Roth Conversion Conundrum

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Topic Author
GeekGal
Posts: 33
Joined: Fri Aug 09, 2019 1:05 pm

Roth Conversion Conundrum

Post by GeekGal » Fri Aug 09, 2019 1:52 pm

Dear Bogleheads,

I am new here and am *so* grateful to have found you. Hoping for help on my topic, as I did not see this particular situation posted already:

- My husband opened Traditional IRAs for himself ($6,000) and me ($6,000) on January 1, 2019 with after-tax money, with the intent of converting to Roth IRAs (he used the backdoor method due to income limit, filed Form 8606 with taxes)

- My husband passed away on January 19, 2019

- I “assumed” (not “inherited”) his Traditional IRA after his death

- I converted both his and my Traditional IRA to a Roth IRA in February 2019 for a total conversion of $12,000 (so he no longer has a Traditional IRA. I left $20 in mine, unaware of the aggregation rules).

- In May 2019, the company for his retirement contributions (pre-tax funds) would only provide a Traditional IRA to me for his contributions

- My Traditional IRA now has $271,000 from my husband’s retirement contributions + the about $20 I left previously

Question: Am I subject to the aggregation taxes in 2019 on the $271,000 currently held in my Traditional IRA, even though those funds were received after I did the $12,000 conversion to Roth? It will probably cost about $80-85,000 in taxes.

If “no” to the question, then my intent is to convert to Roth over the course of the next three years since I can use MFJ for 2019, and QW for 2020 and 2021. If “yes,” I suppose I will have to bite the bullet and pay the taxes for 2019 using brokerage account funds.

In either case, I intend to convert the funds to Roth IRA to: (1) reduce my own future RMDs; (2) reduce the tax burden on my two kids after I die (one daughter is age 4 and the other daughter is 7 months old); and (3) not incur the opportunity cost of conversions to Roth IRAs in perpetuity if I left the funds in the Traditional IRA since I will be over the income limits to directly contribute to a Roth IRA.

The other option I thought of is to move the $271,000 funds to my 457 account, but would prefer to leave them at Vanguard for lower costs, more investment options, and consolidated accounts. And, I am thinking I am better off with conversion to Roth IRA for the 3 reasons above.

If it matters, I am currently 38 years old, and I live in California.

My husband was the personal finance wizard between us and I am now learning without him. Any help you can provide is much appreciated. Thank you.

-GeekGal

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FiveK
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Re: Roth Conversion Conundrum

Post by FiveK » Fri Aug 09, 2019 2:28 pm

GeekGal, welcome to the forum and condolences to you and the rest of the family for your husband.
GeekGal wrote:
Fri Aug 09, 2019 1:52 pm
Question: Am I subject to the aggregation taxes in 2019 on the $271,000 currently held in my Traditional IRA, even though those funds were received after I did the $12,000 conversion to Roth? It will probably cost about $80-85,000 in taxes.
Unfortunately, yes - as things stand. Do a practice form 8606 for 2019 to confirm for yourself, and see comment below.
The other option I thought of is to move the $271,000 funds to my 457 account, but would prefer to leave them at Vanguard for lower costs, more investment options, and consolidated accounts. And, I am thinking I am better off with conversion to Roth IRA for the 3 reasons above.
Even if the fund fees are a little higher, if the 457 will accept the funds then the tax saving due to spreading Roth conversions over multiple years might more than compensate. Worth checking into.

Supurdueper
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Joined: Thu Aug 08, 2019 9:15 pm

Re: Roth Conversion Conundrum

Post by Supurdueper » Fri Aug 09, 2019 2:37 pm

So sorry for your loss. You are a tough one!!

Any chance the 1/1/19 contributions were classified as 2018 ira contributions? Is so you’d be ok.

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WoodSpinner
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Re: Roth Conversion Conundrum

Post by WoodSpinner » Fri Aug 09, 2019 3:00 pm

GeekGal wrote:
Fri Aug 09, 2019 1:52 pm

Question: Am I subject to the aggregation taxes in 2019 on the $271,000 currently held in my Traditional IRA, even though those funds were received after I did the $12,000 conversion to Roth? It will probably cost about $80-85,000 in taxes.

....

My husband was the personal finance wizard between us and I am now learning without him. Any help you can provide is much appreciated. Thank you.

-GeekGal
Welcome to the forum! Still learning myself ...

How do you figure the $80-$85,000 tax hit on a $12,000 conversion? I must be missing something...

WoodSpinner

marcopolo
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Joined: Sat Dec 03, 2016 10:22 am

Re: Roth Conversion Conundrum

Post by marcopolo » Fri Aug 09, 2019 3:23 pm

FiveK wrote:
Fri Aug 09, 2019 2:28 pm
GeekGal, welcome to the forum and condolences to you and the rest of the family for your husband.
GeekGal wrote:
Fri Aug 09, 2019 1:52 pm
Question: Am I subject to the aggregation taxes in 2019 on the $271,000 currently held in my Traditional IRA, even though those funds were received after I did the $12,000 conversion to Roth? It will probably cost about $80-85,000 in taxes.
Unfortunately, yes - as things stand. Do a practice form 8606 for 2019 to confirm for yourself, and see comment below.
The other option I thought of is to move the $271,000 funds to my 457 account, but would prefer to leave them at Vanguard for lower costs, more investment options, and consolidated accounts. And, I am thinking I am better off with conversion to Roth IRA for the 3 reasons above.
Even if the fund fees are a little higher, if the 457 will accept the funds then the tax saving due to spreading Roth conversions over multiple years might more than compensate. Worth checking into.
My condolences for your loss.

Boy, I am VERY hesitant to question any tax advice FiveK gives because he/she is usually dead on with their advice.

But, I think there may have been a mis-understanding here. Given the OPs concern about owing a $80-85k tax bill, it appears she may have misunderstood how the aggregation works. So, while the 271K will indeed be subject to aggregation (perhaps that is what FiveK was referring to in his response), the overall tax liability does not drag in the entire 271K, it does so only proportionally to the amount converted.

So, the new infusion is 271k pre-tax, and there was 12k (post-tax) that was converted. The aggregate amount is 283k, and ~96% (271/283) of the aggregate amount is pre-tax. So, of the $12k that was converted, that same ~97% ($11,491) will be considered taxable. So, the tax bill will be considerably less than the ~80k mentioned. Further Roth conversions,if desired can be put of to future years, and will be subject to similar pro-rated taxation, per form 8606.

I do agree that rolling over to 457 is likely the better option if the plan allows that. That will also clear the path for future backdoor Roth contributions.
Once in a while you get shown the light, in the strangest of places if you look at it right.

