mar 11, 2007 12:10 pm

Postby JW Nearly Retired » Sat Nov 07, 2009 5:26 pm

LarryG wrote: I calculated the difference with an IRA of $2,000,000, SS $36,000, annual withdrawal for living expenses $55,000, State tax 6%, Standard deduction and exemption $21,900

Because I had sufficient funds from 2008 withdrawal, I have not withdrawn anything in 2009 and could go into 2010 before withdrawing anything.

I think you should withdraw/convert just a modest amount (around $28K) and put it all into a Roth. The taxes on this amount will be very small...... I compute a Federal tax of only $1600 on the $28K amount. Given a $2M IRA, $28K is not a big deal but it will reduce your RMD a little going forward. You could do some playing with different IRA withdrawel amounts using tax software like TaxAct/TaxCut/TurboTax using your exact information and then decide just how much to withdraw this year when you have control over the amount.

I did some "what if" Taxcut experimenting using your $36K SS and various IRA withdrawels. Results graph is below. The first thing to note is much of your IRA money is taxed at a marginal rate of 28%. This rate jumps from 15% to 28% at $28K of IRA withdrawel, and only drops back to 25% at $60K. This happens because the tax formula taxes both the IRA withdrawels and also increasing amounts of the SS income as your income increases. Only after you get to 85% of SS being taxed does the marginal rate drop to "normal". If you take only $28K some is taxed at a zero rate and some at 15%, the total tax is only $1600. Don't know what effect the state tax will have.

I'm guessing your RMD next year is around $100K and you won't be into the 28% bracket. If so, I don't see much advantage to converting any more of the IRA money except the smallish amount this year that will be lightly taxed. Maybe someone else can come up with a longer term strategy that yields some benefit.
JW

Image
JW Nearly Retired
 
Posts: 4068
Joined: Sun Dec 16, 2007 1:25 pm

Postby celia » Sun Nov 08, 2009 6:35 am

You need to have a Roth for 5 years before you can withdraw from one tax-free. You don't have to withdraw from the account that is over 5 years old, just have at least one that is. If you don't currently have a Roth and convert everything, you won't be able to withdraw from it for 5 years, without penalty.

I don't quite follow your math. If you came up with being in the 35+6% tax bracket, that is for the last dollars being taxed. Don't forget that the tax rates are graduated: a certain amount is taxed at 0%, then the next dollars are taxed at 10%, then 15%, then 25%, 28%, 33%, and 35%. Let's say you aim for converting enough to not go over the 28% federal +6% state rate. If you are single, you can have taxable income up to $171,550 and $208,850 if married. You could do the calculations in reverse. Subtract your other taxable income from these (85% of SS) and add back your exemptions and standard deduction. Even if you end up going over a little, it is just that little amount that is taxed at a higher rate.

At this point you would then know the amount to withdraw. Anything over the RMD required for the year could be converted to a Roth. Do this in multiple years, and each year you take advantage of some of the withdrawals being taxed at lower rates. By converting all of it now, everything over $372,951 is taxed at the 35+6% rate.

source for my numbers: wikipedia tax rate chart.
User avatar
celia
 
Posts: 2048
Joined: Sun Mar 09, 2008 7:32 am
Location: SoCal

Postby Mel Lindauer » Sun Nov 08, 2009 8:09 am

Hi Larry:

I did exactly what others are recommending -- converted a bit less than my RMD would have normally been had it not been suspended this year. That way, I'm paying at a known (lower) tax rate and the money will grow tax free. Since I already have had a Roth for more than five years, the money's available to me at any time, just as if it were in my taxable account, except I won't be paying annual taxes on any distributions or redemptions.
Best Regards - Mel | | Semper Fi
User avatar
Mel Lindauer
Moderator
 
Posts: 22339
Joined: Mon Feb 19, 2007 9:49 pm
Location: Daytona Beach Shores, Florida

Postby pshonore » Sun Nov 08, 2009 9:34 am

celia wrote:You need to have a Roth for 5 years before you can withdraw from one tax-free. You don't have to withdraw from the account that is over 5 years old, just have at least one that is. If you don't currently have a Roth and convert everything, you won't be able to withdraw from it for 5 years, without penalty.


