Moved to new state for final month of 2018 - Roth conversion opportunity?

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gatsby11
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Moved to new state for final month of 2018 - Roth conversion opportunity?

Post by gatsby11 » Wed Dec 05, 2018 4:46 pm

I was living and working in New York City, but moved to New Jersey starting December 1st. I'm still working in NYC. My understanding is that since I work in New York I will continue to pay NY state taxes, so this seems to potentially be an opportunity to do Roth conversions as a NJ resident and use up the low NJ state brackets. Is that correct, and if so it a good idea?

I project to have $80k in taxable income for the year (after adjustments for 401k contributions, HSA, and standard deduction). $12k of that will be made in December, but my understanding is it will still be NY taxable income. So it seems that the 1 month I'm an NJ resident my taxable income in NJ will be $0. I understand I only get 1/12 of the standard deduction in NJ for that final month, but they still only tax the first $20k in income at 1.4%, and the next $15k in income at 1.75%.

The federal 22% rate ends at $82.5k. Then I would be converting at the 24% federal rate. Basically I'm thinking I could convert up to $35k from Trad IRA to Roth IRA at a ~23.5% federal and ~1.5% state rate, and pay 25% in taxes on it total.

Should I do this, or is a 25% rate still too high? I have about $60k in my Traditional IRA, and my salary is ~$150k so expect to be in the 24% federal, 6.5% state bracket for the foreseeable future.

I realize the common answer is to compare the tax rate you pay now to the tax rate you pay in retirement. The issue is I'm in my late-twenties, and my future retirement date, eventual income, and wealth are too uncertain to really forecast accurately. I'm thinking I should hold off on Roth conversions this year. While it's possible I pay higher than 25% to take that money out of the traditional IRA in the future, that mostly only occurs if I end up with large amounts of future income, in which case the difference between converting now/later will be fairly unimportant. So I see leaving it in the traditional IRA as a hedge against low income prospects in the future (as I'd likely be able to convert the money at very low rates), while the downside is likely only converting at 30-35% if things go well. I'm open to other people's thoughts though.
Last edited by gatsby11 on Wed Dec 05, 2018 5:22 pm, edited 2 times in total.

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grabiner
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Re: Moved to new state for final month of 2018 - Roth conversion opportunity?

Post by grabiner » Wed Dec 05, 2018 5:12 pm

I lived in NJ from 2010-2013, and encountered the same part-year issue as you, because I moved to NJ in November 2010 and was in an unusually low state tax bracket that year. I also paid taxes on a conversion from an IRA which had been rolled from a 403(b); NJ doesn't allow deductions on 403(b) contributions.

The math doesn't quite work the same way you are expecting. If you are a NJ resident working in NY, you compute your NJ tax on all your income, then take a tax credit which is the lesser of the tax you paid to NY, or a prorated share of the NJ income. You won't pay any NJ tax on income already taxed by NY, but it still increases your tax bracket.

Thus, if you earned $10K in salary in NJ, that counts towards the NJ taxable income which you want to keep below $35K. You can convert $25K plus any deductions. (NJ allows very few deductions: personal exemption, medical expenses in excess of 2% of AGI, and property tax including a renter's share.) In addition, note that NJ taxes HSAs and health insurance paid by payroll deduction, so any employer-paid health insurance, and any employer contribution to an HSA, will be taxable if you paid them while a NJ resident. (The employer-paid health insurance may then get deducted right back because of the 2% rule.)

One other note: how did the money get into your traditional IRA? NJ allows deductions for contributions to a 401(k), but not for contributions to an IRA. Thus, if your traditional IRA was funded by deductible contributions, you will only owe NJ tax on the gains, not on the amount you contributed; you could convert a $60K IRA with $30K basis for only $30K in taxes. This would make converting even more attractive. (In contrast, if your traditional IRA was a rollover from a 401(k), then any conversion is fully taxable.)