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FiveK
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Re: Roth Conversion Conundrum

Post by FiveK » Fri Aug 09, 2019 3:26 pm

WoodSpinner wrote:
Fri Aug 09, 2019 3:00 pm
GeekGal wrote:
Fri Aug 09, 2019 1:52 pm
Question: Am I subject to the aggregation taxes in 2019 on the $271,000 currently held in my Traditional IRA, even though those funds were received after I did the $12,000 conversion to Roth? It will probably cost about $80-85,000 in taxes.
How do you figure the $80-$85,000 tax hit on a $12,000 conversion? I must be missing something...
Yeah, that's not what the tax bill will be. I didn't look closely at the whole paragraph. The $271K, if still in an IRA on 31-Dec, will cause most of the $12K to be taxable, but money remaining in an IRA doesn't get taxed.

See form 8606 for what the taxable amount will be.

Topic Author
GeekGal
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Joined: Fri Aug 09, 2019 1:05 pm

Re: Roth Conversion Conundrum

Post by GeekGal » Fri Aug 09, 2019 6:11 pm

Supurdueper wrote:
Fri Aug 09, 2019 2:37 pm
So sorry for your loss. You are a tough one!!

Any chance the 1/1/19 contributions were classified as 2018 ira contributions? Is so you’d be ok.
Ah, no. My husband did the same last year and the Jan. 1 contributions were for 2019. Thank you though, for the idea and your sympathy.

Topic Author
GeekGal
Posts: 33
Joined: Fri Aug 09, 2019 1:05 pm

Re: Roth Conversion Conundrum

Post by GeekGal » Fri Aug 09, 2019 6:15 pm

marcopolo wrote:
Fri Aug 09, 2019 3:23 pm
FiveK wrote:
Fri Aug 09, 2019 2:28 pm
GeekGal, welcome to the forum and condolences to you and the rest of the family for your husband.
GeekGal wrote:
Fri Aug 09, 2019 1:52 pm
Question: Am I subject to the aggregation taxes in 2019 on the $271,000 currently held in my Traditional IRA, even though those funds were received after I did the $12,000 conversion to Roth? It will probably cost about $80-85,000 in taxes.
Unfortunately, yes - as things stand. Do a practice form 8606 for 2019 to confirm for yourself, and see comment below.
The other option I thought of is to move the $271,000 funds to my 457 account, but would prefer to leave them at Vanguard for lower costs, more investment options, and consolidated accounts. And, I am thinking I am better off with conversion to Roth IRA for the 3 reasons above.
Even if the fund fees are a little higher, if the 457 will accept the funds then the tax saving due to spreading Roth conversions over multiple years might more than compensate. Worth checking into.
My condolences for your loss.

Boy, I am VERY hesitant to question any tax advice FiveK gives because he/she is usually dead on with their advice.

But, I think there may have been a mis-understanding here. Given the OPs concern about owing a $80-85k tax bill, it appears she may have misunderstood how the aggregation works. So, while the 271K will indeed be subject to aggregation (perhaps that is what FiveK was referring to in his response), the overall tax liability does not drag in the entire 271K, it does so only proportionally to the amount converted.

So, the new infusion is 271k pre-tax, and there was 12k (post-tax) that was converted. The aggregate amount is 283k, and ~96% (271/283) of the aggregate amount is pre-tax. So, of the $12k that was converted, that same ~97% ($11,491) will be considered taxable. So, the tax bill will be considerably less than the ~80k mentioned. Further Roth conversions,if desired can be put of to future years, and will be subject to similar pro-rated taxation, per form 8606.

I do agree that rolling over to 457 is likely the better option if the plan allows that. That will also clear the path for future backdoor Roth contributions.
Yes, I have misunderstood. :oops: :idea:
And am certainly relieved I don't owe taxes on $271k, unless of course I convert all of it to Roth to avoid future RMDs and be able to pass down to my kids.
Thank you for helping me understand the aggregation rules! :happy

Topic Author
GeekGal
Posts: 33
Joined: Fri Aug 09, 2019 1:05 pm

Re: Roth Conversion Conundrum

Post by GeekGal » Fri Aug 09, 2019 6:17 pm

FiveK wrote:
Fri Aug 09, 2019 3:26 pm
WoodSpinner wrote:
Fri Aug 09, 2019 3:00 pm
GeekGal wrote:
Fri Aug 09, 2019 1:52 pm
Question: Am I subject to the aggregation taxes in 2019 on the $271,000 currently held in my Traditional IRA, even though those funds were received after I did the $12,000 conversion to Roth? It will probably cost about $80-85,000 in taxes.
How do you figure the $80-$85,000 tax hit on a $12,000 conversion? I must be missing something...
Yeah, that's not what the tax bill will be. I didn't look closely at the whole paragraph. The $271K, if still in an IRA on 31-Dec, will cause most of the $12K to be taxable, but money remaining in an IRA doesn't get taxed.

See form 8606 for what the taxable amount will be.
Thank you so much for helping with this. :D
I understand better now, and will give the Form 8606 a run-through.

Topic Author
GeekGal
Posts: 33
Joined: Fri Aug 09, 2019 1:05 pm

Re: Roth Conversion Conundrum

Post by GeekGal » Fri Aug 09, 2019 6:20 pm

FiveK wrote:
Fri Aug 09, 2019 2:28 pm
GeekGal, welcome to the forum and condolences to you and the rest of the family for your husband.
GeekGal wrote:
Fri Aug 09, 2019 1:52 pm
Question: Am I subject to the aggregation taxes in 2019 on the $271,000 currently held in my Traditional IRA, even though those funds were received after I did the $12,000 conversion to Roth? It will probably cost about $80-85,000 in taxes.
Unfortunately, yes - as things stand. Do a practice form 8606 for 2019 to confirm for yourself, and see comment below.
The other option I thought of is to move the $271,000 funds to my 457 account, but would prefer to leave them at Vanguard for lower costs, more investment options, and consolidated accounts. And, I am thinking I am better off with conversion to Roth IRA for the 3 reasons above.
Even if the fund fees are a little higher, if the 457 will accept the funds then the tax saving due to spreading Roth conversions over multiple years might more than compensate. Worth checking into.
And thanks for the welcome, and your condolences. I like it here, and very much appreciate the support. I am figuring out a lot in my life now, and it is not easy with two little kids and working full time. So I certainly appreciate the guidance from you all.

Yeah ... I will see if I can do a CBA on the 457 fees v. taxes on the IRA v. expected taxes at retirement on RMDs

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celia
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Re: Roth Conversion Conundrum

Post by celia » Sat Aug 10, 2019 2:25 am

GeekGal wrote:
Fri Aug 09, 2019 6:11 pm
Supurdueper wrote:
Fri Aug 09, 2019 2:37 pm
So sorry for your loss. You are a tough one!!