Only true if you're under 59 1/2 (per WJS article yesterday) :

http://online.wsj.com/article/SB1257546 ... _investing

I get really confused by the 5 yr rule but here is their quote

"If you already are 59½ and you convert traditional IRA assets to a Roth, you can withdraw the assets you convert at any time without worrying about a five-year deadline or penalties. Again, it is a different story with any earnings on those assets: You have to have held a Roth account for five years to withdraw any earnings tax free. But you generally don't need to worry about separating the converted funds from the earnings, since the withdrawal rules for Roth IRAs say that any distributions first come from contributions, then from conversions, and finally from earnings, says Ed Slott, an IRA consultant in Rockville Centre, N.Y."
pshonore
 
Posts: 3088
Joined: Sun Jun 28, 2009 3:21 pm

Postby Mel Lindauer » Sun Nov 08, 2009 9:57 am

pshonore wrote:
celia wrote:You need to have a Roth for 5 years before you can withdraw from one tax-free. You don't have to withdraw from the account that is over 5 years old, just have at least one that is. If you don't currently have a Roth and convert everything, you won't be able to withdraw from it for 5 years, without penalty.


Only true if you're under 59 1/2 (per WJS article yesterday) :

http://online.wsj.com/article/SB1257546 ... _investing

I get really confused by the 5 yr rule but here is their quote

"If you already are 59½ and you convert traditional IRA assets to a Roth, you can withdraw the assets you convert at any time without worrying about a five-year deadline or penalties. Again, it is a different story with any earnings on those assets: You have to have held a Roth account for five years to withdraw any earnings tax free. But you generally don't need to worry about separating the converted funds from the earnings, since the withdrawal rules for Roth IRAs say that any distributions first come from contributions, then from conversions, and finally from earnings, says Ed Slott, an IRA consultant in Rockville Centre, N.Y."


Larry stated that he's 78, so the age restriciton isn't a problem for him.
Best Regards - Mel | | Semper Fi
User avatar
Mel Lindauer
Moderator
 
Posts: 22339
Joined: Mon Feb 19, 2007 9:49 pm
Location: Daytona Beach Shores, Florida

Postby GG » Sun Nov 08, 2009 10:43 am

Just to confirm, you aren't going to withdraw anything this year, right? You are going to choose an amount to convert. Withdrawing anything you won't need to live on and reinvest in cash or non-qualified account would obviously be silly.
GG
 
Posts: 447
Joined: Mon Nov 17, 2008 9:09 pm

Postby LarryG » Sun Nov 08, 2009 12:15 pm

Thank all of you for your help.

I don't know whether I'm stubborn or stupid (or both), but my tax projections indicate that my Rollover IRA balance remains higher than what my Roth balance would be for a number of years. Our life expectancy,at age 78, is not that long. I assumed an annual growth of 5%.
I have not done any calculation for partial conversion to a Roth, but doubt that it would make a large difference.

Fortunately I can continue to massage numbers into 2010.

I do continue to think of John Bogle's statement "I'll earn my fair share. That's enough for me" as I consider what I should do to minimize my tax impact.

Thanks again.

LarryG
User avatar
LarryG
 
Posts: 250
Joined: Sun Mar 11, 2007 12:10 pm

Postby celia » Sun Nov 08, 2009 3:16 pm

pshonore (and others), Thanks for the correction. There's so many rules for each situation that sometimes we forget about things like this.
LarryG wrote: my tax projections indicate that my Rollover IRA balance remains higher than what my Roth balance would be for a number of years. Our life expectancy,at age 78, is not that long.

Larry, You are probably forgetting that your Rollover IRA has not yet been taxed and the Roth has. A dollar in the Roth is worth more than a dollar in the Rollover IRA. This goes back to the earlier comment of comparing apples and oranges.

