Converting IRA to ROTH. How would this affect my taxes?

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Ostentatious
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Converting IRA to ROTH. How would this affect my taxes?

Post by Ostentatious » Fri Dec 21, 2018 3:27 am

With the market being down, I am thinking about converting an old traditional IRA into a Roth for obvious reasons. However, I am concerned that this would put me in a different/higher tax bracket and therefore negate any gains from the convertion, at least in the immediate. My question is, would I pay taxes on the full converted amount or just the contributions? The IRA was a distribution from an old employee owned company that I worked for but was sold to a bigger company several years ago. I have had it at VG for close to 16 years so there is a lot of gains. I think the gains are more than the contributed amount so it will benefit me a lot if I have to pay taxes only on the gains.

fleckmc
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Re: Converting IRA to ROTH. How would this affect my taxes?

Post by fleckmc » Fri Dec 21, 2018 3:33 am

You will need to pay taxes on the entire amount at your marginal tax rate. Depending on how much you are converting it may throw you into a higher marginal tax bracket.

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Ostentatious
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Re: Converting IRA to ROTH. How would this affect my taxes?

Post by Ostentatious » Fri Dec 21, 2018 4:05 am

That is exactly what I dreaded. I was in the 28%rate so I have to figure out how much I can convert without moving into a higher bracket.

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celia
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Re: Converting IRA to ROTH. How would this affect my taxes?

Post by celia » Fri Dec 21, 2018 4:06 am

Although you would have to pay taxes on all the dollars you convert, you don't have to convert the entire IRA. You could convert 50% or 25% of it, or enough to take you to the top of your current tax bracket.

I imagine you are noticing the value of the traditional IRA going down, thus making it have lower taxes for the conversion now than if you had converted the same shares several months ago. If the markets go down some more, so will the taxes for converting those same shares.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.

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celia
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Re: Converting IRA to ROTH. How would this affect my taxes?

Post by celia » Fri Dec 21, 2018 4:12 am

Ostentatious wrote:
Fri Dec 21, 2018 4:05 am
That is exactly what I dreaded. I was in the 28%rate so I have to figure out how much I can convert without moving into a higher bracket.
There is no longer a 28% tax bracket. You are apparently looking at old data since the tax laws changed as of last January. These are the current tax brackets. When estimating your current bracket, don't forget to subtract the new standard deduction ($12K for Singles, $24K for MFJ) before you look at these brackets.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.

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Ostentatious
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Re: Converting IRA to ROTH. How would this affect my taxes?

Post by Ostentatious » Fri Dec 21, 2018 4:34 am

celia wrote:
Fri Dec 21, 2018 4:12 am
Ostentatious wrote:
Fri Dec 21, 2018 4:05 am
That is exactly what I dreaded. I was in the 28%rate so I have to figure out how much I can convert without moving into a higher bracket.
There is no longer a 28% tax bracket. You are apparently looking at old data since the tax laws changed as of last January. These are the current tax brackets. When estimating your current bracket, don't forget to subtract the new standard deduction ($12K for Singles, $24K for MFJ) before you look at these brackets.
Thanks for the reminder. To be fair though I did say that I “was” in....
I have to get a hold of tax software ASAP and do the calculations before converting.

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Ostentatious
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Re: Converting IRA to ROTH. How would this affect my taxes?

Post by Ostentatious » Fri Dec 21, 2018 7:13 am

celia wrote:
Fri Dec 21, 2018 4:06 am
Although you would have to pay taxes on all the dollars you convert, you don't have to convert the entire IRA. You could convert 50% or 25% of it, or enough to take you to the top of your current tax bracket.

I imagine you are noticing the value of the traditional IRA going down, thus making it have lower taxes for the conversion now than if you had converted the same shares several months ago. If the markets go down some more, so will the taxes for converting those same shares.
That is right. I intend to convert enough so as to not take me into the next higher tax bracket and yes, I’m taking this action because of the IRA being down due to the current market conditions.

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smarcus3
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Re: Converting IRA to ROTH. How would this affect my taxes?

Post by smarcus3 » Fri Dec 21, 2018 8:39 am

Is your income now currently less than what is will be in retirement? If yes, then convert, if no then don't.

If unsure, I prefer to be diversified in my tax treatment, i.e. have some pre tax retirement, ROTH and brokerage in equal amounts if possible.
This is my personal opinion. I'm an engineer not a financial advisor.

cas
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Re: Converting IRA to ROTH. How would this affect my taxes?

Post by cas » Fri Dec 21, 2018 9:18 am

Ostentatious wrote:
Fri Dec 21, 2018 4:05 am
That is exactly what I dreaded. I was in the 28%rate so I have to figure out how much I can convert without moving into a higher bracket.
Don't forget to also consider:
- state taxes
- IRMAA (Income Related Medicare Adjustment Amount) if you are 63 or older
- Net Investment Income Tax if your Adjusted Gross Income (AGI) might go over $200,000 (single) or $250,000 (MJF)
- watch the possibility of tax penalty if you are less than 59.5 (I think) and were planning on withholding tax from the conversion sum.
- probably not anywhere near as big a deal as the amount of virtual ink spilled over it in the forum recently, but you might want to be least be mildly aware how close your withholding has put you to meeting "safe harbor" requirements (both federal and state) for avoiding underpayment penalty on your 2018 tax return if you spike up your income with a Roth conversion right at year end. (I assume you didn't pre-plan this conversion and pay 4 equal quarterly estimated tax payments to the IRS already.)

Plus, I don't think the math works out like you may think it works out if your entire reason for converting is "because the stock market is low."

If you have additional reasons like "I have this little stray trad IRA floating around, and I'd really like to simplify my life by making it go away at as little tax cost as possible" or "I'd like to do backdoor Roth contributions, but the trad IRA is blocking me from doing so" or "my tax rate in retirement is going to be at least as high as it is now"
or "I have very little Roth now, and I'd like a bit more tax diversification" then that is a different matter.

"I'm going to pay the taxes due from a taxable account" is also different math than "I'm going to withhold taxes from the conversion itself."

You may be interested in Vanguard's recent paper on the subject, to get an idea on the factors/math that are important in choosing a Roth conversion: "A “BETR” approach to Roth conversions" https://personal.vanguard.com/pdf/ISGBETR.pdf

Unfortunately, with all the new-tax-bill and market-turmoil-near-year-end complications this year, I suspect most of the people who usually help others with thinking through Roth conversions and taxes are really busy with their own situations right now and may not be looking at/commenting on the forums as much as usual.

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