Any chance the 1/1/19 contributions were classified as 2018 ira contributions? Is so you’d be ok.
Ah, no. My husband did the same last year and the Jan. 1 contributions were for 2019. Thank you though, for the idea and your sympathy.
Since the contributions really were for 2019 (I was going to question it too), they aren’t reported until you file your 2019 taxes next year. You have until tax filing time to decide if the contributions are deductible or not.

Now, since your husband died so early in the year, he didn’t have much wages (unless his employer paid out unused vacation and sick time). If you can project your joint wages for this year AND it is below $193K, you both could have made Roth contributions instead.

https://www.rothira.com/roth-ira-limits

Assuming you will be eligible this year, you can ask the custodian to reclassify the $12K conversion (or two $6K conversions?) as a recharacterization instead. That will make it as if the contribution(s) had been made to Roth all along. Then the pro rata rule will not apply. Try to avoid it since once it applies to the tIRA, it will keep applying every year until all your tIRAs are emptied (and stay emptied on Dec. 31).

However, if you recharacterize, you want to make it clean and also bring over the $20 and account for any gain or loss between the January 1 contribution date and the date of conversion/recharacterization. It is up to the custodian to calculate the amount now that new money has since been added to the account.

If you can’t recharacterize due to income limits, an easier way to think about this is that the $271k Rollover could have happened before the Backdoor contributions were made. You would basically get the same tax result either way because all the same transactions happened in same year. The only slight difference is that the growth or loss would have been slightly different from the money being in the account (or not) on different dates.

If you haven’t yet seen our wiki page on thé Backdoor Roth, it will explain everything about them and even give several examples of the pro rata rule.
Last edited by celia on Sat Aug 10, 2019 11:18 am, edited 2 times in total.
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.

retiredjg
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Re: Roth Conversion Conundrum

Post by retiredjg » Sat Aug 10, 2019 7:44 am

I agree with the others that the tax, if you end up paying it, will be considerably less than your estimate. It will also leave a little bit of basis (already taxed money) in the IRA. If you truly do want to convert the entire IRA to Roth in 2019 - 2021, it would be fine to have a little basis left in the IRA - it will all be used up by the time you finish in 2021. (Sorry, I realize that won't make a lot of sense to you until you have worked through the paperwork.)


If you decide you don't want to convert the entire thing in 3 years...

If the 457b will accept the rollover, I'd roll everything except $20 into the 457b. Convert the $20 to Roth. In 2020 (NOT BEFORE), roll the money out of the 457 back to IRA and convert at whatever schedule you want.

Modification of above idea - roll some of the IRA into 457b and convert the rest to Roth since you can file this year as MFJ. In 2020, roll the rest of the money back out of the 457 and convert at whatever schedule you want.

Either of these ideas means you cannot use the back door after the money is rolled back to IRA from the 457.

Carl53
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Re: Roth Conversion Conundrum

Post by Carl53 » Sat Aug 10, 2019 8:45 am

Several very good suggestions thus far, particularly celia's regarding potentially recharacterization.

Try to look at your taxes for this year and next using tax software (last years if you have it) to set up dummy new returns simulating your reduced income but filing MFJ this year and likely Head of Household next year.

Depending on what you see on your tax projections, you may not really want to convert all of that pension money, now or in near term. If your income is much smaller than your deceased spouse, then you might want to convert more per year, but stay within lower tax brackets. If your income is similar or greater than his, then conversions might be just result in throwing more unnecessarily to Uncle Sam. Remember, once you are 59.5+ and taking money from TIRAs, it will only be taxed at your then marginal bracket. Same is true if it is left for your kids as inheritance, but at their marginal bracket.

How much you might convert also depends on your overall financial situation. Do you have the funds to pay the taxes without cramping your family's life?

You have so many things coming your way, take your time and ask questions on this board. Numerous individuals can provide advice on different things.
Do a search in the website's Google box for 'young widow' for many prior threads.

Again, my condolences.

elainet7
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Re: Roth Conversion Conundrum

Post by elainet7 » Sat Aug 10, 2019 8:59 am

You rollover his Ira into yours
If you want do partial Roth conversions to fill up the lower brackets but that might not be prudent, ask your cpa
Those funds should be mostly in equities at age 38

cherijoh
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Re: Roth Conversion Conundrum

Post by cherijoh » Sat Aug 10, 2019 9:21 am

marcopolo wrote:
Fri Aug 09, 2019 3:23 pm


My condolences for your loss.
FiveK wrote:
Fri Aug 09, 2019 2:28 pm
GeekGal, welcome to the forum and condolences to you and the rest of the family for your husband.
GeekGal wrote:
Fri Aug 09, 2019 1:52 pm
Question: Am I subject to the aggregation taxes in 2019 on the $271,000 currently held in my Traditional IRA, even though those funds were received after I did the $12,000 conversion to Roth? It will probably cost about $80-85,000 in taxes.
Unfortunately, yes - as things stand. Do a practice form 8606 for 2019 to confirm for yourself, and see comment below.
The other option I thought of is to move the $271,000 funds to my 457 account, but would prefer to leave them at Vanguard for lower costs, more investment options, and consolidated accounts. And, I am thinking I am better off with conversion to Roth IRA for the 3 reasons above.
Even if the fund fees are a little higher, if the 457 will accept the funds then the tax saving due to spreading Roth conversions over multiple years might more than compensate. Worth checking into.
Boy, I am VERY hesitant to question any tax advice FiveK gives because he/she is usually dead on with their advice.

But, I think there may have been a mis-understanding here. Given the OPs concern about owing a $80-85k tax bill, it appears she may have misunderstood how the aggregation works. So, while the 271K will indeed be subject to aggregation (perhaps that is what FiveK was referring to in his response), the overall tax liability does not drag in the entire 271K, it does so only proportionally to the amount converted.

So, the new infusion is 271k pre-tax, and there was 12k (post-tax) that was converted. The aggregate amount is 283k, and ~96% (271/283) of the aggregate amount is pre-tax. So, of the $12k that was converted, that same ~97% ($11,491) will be considered taxable. So, the tax bill will be considerably less than the ~80k mentioned. Further Roth conversions,if desired can be put of to future years, and will be subject to similar pro-rated taxation, per form 8606.

I do agree that rolling over to 457 is likely the better option if the plan allows that. That will also clear the path for future backdoor Roth contributions.
I will add my condolences.

Before moving the IRA funds to a 457 plan (which is likely irreversible until the OP separates from her employer), I suggest she verify where she falls with respect to hitting the ceiling for direct Roth contributions.