For IRA purposes, your "life expectancy" is not how long you think you will live (based on current health and genetics) but on what the IRS determines is appropriate for IRA withdrawals. Yes, the RMD increases significantly at your age, but is based on an age that very few of us will reach. Here is the IRS chart for calculating RMDs provided you don't have a living spouse more than 10 years younger than you (then a different chart is needed).
Last edited by celia on Sun Nov 08, 2009 3:53 pm, edited 2 times in total.
User avatar
celia
 
Posts: 2048
Joined: Sun Mar 09, 2008 7:32 am
Location: SoCal

Postby celia » Sun Nov 08, 2009 3:42 pm

LarryG wrote:I do continue to think of John Bogle's statement "I'll earn my fair share. That's enough for me" as I consider what I should do to minimize my tax impact.

Most of us try to minimize our taxes. We want to use the money for ourselves and children and our charities rather than letting the government spend it on what they chose. However, the government is going to get their share of taxes from the Rollover IRA one way or another. They can get some of it each year when you withdraw (RMDs and conversions). They may get a larger share when you die since the balance will put the "last" dollars in a higher tax bracket. Your heirs or estate will have to pay taxes on top of their individual tax rate since they will have to withdraw from it. I'm not sure, but if you give some to a charity, they don't get any.

The longer we project into the future, the more we are subject to tax rate changes or changes in the laws and changes in our lives. So all we can do now is make decisions based on what we know for sure and educated guesses on what we don't know.

I started converting when I reached 59 1/2, partly to take advantage of the "down" market last year and partly because I think tax rates will only increase (at least for the next 10 years). Now, I realize with postings like this, that I'm also glad I started the conversion process when I did so that my survivors don't have to worry (hopefully) about the best time to take RMDs or convert.
User avatar
celia
 
Posts: 2048
Joined: Sun Mar 09, 2008 7:32 am
Location: SoCal

Postby kaneohe » Sun Nov 08, 2009 4:19 pm

Larry......because you would be paying conversion taxes our of the TIRA
(which is generally not recomended but, apparently for you is the only way), the case for conversion (except for a small amount this yr) is not as compelling as for others. One suggestion is to revisit this idea in the future when you have had time to get used to the idea of paying more taxes now for a possible future benefit........I too share your reluctance of paying now.
Sometimes you have to live w/ that idea awhile before you become convinced it may a good idea.
The other suggestion is learn about stretching your IRA and then making sure that your heirs understand that concept. You have a good sized TIRA and it would a shame if they inherited it and, due to ignorance, cashed it in all at once either on purpose or accidentally which would put them in a top tax bracket.
kaneohe
 
Posts: 2608
Joined: Mon Sep 22, 2008 1:38 pm

Postby Ron » Sun Nov 08, 2009 4:39 pm

kaneohe wrote:Larry......because you would be paying conversion taxes our of the TIRA (which is generally not recomended but, apparently for you is the only way), the case for conversion (except for a small amount this yr) is not as compelling as for others.


This is exactly the situation for my wife/me, since around 95% of our retirement holdings are in TIRA's.

In our case, using the VG calculator:

https://personal.vanguard.com/us/RothCo ... omain=true

shows that we would be losing close to 100k more over the long term, when looking at our total to convert, our anticipated tax rate, and the length of time remaining to draw from our respective Roth's.

For those that have taxable holdings and can pay the tax up front and avoid reducing the amount to invest over the long term, it makes sense. For others, it does not.

- Ron
User avatar
Ron
 
Posts: 5247
Joined: Fri Feb 23, 2007 8:46 pm
Location: CCTV Building - Beijing CBD

Postby neverknow » Sun Nov 08, 2009 4:39 pm

..
Last edited by neverknow on Mon Jan 17, 2011 7:59 am, edited 1 time in total.
neverknow
 
Posts: 2392
Joined: Fri Jun 05, 2009 5:45 am

Postby celia » Sun Nov 08, 2009 10:49 pm

Ron wrote:For those that have taxable holdings and can pay the tax up front and avoid reducing the amount to invest over the long term, it makes sense. For others, it does not.

I don't see any real difference paying the taxes from taxable income or from the TIRA withdrawal, except a possible psychological one. Even then, you should realize you are giving up a chunk money to the government, regardless of where the tax money comes from.

For example, say you are in the 28% tax bracket and want to convert $10,000. The taxes on that withdrawal (whether spent or put into a taxable account or converted) is $2800.

Person A can start with $2800 in taxable and a $10,000 TIRA. After conversion, person A is left with 0 in taxable and $10,000 in the Roth. Person A is left with 78.125% of his original assets [10,000/(10,000+2800)].