For similar reasons, you may want to use a Roth IRA while you are a NJ resident, as NJ won't give you a deduction on traditional IRA contributions, and if you don't retire in NJ, your new state will tax the entire traditional IRA contribution when you withdraw it.
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Re: Moved to new state for final month of 2019 - Roth conversion opportunity?

Post by The Wizard » Wed Dec 05, 2018 5:16 pm

2019 is still a ways off...
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Re: Moved to new state for final month of 2018 - Roth conversion opportunity?

Post by gatsby11 » Wed Dec 05, 2018 5:27 pm

The math doesn't quite work the same way you are expecting. If you are a NJ resident working in NY, you compute your NJ tax on all your income, then take a tax credit which is the lesser of the tax you paid to NY, or a prorated share of the NJ income. You won't pay any NJ tax on income already taxed by NY, but it still increases your tax bracket.
To make sure I'm undterstanding: if I was only a resident for 1 month in 12, that means only the final month's worth of income is NJ taxable right? So it's $10-12k against the $25k at low rates.
One other note: how did the money get into your traditional IRA? NJ allows deductions for contributions to a 401(k), but not for contributions to an IRA. Thus, if your traditional IRA was funded by deductible contributions, you will only owe NJ tax on the gains, not on the amount you contributed; you could convert a $60K IRA with $30K basis for only $30K in taxes. This would make converting even more attractive. (In contrast, if your traditional IRA was a rollover from a 401(k), then any conversion is fully taxable.)
It's a mix of 401k rollovers and traditional contributions. Most of it is 401k rollovers though. I'd think NJ would tax either though, since neither was done in NJ, so they (nor any other state) haven't taxed the income?
For similar reasons, you may want to use a Roth IRA while you are a NJ resident, as NJ won't give you a deduction on traditional IRA contributions, and if you don't retire in NJ, your new state will tax the entire traditional IRA contribution when you withdraw it.
Yep. I plan on doing a backdoor Roth next year. Trying to figure out if I want to do Roth conversions now for that reason; anything that isn't converted I plan on rolling into my employer's 401k.

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Re: Moved to new state for final month of 2018 - Roth conversion opportunity?

Post by grabiner » Wed Dec 05, 2018 7:29 pm

gatsby11 wrote:
Wed Dec 05, 2018 5:27 pm
The math doesn't quite work the same way you are expecting. If you are a NJ resident working in NY, you compute your NJ tax on all your income, then take a tax credit which is the lesser of the tax you paid to NY, or a prorated share of the NJ income. You won't pay any NJ tax on income already taxed by NY, but it still increases your tax bracket.
To make sure I'm undterstanding: if I was only a resident for 1 month in 12, that means only the final month's worth of income is NJ taxable right? So it's $10-12k against the $25k at low rates.
This is correct, although the rate is not relevant; you'll get a NJ tax credit against the NY tax on the same income, and this year, the credit will be the full NJ tax on that income since your rate is higher.

However, if your employer paid for health insurance or made HSA contributions through payroll deduction, those will be taxed in NJ and you can't take a credit for NY tax because NY didn't tax that income. You'll have to make this adjustment yourself unless your employer withholds both NY and NJ tax on your income.
One other note: how did the money get into your traditional IRA? NJ allows deductions for contributions to a 401(k), but not for contributions to an IRA. Thus, if your traditional IRA was funded by deductible contributions, you will only owe NJ tax on the gains, not on the amount you contributed; you could convert a $60K IRA with $30K basis for only $30K in taxes. This would make converting even more attractive. (In contrast, if your traditional IRA was a rollover from a 401(k), then any conversion is fully taxable.)
It's a mix of 401k rollovers and traditional contributions. Most of it is 401k rollovers though. I'd think NJ would tax either though, since neither was done in NJ, so they (nor any other state) haven't taxed the income?
NJ doesn't care whether another state has taxed your income in the past; your NJ taxable income is determined by NJ tax law. If you had filed a NJ tax return for the year you made the IRA contribution, you would have reported the amount as taxable income earned outside NJ, so NJ would have used it in figuring your tax for that year. Since it was taxable income in that year, NJ won't tax it again.