According to this IRS webpage, the MAGI phase out for single filers is between $132K and $137K, while it is between $193K and $203K for MFJ (or qualified widower). The higher limit will apply for 2019 and going forward, the single rate will apply. If OP will be able to make regular Roth contributions in the future, I wouldn't rush to do rollover out of t-IRA.

cherijoh
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Re: Roth Conversion Conundrum

Post by cherijoh » Sat Aug 10, 2019 9:23 am

retiredjg wrote:
Sat Aug 10, 2019 7:44 am
I agree with the others that the tax, if you end up paying it, will be considerably less than your estimate. It will also leave a little bit of basis (already taxed money) in the IRA. If you truly do want to convert the entire IRA to Roth in 2019 - 2021, it would be fine to have a little basis left in the IRA - it will all be used up by the time you finish in 2021. (Sorry, I realize that won't make a lot of sense to you until you have worked through the paperwork.)


If you decide you don't want to convert the entire thing in 3 years...

If the 457b will accept the rollover, I'd roll everything except $20 into the 457b. Convert the $20 to Roth. In 2020 (NOT BEFORE), roll the money out of the 457 back to IRA and convert at whatever schedule you want.

Modification of above idea - roll some of the IRA into 457b and convert the rest to Roth since you can file this year as MFJ. In 2020, roll the rest of the money back out of the 457 and convert at whatever schedule you want.

Either of these ideas means you cannot use the back door after the money is rolled back to IRA from the 457.
Maybe I have misunderstood how 457 plans work, but can you roll it back into an IRA at will if still employed? I know it doesn't work that way for 401ks.

retiredjg
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Re: Roth Conversion Conundrum

Post by retiredjg » Sat Aug 10, 2019 10:09 am

cherijoh wrote:
Sat Aug 10, 2019 9:23 am
Maybe I have misunderstood how 457 plans work, but can you roll it back into an IRA at will if still employed? I know it doesn't work that way for 401ks.
This is a good question. The law allows you to "roll out" money that has been "rolled in" a 401k plan and I assume that also applies to a 457b. A person's individual plan could be more restrictive and that would have to be checked ahead of time.

Either way, in this case, the money will be held separately because it is not covered by the same rules as the 457b money.

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celia
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Re: Roth Conversion Conundrum

Post by celia » Sat Aug 10, 2019 10:57 am

Regarding a rollover to a 457b, you need to be mindful of a few things.

First, the plan documents must allow rollovers from Traditional IRAs but might limit it to Rollover IRAs to ensure that no post-tax money is coming in. Right now you have pre-tax money and nondeductible (post-tax) contributions in the TIRA, so, obviously, the entire account can’t be rolled over to the 457. If a Rollover is even permitted, it will be your responsibility to determine the exact amount of pre-tax and nondeductible money in the account. Get another opinion (such as ours) when you start making the calculations.

If you still want to do major Roth conversions this year and the next two years, leave the amounts to be converted in the tIRA but account for future growth. You could even leave some money for conversion in 3 or 4 years, but I wouldn’t want to stretch out that pro rata rule too long.

There’s nothing that says the amount of conversion has to be the same each year. You could wait and see if the stock market drops 20% or more and do conversions then. Each time the markets drop another 10%, another conversion could be done, but you have to be prepared to pay the taxes. (Taxes withheld from the conversion will not only be taxed but also have a 10% penalty due to withdrawing before age 59.5. See Form 5329.)

The advantage of converting during a falling market is that as the shares lose value, that means you can convert more of them for the same tax bill. For example, if shares dropped to half price, you would be able to convert twice as many shares for the same tax bill. Then when they recover to their original price, it is as if you paid half price on the conversion taxes!
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.

cherijoh
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Re: Roth Conversion Conundrum

Post by cherijoh » Sat Aug 10, 2019 11:06 am

celia wrote:
Sat Aug 10, 2019 10:57 am
Regarding a rollover to a 457b, you need to be mindful of a few things.

First, the plan documents must allow rollovers from Traditional IRAs but might limit it to Rollover IRAs to ensure that no post-tax money is coming in. Right now you have pre-tax money and nondeductible (post-tax) contributions in the TIRA, so, obviously, the entire account can’t be rolled over to the 457. If a Rollover is even permitted, it will be your responsibility to determine the exact amount of pre-tax and nondeductible money in the account. Get another opinion (such as ours) when you start making the calculations.

If you still want to do major Roth conversions this year and the next two years, leave the amounts to be converted in the tIRA but account for future growth. You could even leave some money for conversion in 3 or 4 years, but I wouldn’t want to stretch out that pro rata rule too long.

There’s nothing that says the amount of conversion has to be the same each year. You could wait and see if the stock market drops 20% or more and do conversions then. Each time the markets drop another 10%, another conversion could be done, but you have to be prepared to pay the taxes. (Taxes withheld from the conversion will not only be taxed but also have a 10% penalty due to withdrawing before age 59.5. See Form 5329.)

The advantage of converting during a falling market is that as the shares lose value, that means you can convert more of them for the same tax bill. For example, if shares dropped to half price, you would be able to convert twice as many shares for the same tax bill. Then when they recover to their original price, it is as if you paid half price on the conversion taxes!
Celia, your last paragraph may be confusing to newbies because someone could read it that you must have taxes withheld, which is NOT the case. If OP has money outside of the plan to pay the taxes, she can aaoid withholding and the 10% early withdrawal penalty. (OP could easily have a life insurance payout or money in a taxable acct. that could cover taxes from the Roth conversions.

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celia
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Re: Roth Conversion Conundrum

Post by celia » Sat Aug 10, 2019 1:14 pm

cherijoh wrote:
Sat Aug 10, 2019 11:06 am
Celia, your last paragraph may be confusing to newbies because someone could read it that you must have taxes withheld, which is NOT the case. If OP has money outside of the plan to pay the taxes, she can aaoid withholding and the 10% early withdrawal penalty. (OP could easily have a life insurance payout or money in a taxable acct. that could cover taxes from the Roth conversions).
Cherijoh, I agree with you. It is always better to pay the taxes on a Roth conversion from taxable or an increased payroll withholding. I was just pointing out that there was a penalty if you withhold from the Roth conversion and you are under age 59.5.

The reason there is a penalty, is that the withholding is going to taxable (via the IRS/state). The age penalty never applies to Roth conversions, but to amounts withdrawn to taxable, unless you meet one of the exceptions [first-time homebuyer, college tuition, etc]. See the codes to use on line 2 of Form 5329.
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.

Topic Author
GeekGal
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Re: Roth Conversion Conundrum

Post by GeekGal » Sat Aug 10, 2019 4:04 pm

celia wrote:
Sat Aug 10, 2019 2:25 am


Now, since your husband died so early in the year, he didn’t have much wages (unless his employer paid out unused vacation and sick time). If you can project your joint wages for this year AND it is below $193K, you both could have made Roth contributions instead.

https://www.rothira.com/roth-ira-limits

Assuming you will be eligible this year, you can ask the custodian to reclassify the $12K conversion (or two $6K conversions?) as a recharacterization instead. That will make it as if the contribution(s) had been made to Roth all along. Then the pro rata rule will not apply. Try to avoid it since once it applies to the tIRA, it will keep applying every year until all your tIRAs are emptied (and stay emptied on Dec. 31).