Person B can start with a $10,000 TIRA only. Since taxes will be withheld from that conversion, $7,200 is left in the Roth. Person B is left with 78.0% of his original assets [7200/10,000].

To me these are the same. The only difference is that Person A started with a bigger pot. The 0.125% difference ($12.50 in this example) can probably be explained but is not obvious to me at this point.
User avatar
celia
 
Posts: 2048
Joined: Sun Mar 09, 2008 7:32 am
Location: SoCal

Postby celia » Sun Nov 08, 2009 11:06 pm

Ron wrote:In our case, using the VG calculator...shows that we would be losing close to 100k more over the long term, when looking at our total to convert, our anticipated tax rate, and the length of time remaining to draw from our respective Roth's.

OK, let me say it another way. Of course if you pay taxes from the TIRA withdrawal, your Roths will have a smaller dollar amount compared to keeping the money in TIRA's because you paid taxes on the Roths and it had to come from somewhere. I assume we all agree on that. But the only fair way to compare the value of both kinds of accounts is to look at how much spending power remains when you withdraw from either account. If you need $x for something, you can:
1) take $x tax-free from the Roth
2) take $x+taxes from the TIRA, give up the taxes and have $x left to spend
3) take $x from the TIRA and give up taxes from another source

To compare the value of the accounts, since the TIRA is not yet taxed, you need to subtract taxes from the value before you compare it to the Roth.

You can do conversions or not. I just hope you understand how to make fair comparisons.
User avatar
celia
 
Posts: 2048
Joined: Sun Mar 09, 2008 7:32 am
Location: SoCal

Postby LarryG » Sun Nov 08, 2009 11:22 pm

Vanguard has an excellent discussion about the many factors involved in deciding to convert an IRA to a Roth.

http://www.vanguard.com/pdf/rpd21.pdf?c ... omain=true

The negative aspect of converting if the taxes come from the IRA (my case) is made.

Thank all of you for your contributions to this discussion. I had a serious question about whether converting was right for me.

LarryG.
User avatar
LarryG
 
Posts: 250
Joined: Sun Mar 11, 2007 12:10 pm

Postby kaneohe » Mon Nov 09, 2009 2:21 am

celia wrote:
For example, say you are in the 28% tax bracket and want to convert $10,000. The taxes on that withdrawal (whether spent or put into a taxable account or converted) is $2800.

Person A can start with $2800 in taxable and a $10,000 TIRA. After conversion, person A is left with 0 in taxable and $10,000 in the Roth. Person A is left with 78.125% of his original assets [10,000/(10,000+2800)].

Person B can start with a $10,000 TIRA only. Since taxes will be withheld from that conversion, $7,200 is left in the Roth. Person B is left with 78.0% of his original assets [7200/10,000].
.


Celia, I believe there is a typo in your example above. For Person B, the % should be 72%. Unfortunately that seems inconsistent w/ your conclusion.

I do believe you are correct when you say there is no difference if you pay the tax from the conversion amount. I think what the other posters are saying is that if you pay the tax from other (taxable) funds , then the Roth would then come out ahead (assuming same tax rates)......so it is more compelling to do the conversion if you pay the tax from outside fund; not so compelling if you do it from the TIRA.

I) Pay tax from TIRA (using your 28% tax rate)
After tax $7200 in Roth vs $10000 in TIRA
After some yrs, assets double in value
Roth has $14400; TIRA has 20000
After taxes Roth has $14400; TIRA has $14400

II) Pay tax from outside funds
Roth has $10000 but owner has $2800 less in taxable funds
TIRA has $10000

After some yrs, assets double
Roth owner has $20000; TIRA owner has $20000 in TIRA and essentially has something like $5600 in taxable account

After taxes, Roth owner has $20000; TIRA owner has $14400 from TIRA after taxes but less than $5600 because taxes were paid.......either along the way or at the end. So TIRA owner has something less than $20000. This is where the more compelling case for converting comes.

