Paying Roth conversion taxes with IRA funds

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JoelT1
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Joined: Sat May 05, 2018 1:40 pm

Paying Roth conversion taxes with IRA funds

Post by JoelT1 » Fri May 11, 2018 11:09 am

Hi, I’d appreciate your thoughts on the matter of paying Roth conversion taxes with IRA funds. I’m retired, 60 years old, and have traditional and Roth IRAs; my Roth is funded by trad. IRA conversions (about $35,000) and have been paying taxes with IRA funds. I do not have a taxable account. I have been advised not to pay Roth conversion taxes with IRA funds, however, I have no other source for paying the taxes. And, if I do not fund a Roth with conversions, I’ll eventually get hit with RMDs at a likely higher tax rate which could also cause social security taxation.

So, the way I see it, it’s still better to do Roth conversions while my tax bracket is lower (12%) and work toward a lower balance in my trad. iRA, lower RMD, and make withdrawals from my Roth which won’t cause social security taxation,

Your thoughts, please.

ExitStageLeft
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Re: Paying Roth conversion taxes with IRA funds

Post by ExitStageLeft » Fri May 11, 2018 12:01 pm

Since you don't have a taxable account available then it doesn't matter. What does matter is whether you'd rather pay the tax up front by doing a conversion versus paying the tax down the road. I will be in a similar position when I retire in a few years, and I've cooked up a spreadsheet to compare different Roth conversion scenarios.

In my case it definitely reduces the overall amount of tax dollars that go to Uncle, especially with the currently lower rates. But when I look at the real dollars paid, it makes little difference. Certainly not enough to justify jumping up a bracket or two to convert my entire tIRA before I turn 63.

When I apply for Medicare at age 65, the premium will be based on my MAGI from the tax year two years prior. If my MAGI is too high ($85,000 for single filer and $170,000 for MFJ) then the IRMAA premium surcharge kicks in.

All of this is to say that unless you are sitting on a huge nest egg or have to deal with significant pension income at age 70, the RMD factor may not be that big of a deal. It certainly can be, and you should run some estimates of what your portfolio and income will be when you have to start withdrawing the RMD. Without knowing some of that basic info though, no one can advise you on which is the best path forward. If it turns out that your savings will be greatest if you convert and pay the tax out of your IRA then by all means you should consider doing so. But be aware that is an additional withdrawal that increases your vuilnerability to sequence risk.

The Wizard
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Re: Paying Roth conversion taxes with IRA funds

Post by The Wizard » Fri May 11, 2018 12:49 pm

I was in similar situation at start of retirement at age 63 with 95% of financial assets in tax deferred, so all of my income for the first three years derived from tax deferred:
1) lifetime annuity income from tax deferred
2) monthly withdrawals from tax deferred
3) Roth conversions (from tax deferred, obviously)

Divorced Spouse SS income started at age 66, so I suppose you could say I'm paying taxes on my Roth conversions since then with my SS money.

But this is a silly waste of words since money is fungible.
What really matters is managing your AGI or taxable income to avoid a large increase around age 70 and after.
I do that with Roth conversions now, at age 68, to get my AGI up close to what it will be at age 70 with no further Roth conversions.
And while I'll never be in the base IRMAA tier, I try to manage my Roth conversions to avoid being just over the next higher tier threshold...
Attempted new signature...

CnC
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Re: Paying Roth conversion taxes with IRA funds

Post by CnC » Fri May 11, 2018 3:24 pm

You should always pay for Roth conversions with non tax deferred money, it is always to your advantage to have 10,000 in Roth and 7500 in your checking account rather than 7500 in Roth and 10,000 in your checking.

Unless of course you don't have money laying around to pay the taxes taxes. If you don't have the money to do it differently you are stuck doing what you can.

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Peter Foley
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Re: Paying Roth conversion taxes with IRA funds

Post by Peter Foley » Fri May 11, 2018 3:41 pm

The ideal is to pay for conversions with taxable account. You situation may be such that you can come out ahead paying with pre-tax. In the scenarios I've run on i-orp and the Retiree Portfolio Model, conversions early in retirement make more sense than those close to age 70.

At age 60, my guess is that your strategy is sound. Of course, much depends on the ratio of pre tax savings (IRA) to post tax savings (Roth).

retiredjg
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Re: Paying Roth conversion taxes with IRA funds

Post by retiredjg » Fri May 11, 2018 5:42 pm

JoelT1 wrote:
Fri May 11, 2018 11:09 am
I have been advised not to pay Roth conversion taxes with IRA funds, however, I have no other source for paying the taxes.
Sounds like the person who advised you didn't have a complete understanding of how things are.

Sure, it is better to pay the taxes out of a different account if you have one. It means you end up with more money in Roth IRA (although you have less in taxable). But even if you don't have a taxable account, doing Roth conversions can be a good idea because it makes less money subject to RMDs when the time comes.

Having too much money subject to RMDs can raise your tax bracket in your RMD years. Doing conversions early can reduce or eliminate that.

That's why I'm doing Roth conversions now - to try to keep from being pushed into a higher bracket if I live until middle or late 70's.

Looking4Answers
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Re: Paying Roth conversion taxes with IRA funds

Post by Looking4Answers » Fri May 11, 2018 5:51 pm

Don't know if this would be a factor for OP, but if there is a spouse involved there might be an added reason to convert earlier. Surviving spouse likely will be forced into a higher bracket when RMDs are being withdrawn from TIRA.

RetiredAL
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Re: Paying Roth conversion taxes with IRA funds

Post by RetiredAL » Fri May 11, 2018 6:46 pm

Looking4Answers wrote:
Fri May 11, 2018 5:51 pm
Don't know if this would be a factor for OP, but if there is a spouse involved there might be an added reason to convert earlier. Surviving spouse likely will be forced into a higher bracket when RMDs are being withdrawn from TIRA.
+1 to Looking4Answers post.

In my case, when either I or DW die, the survivor's RMDs force a much higher tax bill, so I convert some now even though I'm using tIRA $ to pay the taxes on the conversions. Adding to that, the Roth's will be our last money to spend, thus it's likely a significant amount of Roth $ will pass to our three kids, which is much more tax advantageous to them compared to inheriting tIRA $.

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