However, if you recharacterize, you want to make it clean and also bring over the $20 and account for any gain or loss between the January 1 contribution date and the date of conversion/recharacterization. It is up to the custodian to calculate the amount now that new money has since been added to the account.

If you can’t recharacterize due to income limits, an easier way to think about this is that the $271k Rollover could have happened before the Backdoor contributions were made. You would basically get the same tax result either way because all the same transactions happened in same year. The only slight difference is that the growth or loss would have been slightly different from the money being in the account (or not) on different dates.


Thank you. Hmmm - OK. I am under the impression that the ability to recharacterize went away with the new tax law changes?

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GeekGal
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Re: Roth Conversion Conundrum

Post by GeekGal » Sat Aug 10, 2019 4:09 pm

Carl53 wrote:
Sat Aug 10, 2019 8:45 am
Several very good suggestions thus far, particularly celia's regarding potentially recharacterization.

Try to look at your taxes for this year and next using tax software (last years if you have it) to set up dummy new returns simulating your reduced income but filing MFJ this year and likely Head of Household next year.

Depending on what you see on your tax projections, you may not really want to convert all of that pension money, now or in near term. If your income is much smaller than your deceased spouse, then you might want to convert more per year, but stay within lower tax brackets. If your income is similar or greater than his, then conversions might be just result in throwing more unnecessarily to Uncle Sam. Remember, once you are 59.5+ and taking money from TIRAs, it will only be taxed at your then marginal bracket. Same is true if it is left for your kids as inheritance, but at their marginal bracket.

How much you might convert also depends on your overall financial situation. Do you have the funds to pay the taxes without cramping your family's life?

You have so many things coming your way, take your time and ask questions on this board. Numerous individuals can provide advice on different things.
Do a search in the website's Google box for 'young widow' for many prior threads.

Again, my condolences.
Thank you. Yes, I think I need to take some meaningful time to reevaluate the big picture. I was previously a bit panicked and had a sense of urgency bc I thought I would be on the hook for taxes for the $271k and did not want a penalty when I do my taxes next year for 2019. But, now that I understand the aggregation rules better, I feel better, and will allocate some time to take a more holistic perspective. I have been trying to do that here and there, but need to dedicate some meaningful chunks of time (probably late at night in between baby's feedings and I get some peace and quiet) to fully evaluate my options.

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Re: Roth Conversion Conundrum

Post by FiveK » Sat Aug 10, 2019 4:10 pm

GeekGal wrote:
Sat Aug 10, 2019 4:04 pm
Thank you. Hmmm - OK. I am under the impression that the ability to recharacterize went away with the new tax law changes?
One may recharacterize a contribution, but not a conversion.

See IRA recharacterization - Bogleheads.

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GeekGal
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Re: Roth Conversion Conundrum

Post by GeekGal » Sat Aug 10, 2019 4:14 pm

celia wrote:
Sat Aug 10, 2019 1:14 pm
cherijoh wrote:
Sat Aug 10, 2019 11:06 am
Celia, your last paragraph may be confusing to newbies because someone could read it that you must have taxes withheld, which is NOT the case. If OP has money outside of the plan to pay the taxes, she can aaoid withholding and the 10% early withdrawal penalty. (OP could easily have a life insurance payout or money in a taxable acct. that could cover taxes from the Roth conversions).
Cherijoh, I agree with you. It is always better to pay the taxes on a Roth conversion from taxable or an increased payroll withholding. I was just pointing out that there was a penalty if you withhold from the Roth conversion and you are under age 59.5.

The reason there is a penalty, is that the withholding is going to taxable (via the IRS/state). The age penalty never applies to Roth conversions, but to amounts withdrawn to taxable, unless you meet one of the exceptions [first-time homebuyer, college tuition, etc]. See the codes to use on line 2 of Form 5329.
Yes, I was planning to used "savings" held in a taxable brokerage account to pay taxes on any converted funds (held in a sweep account - need to determine investment allocation, but that is a whole other task). Based on my initial calculations for RMDs using a modest ROR and the Rule of 72, I think the my RMDs will be more than enough, and I would like to diversify my tax liability at retirement by increasing my Roth IRA holdings (and pay no taxes on this money), with the long-term objective of leaving the Roth IRA for my kids since I don't think I will need to touch the Roth IRA in my lifetime. I would very much like to avoid any penalties.

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Re: Roth Conversion Conundrum

Post by retiredjg » Sat Aug 10, 2019 4:15 pm

GeekGal wrote:
Sat Aug 10, 2019 4:04 pm
Thank you. Hmmm - OK. I am under the impression that the ability to recharacterize went away with the new tax law changes?
The ability to recharacterize a Roth conversion did go away with the new tax laws.

Celia is suggesting that you recharacterize something different - recharacterize the contribution to tIRA to a contribution to Roth IRA if you find you would have been eligible for Roth IRA in 2019 since you can still file MFJ but the income will be less.

I don't know if this can be done after a Roth conversion but it is an interesting question.
Last edited by retiredjg on Sat Aug 10, 2019 4:17 pm, edited 1 time in total.

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GeekGal
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Re: Roth Conversion Conundrum

Post by GeekGal » Sat Aug 10, 2019 4:17 pm

FiveK wrote:
Sat Aug 10, 2019 4:10 pm
GeekGal wrote:
Sat Aug 10, 2019 4:04 pm
Thank you. Hmmm - OK. I am under the impression that the ability to recharacterize went away with the new tax law changes?
One may recharacterize a contribution, but not a conversion.

See IRA recharacterization - Bogleheads.
OK - got it. If I converted post-tax funds from an IRA to a Roth, then I can't change my mind anymore .. :?

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celia
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Re: Roth Conversion Conundrum

Post by celia » Sat Aug 10, 2019 6:18 pm

GeekGal wrote:
Sat Aug 10, 2019 4:17 pm
FiveK wrote:
Sat Aug 10, 2019 4:10 pm
GeekGal wrote:
Sat Aug 10, 2019 4:04 pm
Thank you. Hmmm - OK. I am under the impression that the ability to recharacterize went away with the new tax law changes?
One may recharacterize a contribution, but not a conversion.

See IRA recharacterization - Bogleheads.
OK - got it. If I converted post-tax funds from an IRA to a Roth, then I can't change my mind anymore .. :?
No. No. no. I think there is still some confusion here. First you need to clarify if you are eligible for a Roth contribution this year as married taxpayers, due to your expected lower joint income (if joint earnings will be less than $193K).

