Newbie question: IRA conversion with high pensions

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Sidneyplace
Posts: 1
Joined: Sun Nov 04, 2018 6:53 am

Newbie question: IRA conversion with high pensions

Post by Sidneyplace » Sun Nov 04, 2018 7:20 am

Hi-learning late in life! 54 and 8-9 years from retirement in a high cost of living state. We will have 130k in pension leaving us in a high tax bracket. Deciding best route for our IRA. Just learned we can do a backdoor conversion to a Roth with my SEP and rollover IRA. We have a good amount in there (around 650K). With the current tax cuts-might be a good idea. My questions:
-Do you agree that this is a sound thing to do? If yes, how much should we shoot to convert?
-I don’t know if we will hit the AMT this year with the changes. Even if we do, is it worth converting some each year over the next seven?
-We have extra cash to pay the taxes this year on about 60K. After that, not sure how much we can save since we are putting 49K into our work pretax plans. If we can’t save more, is it worth taking posttax investment money to pay the taxes to convert to a Roth? We could cut down on our work contributions but I assume best to keep that so we reach our goals.
-the pensions will not increase over time so I am thinking later in retirement, we will not be in a high bracket with inflation.
Thank you for your thoughts.

ExitStageLeft
Posts: 988
Joined: Sat Jan 20, 2018 4:02 pm

Re: Newbie question: IRA conversion with high pensions

Post by ExitStageLeft » Sun Nov 04, 2018 10:02 am

Welcome to the forum!

You're on the right track investigating Roth conversions. The benefits can be substantial, but it can be quite complicated figuring when and how much to move from tax-deferred to Roth.

The wiki page on Roth Conversions is a great place to start learning more. If you would like more specific advice on your individual situation, it would help us immensely to know much more about your portfolio. The recommended format for asking portfolio questions is given in this thread: viewtopic.php?f=1&t=6212

It's a lot of information to gather, but I know from firsthand experience that much insight will be gained from doing a deep dive on your finances.

retiredjg
Posts: 34372
Joined: Thu Jan 10, 2008 12:56 pm

Re: Newbie question: IRA conversion with high pensions

Post by retiredjg » Sun Nov 04, 2018 10:20 am

Sidneyplace wrote:
Sun Nov 04, 2018 7:20 am
Hi-learning late in life! 54 and 8-9 years from retirement in a high cost of living state. We will have 130k in pension leaving us in a high tax bracket.
If that is the majority of your income in retirement, it appears you will be in the 25% bracket if taxes revert to old rates. Do you consider that a high rate? Or do you think you'll be in some other bracket?

Deciding best route for our IRA. Just learned we can do a backdoor conversion to a Roth with my SEP and rollover IRA.
Terminology is important for this discussion. What you are talking about is not a "back door" although some people call it that. What you are talking about is a simple Roth conversion of tax-deferred money. Whether you should do Roth conversions now or later depends a lot on your tax bracket now. We don't know what that is.

We have a good amount in there (around 650K). With the current tax cuts-might be a good idea.
Maybe, maybe not.

-Do you agree that this is a sound thing to do? If yes, how much should we shoot to convert?
Impossible to tell without more information. What would be the point in paying a 35% tax rate now when you could pay 25% later?

-We have extra cash to pay the taxes this year on about 60K.
Until you are 59.5, you would definitely want to pay the taxes out of savings, not out of the IRAs. If you pay taxes out of the IRA, that would be an early withdrawal and that triggers a penalty.

After that, not sure how much we can save since we are putting 49K into our work pretax plans. If we can’t save more, is it worth taking posttax investment money to pay the taxes to convert to a Roth? We could cut down on our work contributions but I assume best to keep that so we reach our goals.
Keep in mind that deferring taxes on 49k income and converting taxes on 49k in IRA is a wash.


I too think it would be helpful to know more.

JW-Retired
Posts: 6993
Joined: Sun Dec 16, 2007 12:25 pm

Re: Newbie question: IRA conversion with high pensions

Post by JW-Retired » Sun Nov 04, 2018 10:44 am

Sidneyplace wrote:
Sun Nov 04, 2018 7:20 am
Hi-learning late in life! 54 and 8-9 years from retirement in a high cost of living state. We will have 130k in pension leaving us in a high tax bracket. Deciding best route for our IRA. Just learned we can do a backdoor conversion to a Roth with my SEP and rollover IRA. We have a good amount in there (around 650K). With the current tax cuts-might be a good idea. My questions:
-Do you agree that this is a sound thing to do? If yes, how much should we shoot to convert?
-I don’t know if we will hit the AMT this year with the changes. Even if we do, is it worth converting some each year over the next seven?
.......................
-the pensions will not increase over time so I am thinking later in retirement, we will not be in a high bracket with inflation.
How high is high? The key issue is if you pay a high marginal tax rate on the present conversion amount now, is it apt to be higher or lower than the marginal rate you will pay if you do nothing and pay the tax on those deferred income assets in retirement?