In the end, the devil is in the numbers and without doing the calculation, it is hard to prove the benefits.
kaneohe
 
Posts: 2608
Joined: Mon Sep 22, 2008 1:38 pm

Postby celia » Mon Nov 09, 2009 4:02 am

kaneohe, You are right about my typo. Thanks for clarifying.

Larry, I like the memo you linked to at Vanguard. At the end, in Figure 4, I noticed that according to the current tax code, the tax rates are scheduled to increase in 2011. It is good to see what they are a few years before they take effect.
User avatar
celia
 
Posts: 2048
Joined: Sun Mar 09, 2008 7:32 am
Location: SoCal

Postby Ron » Mon Nov 09, 2009 8:21 am

The cited paper does mention the reason that we (on a personal situation basis) are not going to convert; that is our remainder estate (including the TIRA accounts) is going to charity.

The paper states "On the other hand, for investors who are charitably inclined, converting a traditional IRA to a Roth IRA may not maximize the value of the transfer since assets that pass to a charity are not subject to income taxes."

Again, this is a situation that tax wise, could change in the future. However since we have no need for "wealth transfer" to future generations, the any long term advantage of a Roth (if any) are not as important to us.

Just another situation to add to the variations on the theme.

- Ron
User avatar
Ron
 
Posts: 5247
Joined: Fri Feb 23, 2007 8:46 pm
Location: CCTV Building - Beijing CBD

Postby JW Nearly Retired » Mon Nov 09, 2009 10:10 am

LarryG wrote: I don't know whether I'm stubborn or stupid (or both), but my tax projections indicate that my Rollover IRA balance remains higher than what my Roth balance would be for a number of years. Our life expectancy,at age 78, is not that long. I assumed an annual growth of 5%.
I have not done any calculation for partial conversion to a Roth, but doubt that it would make a large difference.

I don't think there is anyone saying to do anything but a partial one-time or yearly conversion of a small amount. In my case I'm saying just withdraw & convert $28K this one year only, and don't withdraw any more then that. You will pay only 6% in 2009 Federal Tax on this money, versus 25% or 28% if you leave it in the TIRA and withdraw it later. Put whatever of this $28K that's left after taxes into a Roth and you will never have to pay any more taxes on this money or it's earnings. Doing this is a complete no-brainer that needs no complex analysis.

If $28K is too small an amount for you to bother with then don't do anything.
JW
JW Nearly Retired
 
Posts: 4068
Joined: Sun Dec 16, 2007 1:25 pm

Postby kaneohe » Mon Nov 09, 2009 12:20 pm

JW Nearly Retired wrote:If $28K is too small an amount for you to bother with then don't do anything.
JW


Must be the theory of relativity of money......28K seems small in relation to 2M in IRA funds in question. Yet might save a 2-6K in taxes depending on difference in tax rates now vs then. And would probably jump at the chance to save $10 on a free meal somewhere.
kaneohe
 
Posts: 2608
Joined: Mon Sep 22, 2008 1:38 pm

Postby Mel Lindauer » Mon Nov 09, 2009 12:37 pm

kaneohe wrote:
JW Nearly Retired wrote:If $28K is too small an amount for you to bother with then don't do anything.
JW


Must be the theory of relativity of money......28K seems small in relation to 2M in IRA funds in question. Yet might save a 2-6K in taxes depending on difference in tax rates now vs then. And would probably jump at the chance to save $10 on a free meal somewhere.


So true, and saving on taxes is precisely why I did a conversion even though I wasn't required to take an RMD this year.
Best Regards - Mel | | Semper Fi
User avatar
Mel Lindauer
Moderator
 
Posts: 22339
Joined: Mon Feb 19, 2007 9:49 pm
Location: Daytona Beach Shores, Florida

Postby livesoft » Mon Nov 09, 2009 12:48 pm

To add to the discussion ....

It doesn't appear that you need this money anytime soon and that much of it will go to heirs or charity when you die. For heirs that receive an inherited IRA, they will be forced into RMDs themselves each year as they stretch out the inherited IRA. Thus their tax brackets may be important to your planning. If they are in higher marginal income tax brackets than you are, then they may end up paying more tax on the withdrawals than you would have.