A recharacterization means to change "the character" of a contribution from one type to another, as from a Traditional IRA contribution to a Roth IRA contribution or the other way around. Recharacterizing contributions will probably always be allowed as long as contributions are allowed since there will always be people who contributed to Roth, only to find out at tax time that they were not eligible. So they need a way to change that contribution (and its earnings) to go into a Traditional IRA instead or remove it (and its earnings) from the Roth.

So where does that leave you? If you recharacterize the full amount of the original Traditional IRA contributions to be Roth IRA contributions instead, it will be as if the contributions had been made to the Roth instead. There will be no non-deductible contributions in the Traditional IRA since you will no longer have any 2019 contributions in the Traditional IRA. The pro rata rule will not apply. Your future Roth conversions will be simpler. If you are allowed to put part of the Rollover $271K into a 457 plan, there will be no "contamination" in the tIRA from non-deductible contributions and any amount you roll over to the 457 will be acceptable.

The way to make this happen, if eligible, is to call up the custodian and let them know you want to recharacterize both January 1 Traditional contributions to be Roth contributions instead of the Roth conversions you did earlier. (You must use the word "recharacterize".) You likely did two conversions, one from your husband's tIRA to your Roth (while "assuming" his account). So you want to change that conversion to be a recharacterization instead. (Ask what code they will use for the tIRA withdrawal. They should say "N" [Recharacterization of a contribution made for 2019 and recharacterized in 2019]). Changing the conversion from your tIRA to your Roth to be a recharacterizatiion instead is a little more complicated since you left behind part of the money (possibly growth which needs to go with the contribution to the Roth when recharacterizing). Ask the rep to have someone figure out the exact remaining additional amount to recharacterize (probably around $20), and move it as the remaining part of your recharacterization.

When completed, you will not see any difference in your accounts, except for the transfer of about $20. So to protect yourself that things happened correctly, write down and save the date, time, and person's name you talked to. (The phone call should be recorded for future reference.) A week later, call up and see if there is any 2019 Roth conversion associated with any of the accounts. Does the rep see a recharacterization instead? If you don't follow up on this and instead wait for the Form 1099-R in January and it has the code for Roth conversion still, it will be difficult to change this as they would have already notified the IRS that you did a Roth conversion. Meanwhile, hold off a month or so on converting any of the $271K rollover since we want to see that the $6,000 recharacterization happened correctly for his and her contributions.

Hope this makes more sense. It is a bit confusing, but not as big a complication as living with the pro rata rule for several years.
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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Re: Roth Conversion Conundrum

Post by FiveK » Sat Aug 10, 2019 6:54 pm

celia wrote:
Sat Aug 10, 2019 6:18 pm
No. No. no. I think there is still some confusion here.
If a contribution to traditional and then a conversion from traditional to Roth has been done, one cannot recharacterize the initial contribution and thus nullify the conversion.

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celia
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Re: Roth Conversion Conundrum

Post by celia » Sat Aug 10, 2019 8:08 pm

FiveK wrote:
Sat Aug 10, 2019 6:54 pm
If a contribution to traditional and then a conversion from traditional to Roth has been done, one cannot recharacterize the initial contribution and thus nullify the conversion.
According to the third paragraph here: https://www.irs.gov/retirement-plans/ir ... tributions
IRS wrote: Can I recharacterize a rollover or conversion to a Roth IRA?

Effective January 1, 2018, pursuant to the Tax Cuts and Jobs Act (Pub. L. No. 115-97), a conversion from a traditional IRA, SEP or SIMPLE to a Roth IRA cannot be recharacterized. The new law also prohibits recharacterizing amounts rolled over to a Roth IRA from other retirement plans, such as 401(k) or 403(b) plans.
But I am not not proposing the recharacterization of a conversion (where the money would be going back to the other account) but a recharacterization of a contribution (which is already in the desired account).

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Re: Roth Conversion Conundrum

Post by retiredjg » Sat Aug 10, 2019 8:12 pm

I think the question still remains if one can recharacterize the contribution...after a conversion has occurred.

Has anyone done this? Heard of it done?

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FiveK
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Re: Roth Conversion Conundrum

Post by FiveK » Sat Aug 10, 2019 8:27 pm

retiredjg wrote:
Sat Aug 10, 2019 8:12 pm
I think the question still remains if one can recharacterize the contribution...after a conversion has occurred.
Agreed that that is the question.

After a conversion has occurred, the money is no longer in the original account and thus one can't recharacterize it (aka "transfers in a trustee-to-trustee transfer any contribution to an individual retirement plan made during such taxable year from such plan to any other individual retirement plan") - see [USC02] 26 USC 408A(d)(6)(A) and 408A(d)(6)(B)(iii).

At least, that's how it seems to read....

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Re: Roth Conversion Conundrum

Post by celia » Sat Aug 10, 2019 8:55 pm

I probably brought this up, since I recall posts like this, but they may have been before the tax law changed in 2017.

Another option would be to remove the contributions altogether and do a Roth contribution at another custodian (if eligible). But OP wouldn't be able to contribute for her husband any more.
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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Re: Roth Conversion Conundrum

Post by retiredjg » Sun Aug 11, 2019 5:46 am

celia wrote:
Sat Aug 10, 2019 8:55 pm
Another option would be to remove the contributions altogether and do a Roth contribution at another custodian (if eligible). But OP wouldn't be able to contribute for her husband any more.
I think there is still the same question. Can you remove the contribution after it has been converted to Roth?

Of course, these are both moot questions if GeekGal wants to convert the whole thing to Roth over this and the next two years.

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GeekGal
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Re: Roth Conversion Conundrum

Post by GeekGal » Sun Aug 11, 2019 10:01 am

Thanks to all who replied. Some good ideas!
I'm planning to:
- do a spin through of Form 8606
- project joint wages for 2019 (and determine is MAGI is less than 193k, it could be)
- look into 457 to determine: (1) accept tIRA?; (2) fees compared to Vanguard; and (3) can I move funds back out without separation from current employer
- CBA of 457 v. taxes on IRA conversation v. expected taxes on RMDs
- consider recharacterizing the contribution (assuming we are referring to the rollover of the $271k when we say 'contribution'?), if this is permitted after a conversion has occurred. This could be moot if it makes more sense to convert the $271k to Roth ...

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Re: Roth Conversion Conundrum

Post by retiredjg » Sun Aug 11, 2019 10:12 am

GeekGal wrote:
Sun Aug 11, 2019 10:01 am
Thanks to all who replied. Some good ideas!
I'm planning to:
- do a spin through of Form 8606
- project joint wages for 2019 (and determine is MAGI is less than 193k, it could be)
This will be a waste of time unless you find that the contribution to tIRA can be recharacterized to a contribution to Roth IRA (which I seriously doubt since the Roth conversion has already occurred.)
- look into 457 to determine: (1) accept tIRA?; (2) fees compared to Vanguard; and (3) can I move funds back out without separation from current employer
- CBA of 457 v. taxes on IRA conversation v. expected taxes on RMDs
- consider recharacterizing the contribution (assuming we are referring to the rollover of the $271k when we say 'contribution'?). No. The rollover of $271 is not the contribution. The contribution was the $6k done last January. Again, I seriously doubt you will be able to recharacterize that since the Roth conversion has already occurred. if this is permitted after a conversion has occurred. This could be moot if it makes more sense to convert the $271k to Roth ...

