IRA Conversion

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jscwj
Posts: 11
Joined: Mon Feb 06, 2017 11:15 am

IRA Conversion

Post by jscwj »

We recently rolled over a 401(k) into a traditional IRA with an investment advisor who put us in a complicated set of expensive funds. After reading several books, websites and this forum, I now have the knowledge that this account needs to be transitioned into a simpler, less expensive portfolio. I've also read recently about converting tIRA accounts into a Roth IRA but do not know enough about this process.

We are in our early 30's and are also in the 15% bracket. The amount involved is about $63k. Would doing a Roth conversion be beneficial for us?
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retiredjg
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Re: IRA Conversion

Post by retiredjg »

Maybe, but not enough information.

Getting money into Roth IRA at 15% is generally a good thing, but other factors need to be considered too. If you convert the entire $63k, chances are that will push you out of the 15% bracket and the excess will be taxed at 25% instead. Not such a great deal.

However, you don't have to convert it all at one time. If you have $5k of space in the 15% bracket, you could convert just $5k of the tIRA to Roth IRA. Doing this several years in a row could be beneficial.

You also have to consider if you have the money in savings to pay the taxes. If you convert $10k, you'll need $1.5k from savings to pay the tax. If you don't have extra money in savings....you can convert but probably should not because taking money from the tIRA to pay the tax would be an early withdrawal - 10% penalty on the amount used to pay tax.

Knowing more about your circumstances might be helpful. Do you have extra money in savings? Do you already have Roth accounts or traditional IRA accounts? Expect to be in the 15% bracket for a long time? What plans are available to each of you at work? How much extra space in the 15% bracket?

You are wise to get away from the expensive and complicated set of funds. And the advisor.
Topic Author
jscwj
Posts: 11
Joined: Mon Feb 06, 2017 11:15 am

Re: IRA Conversion

Post by jscwj »

We've got a good bit of room left in the 15% bracket as my wife is a stay at home mother (this is her account from previous employment). It's good to know that if we paid the taxes from the account would incur the penalty. Just roughly looking at it, we do not have sufficient funds in savings to pay the taxes.
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retiredjg
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Re: IRA Conversion

Post by retiredjg »

Well, you can do a little at a time if you want. Only problem would be if there is any basis (already taxed money from non-deductible contributions) in any IRA in her name. I didn't mention it before because it seems unlikely you have that.

Leaving that money in traditional IRA is fine too. When you retire, you will want some money in traditional accounts to fill the lower tax brackets.
FinancialDave
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Joined: Thu May 26, 2011 9:36 pm

Re: IRA Conversion

Post by FinancialDave »

jscwj wrote:
We are in our early 30's and are also in the 15% bracket. The amount involved is about $63k. Would doing a Roth conversion be beneficial for us?
There is really no way to know the answer to your question, unless you can predict your tax rates in retirement some 30-40 years from now.

However, let's say you could predict those rates. I think it is probably safe to say you aren't going to stop investing with only $63k in retirement funds so just make future allocations in a way to diversify your tax holdings (Roth and Trad IRA.) No reason to waste tax space by doing a Roth conversion now. Instead just put your salary to the Roth side of the equation if that is what you decide you need at this point in time.


Dave
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celia
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Re: IRA Conversion

Post by celia »

retiredjg wrote:You also have to consider if you have the money in savings to pay the taxes. If you convert $10k, you'll need $1.5k from savings to pay the tax. If you don't have extra money in savings....you can convert but probably should not because taking money from the tIRA to pay the tax would be an early withdrawal - 10% penalty on the amount used to pay tax.
The penalty for "early withdrawal" (if taxes are withheld from the conversion) only applies if the account owner is under 59.5 (as in this case). More importantly, though, is if you do any withholding for taxes, that is a loss within the IRA space. I would wait and save up money for the taxes and then convert when the funds are available.

One great feature of converting is that you can change your mind until October 15 of the following year. The "un-do" feature is called a recharacterization. Say you convert $10,000 and have saved up the $1,500 for taxes. So you convert. Then when doing taxes the following year, you find that you only had room in the 15% tax for $8,000. The last $2,000 is then being taxed at 25% so you wish you had only converted $8,000. Then you can recharacterize $2,000 of the original conversion and that is exactly the same as if you had only converted that much.

I also want to make sure that you know that WHAT ASSETS (funds, stocks, bonds) you invest in have no impact on WHAT KIND OF ACCOUNT you put them in. You can buy 100 shares of xxx and it will grow/lose the same amount whether it is in a taxable brokerage account, a traditional IRA, or a Roth. You can also have any of these accounts at an advisor-led brokerage house, at a low cost investment firm (Vanguard, Fidelity), or at an employer retirement account. Each of these will have different fees on the same asset. So that is one important thing you should consider.
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