OTOH, it is hard to believe that if you have to pay the taxes out of the IRA in the first place that you can make this work.
livesoft
 
Posts: 34303
Joined: Thu Mar 01, 2007 9:00 pm

Postby Ron » Mon Nov 09, 2009 1:08 pm

livesoft wrote:OTOH, it is hard to believe that if you have to pay the taxes out of the IRA in the first place that you can make this work.


Also to add, even though I did use the VG calculator which shows it makes little sense in our situation, and regardless of our leaving our remainder estate to charity (which should, under current tax rules, leave most/all of it not taxable), I also found a calculator provided by Fidelity:

https://calcsuite.fidelity.com/rothconv ... chPage.htm

Since our T/R-IRA's are split between both companies (VG & Fidelity), I wanted to see how their respective "methodology" turned out. While there is a difference in results (about a $50k variance), in both cases it did not work out for a person who had to take the tax payment out of existing TIRA's.

- Ron
User avatar
Ron
 
Posts: 5247
Joined: Fri Feb 23, 2007 8:46 pm
Location: CCTV Building - Beijing CBD

Postby LarryG » Mon Nov 09, 2009 1:52 pm

Any conversion, in my case, will require money to be taken after RMD and will be taxed entirely at the higher rate. I haven't looked at how the tax saved compares to the lost tax sheltered growth. I will.

As far as the $10 free dinner (or lunch) the only ones around here come with a pitch of how the host (investment advisor) will show me how to earn 20% per year.

There ain't no free lunch!

Larry
User avatar
LarryG
 
Posts: 250
Joined: Sun Mar 11, 2007 12:10 pm

Postby Mel Lindauer » Mon Nov 09, 2009 2:04 pm

LarryG wrote:Any conversion, in my case, will require money to be taken after RMD and will be taxed entirely at the higher rate. I haven't looked at how the tax saved compares to the lost tax sheltered growth. I will.

As far as the $10 free dinner (or lunch) the only ones around here come with a pitch of how the host (investment advisor) will show me how to earn 20% per year.

There ain't no free lunch!

Larry


But there is no RMD this year, Larry, and that's why we're suggesting it for this year only, because you're in a very low tax bracket. That's the same reason I did a conversion this year. (Like you, I'll have to take an RMD next year which will kick my tax bracket back up again.)
Best Regards - Mel | | Semper Fi
User avatar
Mel Lindauer
Moderator
 
Posts: 22339
Joined: Mon Feb 19, 2007 9:49 pm
Location: Daytona Beach Shores, Florida

Postby Ron » Mon Nov 09, 2009 3:09 pm

Mel Lindauer wrote:(Like you, I'll have to take an RMD next year which will kick my tax bracket back up again.)


You know I need to harass (and acknowledge your presence) as a "published author".

If you didn't have the money, you would not be paying taxes :lol: ...

(OK, I'm also one of "those" also, but I figured I get my $.02 in)...

- Ron
User avatar
Ron
 
Posts: 5247
Joined: Fri Feb 23, 2007 8:46 pm
Location: CCTV Building - Beijing CBD

Postby Mel Lindauer » Mon Nov 09, 2009 4:30 pm

Ron wrote:
Mel Lindauer wrote:(Like you, I'll have to take an RMD next year which will kick my tax bracket back up again.)


You know I need to harass (and acknowledge your presence) as a "published author".

If you didn't have the money, you would not be paying taxes :lol: ...

(OK, I'm also one of "those" also, but I figured I get my $.02 in)...

- Ron


Hi Ron:

One of the reasons I have the money is because I practiced tax-efficiency. Now that I'm retired, nothing's changed. I still want to minimize my taxes, so I don't want to make stupid investing decisions that will unnecessarily increase my tax burden.
Best Regards - Mel | | Semper Fi
User avatar
Mel Lindauer
Moderator
 
Posts: 22339
Joined: Mon Feb 19, 2007 9:49 pm
Location: Daytona Beach Shores, Florida

Postby Ron » Mon Nov 09, 2009 4:40 pm

Mel Lindauer wrote:Hi Ron:

One of the reasons I have the money is because I practiced tax-efficiency. Now that I'm retired, nothing's changed. I still want to minimize my taxes, so I don't want to make stupid investing decisions that will unnecessarily increase my tax burden.