I can't guess which might be better since you didn't tell us your tax rate now.
JW
Retired at Last

suemarkp
Posts: 60
Joined: Sun Nov 12, 2017 8:18 pm

Re: Newbie question: IRA conversion with high pensions

Post by suemarkp » Sun Nov 04, 2018 3:47 pm

Is your pension reduced if you take it before age 65? If so, how much? Will you collect Social Security? If so, that will also add to your income. You will have RMDs at age 70 1/2, so that will also add to you income...

My wife's pension is rather severely penalized if she takes it before age 65. Mine is not (only about a 2% hit per year) and it is better to be on the payroll when you retire than being off of it. My plan when I retire is to collect my pension (around $6K/month) and use saved cash to make up the extra required living expenses and pay conversion taxes while I do Roth conversions. I'll do this for 2 or 3 years only because I probably won't have enough cash to do it longer. If I had enough cash, I could only do it for a few more yeas, since the wife's pension will kick in plus I want to start her on SS first while I defer.

So if your pension is severely reduced by retiring early, consider waiting to collect it for a year or two while you do Roth conversions. But you'll need already taxed and saved money to live on and pay conversion taxes during that period. And depending on your pension rules, you may shoot yourself in the foot waiting to collect your pension -vs- the pension money you could have had by not deferring it.

One other thing to consider is if you can do an after tax 401K now or a Roth 401K if you have those available to you. These you can convert each year with little to no tax consequences.
Mark | Kent, WA

heyyou
Posts: 3195
Joined: Tue Feb 20, 2007 4:58 pm

Re: Newbie question: IRA conversion with high pensions

Post by heyyou » Sun Nov 04, 2018 5:09 pm

Initially, Roth conversions will seem complicated, before they become routine. Yes, you will learn how to do them, and through annual repetitions, you will get the long term benefit. If you can only convert four digit amounts after age 70, a dozen or more of those annual conversions will make a difference after one of you is gone, when the surviving spouse has most of the same income but only half as many tax exemptions and deductions, at a time when the Required Minimum Deductions (RMDs) from your traditional IRAs are in double digit percentages.

Roughly, you find the amount of your Married Filing Jointly (MFJ) deductions and exemptions, to subtract them from your total income in order to get the number that is your Adjusted Gross Income (AGI), which is the amount that is taxed. You each get one tax exemption, but a couple only get one of the Married Filing Jointly deductions.

Your total income would include wages, interest, and an estimate of your stock dividends and cap gains of which you won't get true numbers until about Dec.10th if you wait until then to make the conversion. Many of us just estimate those from looking at their dividend and cap gain history on older tax returns.

I have to pay attention to always look past the single tax filer tax tables, and past the head-of-household tables, to get to the MFJ tables since each one can fill the whole screen on the display. You look for how your AGI income fits into the width of your tax bracket, then you boost your income to fill up that bracket by making a Roth conversion of the right amount.

If your dividends and cap gains are higher than expected, your AGI income could spill into the next higher tax bracket. That is not the end of the world since only the overflow portion is taxed at the higher rate.

Since I'm only semi-literate on Roth conversions, would others please suggest edits to the above, and suggest other locations for better info about Roth conversions.

sawdust60
Posts: 56
Joined: Tue Jul 17, 2018 12:06 pm

Re: Newbie question: IRA conversion with high pensions

Post by sawdust60 » Sun Nov 04, 2018 11:02 pm

When you are considering tax rates and Roth conversions, remember to check the IRMAA penalty for Medicare. You won't see it until you get the bill from Medicare two years later. And where the tax rate tables are based on taxable income, the IRMAA is MAGI-based and different brackets.

JW-Retired
Posts: 6993
Joined: Sun Dec 16, 2007 12:25 pm

Re: Newbie question: IRA conversion with high pensions

Post by JW-Retired » Mon Nov 05, 2018 10:30 am

Sidneyplace wrote:
Sun Nov 04, 2018 7:20 am
We will have 130k in pension leaving us in a high tax bracket. Deciding best route for our IRA. Just learned we can do a backdoor conversion to a Roth with my SEP and rollover IRA. We have a good amount in there (around 650K). With the current tax cuts-might be a good idea.
We didn't get any more information. I'll just add a little more explanation why you cannot do a "backdoor conversion to a Roth with my SEP and rollover IRA." A "backdoor Roth" is something else that you can do when you have no SEP/Simple/rollover IRA/or tIRA to mess it up. In that case you can make a non-deductible $5500 contribution to a tIRA, and then immediately convert those funds to a Roth IRA. The net effect is exactly like contributing to a Roth even if you currently make too much to do it directly. You pay no tax because you didn't take a tax deduction on the tIRA contribution in the first place. It only amounts to $5500/year into the Roth.

If you have a tax deferred IRA of any sort already, then you would pay large pro-rata taxes when you do this. See IRS form 8606, which considers all your IRAs of any sort together as your "IRA" in computing your tax owed on any conversion.
JW
Retired at Last

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