Just as often, this inconsistency in state taxes works the other way. If you contribute to a deductible IRA while a NJ resident, you don't get a tax deduction. If you then move to NY and withdraw the money, NY doesn't care that NJ taxed the money in a previous year; your withdrawal is fully taxable. This is what makes Roth IRAs particularly attractive to NJ residents.

The only case in which taxation by another state is relevant is the tax credit when the same income is taxed by multiple states in the same year. If you earn income in NJ with a source in NY which is taxed in the same year, NJ allows you to take a credit for the NY tax on the same income. (Similarly, NY residents who earn income in NJ can take a credit for the NJ tax paid on that income.)

For similar reasons, you may want to use a Roth IRA while you are a NJ resident, as NJ won't give you a deduction on traditional IRA contributions, and if you don't retire in NJ, your new state will tax the entire traditional IRA contribution when you withdraw it.
Yep. I plan on doing a backdoor Roth next year. Trying to figure out if I want to do Roth conversions now for that reason; anything that isn't converted I plan on rolling into my employer's 401k.
If you might retire in NJ, converting will make the accounting simpler. Otherwise, any contributions which are non-deductible in NJ will remain non-deductible when you withdraw them in retirement.

(edited to complete final sentence)
Last edited by grabiner on Thu Dec 06, 2018 11:02 pm, edited 1 time in total.
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Re: Moved to new state for final month of 2018 - Roth conversion opportunity?

Post by gatsby11 » Thu Dec 06, 2018 2:39 pm

Thanks for all the helpful info. So what do you and others think? Should I convert at least some of the Trad money to Roth now, or hold off and roll it all into my company’s 401k so that I can do a back foot Roth next year?

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Re: Moved to new state for final month of 2018 - Roth conversion opportunity?

Post by gatsby11 » Tue Dec 11, 2018 11:09 am

Anyone have any thoughts?

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Re: Moved to new state for final month of 2018 - Roth conversion opportunity?

Post by grabiner » Tue Dec 11, 2018 11:24 pm

gatsby11 wrote:
Thu Dec 06, 2018 2:39 pm
Thanks for all the helpful info. So what do you and others think? Should I convert at least some of the Trad money to Roth now, or hold off and roll it all into my company’s 401k so that I can do a back foot Roth next year?
Converting as much as you can in NJ at a low rate is a good deal; after that, I would put the rest into the 401(k). You need to get rid of the whole IRA if you will need to do a backdoor Roth. (Note that income from a traditional IRA conversion is not counted towards the limit for direct Roth contributions.)
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Re: Moved to new state for final month of 2018 - Roth conversion opportunity?

Post by gatsby11 » Wed Dec 12, 2018 7:33 pm

grabiner wrote:
Tue Dec 11, 2018 11:24 pm
gatsby11 wrote:
Thu Dec 06, 2018 2:39 pm
Thanks for all the helpful info. So what do you and others think? Should I convert at least some of the Trad money to Roth now, or hold off and roll it all into my company’s 401k so that I can do a back foot Roth next year?
Converting as much as you can in NJ at a low rate is a good deal; after that, I would put the rest into the 401(k). You need to get rid of the whole IRA if you will need to do a backdoor Roth. (Note that income from a traditional IRA conversion is not counted towards the limit for direct Roth contributions.)
Thanks for the reply. Agreed on the backdoor Roth. I will certainly roll any non-converted money into the 401k. Anyone else with thoughts on how much to convert from traditional to Roth given the 25% effective tax rate?

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Re: Moved to new state for final month of 2018 - Roth conversion opportunity?

Post by gatsby11 » Fri Dec 14, 2018 1:24 pm

I know it's a fairly boring topic, but does anyone else have any thoughts? I'd really appreciate any further advice.

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