The whole idea of converting $271k would make more sense to us if you can estimate your tax bracket for 2019, 2020, and 2021.

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FiveK
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Re: Roth Conversion Conundrum

Post by FiveK » Sun Aug 11, 2019 10:12 am

GeekGal wrote:
Sun Aug 11, 2019 10:01 am
- consider recharacterizing the contribution (assuming we are referring to the rollover of the $271k when we say 'contribution'?), if this is permitted after a conversion has occurred. This could be moot if it makes more sense to convert the $271k to Roth ...
Contribution: addition of money to an IRA that was not previously in an IRA. Subject to the $6K/yr limit. Recharacterizable.

Conversion: movement of money from a traditional IRA to a Roth IRA. Not subject to, and does not affect, the $6K/yr limit. Not recharacterizable.

Rollover: movement of money from one brokerage to another, without changing the type of account (e.g., traditional to traditional, or Roth to Roth). Not subject to, and does not affect, the $6K/yr limit. Recharacterization is not applicable.

Does that help?

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GeekGal
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Re: Roth Conversion Conundrum

Post by GeekGal » Sun Aug 11, 2019 6:19 pm

retiredjg wrote:
Sun Aug 11, 2019 10:12 am
GeekGal wrote:
Sun Aug 11, 2019 10:01 am
Thanks to all who replied. Some good ideas!
I'm planning to:
- do a spin through of Form 8606
- project joint wages for 2019 (and determine is MAGI is less than 193k, it could be)
This will be a waste of time unless you find that the contribution to tIRA can be recharacterized to a contribution to Roth IRA (which I seriously doubt since the Roth conversion has already occurred.)
- look into 457 to determine: (1) accept tIRA?; (2) fees compared to Vanguard; and (3) can I move funds back out without separation from current employer
- CBA of 457 v. taxes on IRA conversation v. expected taxes on RMDs
- consider recharacterizing the contribution (assuming we are referring to the rollover of the $271k when we say 'contribution'?). No. The rollover of $271 is not the contribution. The contribution was the $6k done last January. Again, I seriously doubt you will be able to recharacterize that since the Roth conversion has already occurred. if this is permitted after a conversion has occurred. This could be moot if it makes more sense to convert the $271k to Roth ...


The whole idea of converting $271k would make more sense to us if you can estimate your tax bracket for 2019, 2020, and 2021.
OK I see now. Will do re: tax brackets. thanks.

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GeekGal
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Re: Roth Conversion Conundrum

Post by GeekGal » Sun Aug 11, 2019 6:20 pm

Yes, that helps. Thank you.

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Re: Roth Conversion Conundrum

Post by Alan S. » Mon Aug 12, 2019 2:00 pm

GeekGal wrote:
Fri Aug 09, 2019 1:52 pm
Dear Bogleheads,

I am new here and am *so* grateful to have found you. Hoping for help on my topic, as I did not see this particular situation posted already:

- My husband opened Traditional IRAs for himself ($6,000) and me ($6,000) on January 1, 2019 with after-tax money, with the intent of converting to Roth IRAs (he used the backdoor method due to income limit, filed Form 8606 with taxes)

You mean, you WILL file Form 8606 when you do your joint return for 2019? You should not have already filed it. It is possible that you will be able to deduct YOUR IRA contribution. You will have to determine what your modified AGI is for 2019. He was an active participant in an employer plan, but not sure if you were. I assume that you will have enough joint earned income in 2019 to support these contributions including spousal if needed, but if you have any doubt, please advise.

- My husband passed away on January 19, 2019

Sorry for your loss.

- I “assumed” (not “inherited”) his Traditional IRA after his death

Might have been better to keep all or most of this as inherited in case you need distributions before you reach 59.5. Those distributions would have been penalty free. You could have done a direct rollover to an inherited TIRA, then when you wanted to convert an incremental amount you could have done so from the inherited IRA to your own Roth IRA. However, once you assumed ownership you cannot go back to inherited status.

- I converted both his and my Traditional IRA to a Roth IRA in February 2019 for a total conversion of $12,000 (so he no longer has a Traditional IRA. I left $20 in mine, unaware of the aggregation rules).

If it turns out that one or both of your TIRA Contributions are non deductible, you will file a Form 8606 for each spouse reporting whose contribution is non deductible for 2019. Since you couldn't have converted HIS TIRA until you assumed ownership of it, his 6000 of basis is transferred to YOU and the combined 12000 conversion will be reported only on YOUR Form 8606. You will therefore show 12000 of basis on your Form 8606, but as others have noted, the later rollover of his employer plan will result in pro rating of the entire year end 2019 balance and most of the 12000 conversion being taxable, but no more than that. Most of your 12000 basis will be left over and then carried over to later years.

- In May 2019, the company for his retirement contributions (pre-tax funds) would only provide a Traditional IRA to me for his contributions

This is what is called the "spousal rollover" where you rolled over the inherited employer plan into your own IRA.

- My Traditional IRA now has $271,000 from my husband’s retirement contributions + the about $20 I left previously

Question: Am I subject to the aggregation taxes in 2019 on the $271,000 currently held in my Traditional IRA, even though those funds were received after I did the $12,000 conversion to Roth? It will probably cost about $80-85,000 in taxes.

As others have indicated, NO it will not. The taxable income will be ~ 11,470 as determined on Form 8606 referenced above. This assume you cannot deduct either 6000 contribution.

If “no” to the question, then my intent is to convert to Roth over the course of the next three years since I can use MFJ for 2019, and QW for 2020 and 2021. If “yes,” I suppose I will have to bite the bullet and pay the taxes for 2019 using brokerage account funds.

Be careful not to "over convert". The amount you convert each year should be determined late in the year when you have figured what your marginal rate will be for the amount you convert. I know your rate will rise when you can no longer file with QW status, so after that happens you may very well not be converting any longer. Not enough info here to know.

In either case, I intend to convert the funds to Roth IRA to: (1) reduce my own future RMDs; (2) reduce the tax burden on my two kids after I die (one daughter is age 4 and the other daughter is 7 months old); and (3) not incur the opportunity cost of conversions to Roth IRAs in perpetuity if I left the funds in the Traditional IRA since I will be over the income limits to directly contribute to a Roth IRA.

The other option I thought of is to move the $271,000 funds to my 457 account, but would prefer to leave them at Vanguard for lower costs, more investment options, and consolidated accounts. And, I am thinking I am better off with conversion to Roth IRA for the 3 reasons above.

