ROTH IRA conversion question

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emh
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Joined: Sun Dec 12, 2010 8:01 am

ROTH IRA conversion question

Post by emh » Fri Oct 21, 2011 11:37 am

Here's my situation. I will have essentially zero income in 2011. My only income will be from dividends and capital gains from my investments. I'm expecting those to be less than $3,000.

My retirement is in a regular IRA with vanguard. If I understand how this works, this year would be a good time to convert some of my regular IRA into a Roth IRA. As long as the amount my conversion plus my dividends and capital gains is less than the standard deduction and personal exemption, I would pay no taxes. Is that correct? Or is a conversion taxed regardless of other personal income factors?

Thanks!

earlyout
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Re: ROTH IRA conversion question

Post by earlyout » Fri Oct 21, 2011 11:55 am

The conversion is included in regular income. In the scenario you outline you would pay no taxes.

You could also take this opportunity to convert enough of your traditional IRA to fill up the 10% or 15% tax brackets. Just don't pay taxes now at a higher rate than you think you would pay after you start RMDs.

EO

MCM 2008
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Re: ROTH IRA conversion question

Post by MCM 2008 » Fri Oct 21, 2011 12:05 pm

I would check last year's Form 1040 instruction manual. I think you can go $9,000 or so in taxable income without even being required to file, let alone pay taxes.

My point is, I think you can go a little above the combined value of your standard deduction and personal exemption in your conversion and still not have to pay income taxes. Verify, though, as my numbers may not be correct.

emh
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Re: ROTH IRA conversion question

Post by emh » Fri Oct 21, 2011 12:24 pm

Great, thanks for the information! Does the conversion have to be completed by December 31st? Or is there some leeway on the date?

Alan S.
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Re: ROTH IRA conversion question

Post by Alan S. » Fri Oct 21, 2011 12:32 pm

If you do the conversion the usual way by direct transfer, it must be completed by 12/31. However, if you convert by doing a 60 day (indirect rollover), you must take your distribution by 12/31, but you have 60 days to roll it to the Roth IRA. That would still be considered a 2011 conversion even though the Roth did not receive the funds until 2012.

If you have any basis in your TIRA from non deductible contributions, you must file a return OR a stand alone 8606 even if you are under the filing limit. The 8606 would show the conversion amount and the amount of basis applied to the conversion.

emh
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Joined: Sun Dec 12, 2010 8:01 am

Re: ROTH IRA conversion question

Post by emh » Fri Oct 21, 2011 12:59 pm

Thanks Alan S. Pardon my ignorance, but how would I know if I have "basis in my TIRA from non deductible contributions?

kaneohe
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Re: ROTH IRA conversion question

Post by kaneohe » Fri Oct 21, 2011 1:15 pm

You would have basis if you ever made a contribution to your TIRA and didn't take a full deduction
because your income was too high.

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House Blend
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Re: ROTH IRA conversion question

Post by House Blend » Fri Oct 21, 2011 1:25 pm

emh wrote:Here's my situation. I will have essentially zero income in 2011. My only income will be from dividends and capital gains from my investments. I'm expecting those to be less than $3,000.

My retirement is in a regular IRA with vanguard. If I understand how this works, this year would be a good time to convert some of my regular IRA into a Roth IRA. As long as the amount my conversion plus my dividends and capital gains is less than the standard deduction and personal exemption, I would pay no taxes. Is that correct?
Correct, but there's a bit more wiggle room related to the fact that in 2011, qualified dividends and long term cap gains are taxed at 0% until you reach the 25% bracket.

So if your $3000 in divs are qualfied and your cap gains LT (and you have no other income), then you can Roth convert another $3K beyond what you are thinking, and still pay no Federal income tax.

emh
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Joined: Sun Dec 12, 2010 8:01 am

Re: ROTH IRA conversion question

Post by emh » Fri Oct 21, 2011 1:46 pm

Great, thanks for the additional information!

And now that I think about it, I have one more questions: I have about $20,000 in capital loss carryover. Can I use that as well to pull more money out of my traditional IRA and into a Roth IRA without paying taxes?

earlyout
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Re: ROTH IRA conversion question

Post by earlyout » Fri Oct 21, 2011 1:59 pm

The IRA conversion (a distribution from your IRA) is taxed as regular income. Your capital loss carryover can only offset a maximum of $3000 of regular income after it has offset capital gain you have for that year.

EO

Alan S.
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Re: ROTH IRA conversion question

Post by Alan S. » Fri Oct 21, 2011 5:59 pm

Your capital loss carryover will offset the portion of your 3,000 of income that is cap gains plus produce a 3,000 loss against ordinary income. Before converting, your gross income would consist of your dividends less 3,000 in ordinary income, and therefore would be a negative amount. If the dividends are qualified (0 tax rate up to top of 15% bracket), you could convert a total of $3,000 plus your exemptions, standard or itemized deductions, and your qualified dividends before paying any federal taxes. From there you could decide if you want to convert enough to fill your 10% bracket in addition.

But be careful if you want to push this to the top of the 15% bracket. At that point if you convert to the top of the 15% bracket and push the qualified dividends up to the 25% bracket, you actually get hit with a 30% marginal rate for each dollar converted. This happens because you are triggering two adjustments:
1) You are replacing the 0 taxed dividends with ordinary conversion income and paying 15% on that ordinary conversion income
2) The dividends get pushed up into the 25% bracket where they are taxed at 15%.

That's 30%, so you would want to stop before you push dividends out of the 15% bracket. It is easy to get faked out here because you don't pay more than 15% on anything so you think you have this added room. But the problem is that even though you don't pay more than 15%, you get taxed on twice as much income @15% which makes it equivalent to 30%.

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