Maybe we can discuss the subject (one on one) in your "home town" next year :lol: ..

- Ron
User avatar
Ron
 
Posts: 5247
Joined: Fri Feb 23, 2007 8:46 pm
Location: CCTV Building - Beijing CBD

Postby MarkNYC » Mon Nov 09, 2009 5:22 pm

Larry,

I mentioned this in my response on Nov 4th but perhaps should explain further to be clear:

With $36K SS income, filing jointly, and $21,900 of exemptions and standard deduction, you could convert $19k in 2009 and pay zero federal tax. I'm not sure of your resident state but your state tax may also be zero. Your Adjusted Gross Income would be the $19K IRA plus $2,500 of taxable SS = $21,500. With $21,900 of deductions, your taxable income would be ($400).

If you live ten more years, the $19K Roth might grow to $35K-$40K, at which point your surviving spouse or a younger beneficiary could reap many years of tax-free income as the Roth continues to compound during the beneficiary's distribution years. The potential tax savings (perhaps to your beneficiary rather than you) could be $10K- $15K, possibly more.
If the law changes later on Roth taxability, nothing is lost.

Why would you not do this? (Sometimes there is a free lunch?)
MarkNYC
 
Posts: 779
Joined: Mon May 05, 2008 8:58 pm

Postby Mel Lindauer » Mon Nov 09, 2009 5:46 pm

Ron wrote:
Mel Lindauer wrote:Hi Ron:

One of the reasons I have the money is because I practiced tax-efficiency. Now that I'm retired, nothing's changed. I still want to minimize my taxes, so I don't want to make stupid investing decisions that will unnecessarily increase my tax burden.


Maybe we can discuss the subject (one on one) in your "home town" next year :lol: ..

- Ron


Actually, Ron, Philly isn't my home town if that's what you're referring to. It was simply a rather long stop along the way to retirement.
Best Regards - Mel | | Semper Fi
User avatar
Mel Lindauer
Moderator
 
Posts: 22339
Joined: Mon Feb 19, 2007 9:49 pm
Location: Daytona Beach Shores, Florida

Postby JW Nearly Retired » Mon Nov 09, 2009 10:32 pm

MarkNYC wrote:Larry,
I mentioned this in my response on Nov 4th but perhaps should explain further to be clear:
With $36K SS income, filing jointly, and $21,900 of exemptions and standard deduction, you could convert $19k in 2009 and pay zero federal tax. I'm not sure of your resident state but your state tax may also be zero. Your Adjusted Gross Income would be the $19K IRA plus $2,500 of taxable SS = $21,500. With $21,900 of deductions, your taxable income would be ($400).

LarryG is having none of this. Do you think he is a Troll and just toying with us?
JW
JW Nearly Retired
 
Posts: 4068
Joined: Sun Dec 16, 2007 1:25 pm

Postby LarryG » Tue Nov 10, 2009 8:28 pm

Mark,
I haven't eliminated the idea of a small conversion but I have to massage the figures.

I have decided not to convert all or a large part of the IRA because I would have to pay taxes from the IRA and this doesn't work.

JW Nearly,
I am not a troll. My friend, Mel, will vouch for me.

Larry
User avatar
LarryG
 
Posts: 250
Joined: Sun Mar 11, 2007 12:10 pm

Postby Mel Lindauer » Tue Nov 10, 2009 8:33 pm

LarryG wrote:Mark,
I haven't eliminated the idea of a small conversion but I have to massage the figures.

I have decided not to convert all or a large part of the IRA because I would have to pay taxes from the IRA and this doesn't work.

JW Nearly,
I am not a troll. My friend, Mel, will vouch for me.

Larry


Yes, JW, Larry's for real. He's a retired physician (ask him about his specialty). I first met him at Diehards II in Philly many years ago.
Best Regards - Mel | | Semper Fi
User avatar
Mel Lindauer
Moderator
 
Posts: 22339
Joined: Mon Feb 19, 2007 9:49 pm
Location: Daytona Beach Shores, Florida

Next

Return to Personal Finance (Not Investing)

Who is online

Users browsing this forum: hmw, OldLearner, PatrickA5, reisner, speedbump101, tecmage, TomatoTomahto and 87 guests