If it matters, I am currently 38 years old, and I live in California.

My husband was the personal finance wizard between us and I am now learning without him. Any help you can provide is much appreciated. Thank you.

Note that you cannot recharacterize the conversion and you cannot treat it as a failed conversion. It would be a failed conversion if the contributions were excess contributions, but they are not excess contributions. Not qualifying for the deduction does not create an excess contribution, it just means you cannot deduct the contribution. Therefore, the conversion is allowed and must be retained. This is not a disaster if you were planning taxable conversions anyway.

-GeekGal

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Re: Roth Conversion Conundrum

Post by retiredjg » Mon Aug 12, 2019 2:17 pm

Alan S. wrote:
Mon Aug 12, 2019 2:00 pm
Note that you cannot recharacterize the conversion and you cannot treat it as a failed conversion. It would be a failed conversion if the contributions were excess contributions, but they are not excess contributions. Not qualifying for the deduction does not create an excess contribution, it just means you cannot deduct the contribution. Therefore, the conversion is allowed and must be retained. This is not a disaster if you were planning taxable conversions anyway.
Thanks for joining in this discussion, Alan. This "failed conversion" idea is a new little tidbit. I had wondered how that would be handled.

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Re: Roth Conversion Conundrum

Post by LilyFleur » Mon Aug 12, 2019 2:59 pm

Hi, GeekGal, and welcome to the forum.

Please accept my heartfelt sympathies. You have a lot on your plate now with two children to raise and a full-time job.

I am so appreciate of your ability to plan now for your children's inheritance. Doing Roths now is a great move.

I have been a single mom for about ten years now. I got them both through college, and 2019 is my first year to file taxes as single. (Head of household is way better.) So from my perspective, as I begin my own Roth conversions but at the higher single tax rate (in California), what you are doing looks extremely wise.

I learn new things from this wonderful forum all the time. RMDs--I had no idea how high my income could rise by the time I'm 80. I, too, am concerned about my children's inheritance, and it would be so much easier for them if they have a tax-free pot of money without RMDs.

I'm so grateful to this community for their knowledge and advice.

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GeekGal
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Re: Roth Conversion Conundrum

Post by GeekGal » Tue Aug 13, 2019 1:15 am

[/quote]

The whole idea of converting $271k would make more sense to us if you can estimate your tax bracket for 2019, 2020, and 2021.
[/quote]

I am estimating AGI/MAGI as follows:

2019: 176k
2020: 168k
2021: 174k

This puts me in the 24% tax bracket for the next three years using MFJ, QW, and QW for years 2019, 2020, and 2021, although please correct me if I am wrong.

I used an RMD calculator* to calculate RMDs on the current balance of my 457, but excluding the $271k tIRA. I expect to have an AGI of at least $250k inclusive of a pension and the RMDs for the current balance of my 457 (excluding the $271 tIRA) based on a 5% ROR . Assuming "single" filing status at age 70.5, I think this correlates to the 35% tax bracket based on current tax brackets.

I am hoping I did the projections accurately since that is what all this is based on, but ... this is the reason for my proposal to do some significant Roth conversions ... thoughts?

*although I have yet to find one that accounts for continued contributions until I turn 70. Given my current age the contributions and their earnings are significant
Last edited by GeekGal on Tue Aug 13, 2019 1:29 am, edited 1 time in total.

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Re: Roth Conversion Conundrum

Post by GeekGal » Tue Aug 13, 2019 1:28 am

Alan S. wrote:
Mon Aug 12, 2019 2:00 pm
GeekGal wrote:
Fri Aug 09, 2019 1:52 pm
Dear Bogleheads,

I am new here and am *so* grateful to have found you. Hoping for help on my topic, as I did not see this particular situation posted already:

- My husband opened Traditional IRAs for himself ($6,000) and me ($6,000) on January 1, 2019 with after-tax money, with the intent of converting to Roth IRAs (he used the backdoor method due to income limit, filed Form 8606 with taxes)

You mean, you WILL file Form 8606 when you do your joint return for 2019? You should not have already filed it. It is possible that you will be able to deduct YOUR IRA contribution. You will have to determine what your modified AGI is for 2019. He was an active participant in an employer plan, but not sure if you were. I assume that you will have enough joint earned income in 2019 to support these contributions including spousal if needed, but if you have any doubt, please advise.

Yes, I will file 8606 for 2019. What I meant to indicate was that my husband filed form 8606 annually with taxes to account for the backdoor Roth he did each year. Sorry for the confusing wording.

- My husband passed away on January 19, 2019

Sorry for your loss.

- I “assumed” (not “inherited”) his Traditional IRA after his death

Might have been better to keep all or most of this as inherited in case you need distributions before you reach 59.5. Those distributions would have been penalty free. You could have done a direct rollover to an inherited TIRA, then when you wanted to convert an incremental amount you could have done so from the inherited IRA to your own Roth IRA. However, once you assumed ownership you cannot go back to inherited status.

Yes ... I was/am hoping I won't need the 6k/12k. I am learning first hand life can change so quickly, so perhaps this wasn't the best call in my weary state of shock ... but I would like to remain hopeful I won't need these funds.

- I converted both his and my Traditional IRA to a Roth IRA in February 2019 for a total conversion of $12,000 (so he no longer has a Traditional IRA. I left $20 in mine, unaware of the aggregation rules).

If it turns out that one or both of your TIRA Contributions are non deductible, you will file a Form 8606 for each spouse reporting whose contribution is non deductible for 2019. Since you couldn't have converted HIS TIRA until you assumed ownership of it, his 6000 of basis is transferred to YOU and the combined 12000 conversion will be reported only on YOUR Form 8606. You will therefore show 12000 of basis on your Form 8606, but as others have noted, the later rollover of his employer plan will result in pro rating of the entire year end 2019 balance and most of the 12000 conversion being taxable, but no more than that. Most of your 12000 basis will be left over and then carried over to later years.


OK ... thank you .. will need to digest this a bit ...

- In May 2019, the company for his retirement contributions (pre-tax funds) would only provide a Traditional IRA to me for his contributions

This is what is called the "spousal rollover" where you rolled over the inherited employer plan into your own IRA.

- My Traditional IRA now has $271,000 from my husband’s retirement contributions + the about $20 I left previously

Question: Am I subject to the aggregation taxes in 2019 on the $271,000 currently held in my Traditional IRA, even though those funds were received after I did the $12,000 conversion to Roth? It will probably cost about $80-85,000 in taxes.

As others have indicated, NO it will not. The taxable income will be ~ 11,470 as determined on Form 8606 referenced above. This assume you cannot deduct either 6000 contribution.

If “no” to the question, then my intent is to convert to Roth over the course of the next three years since I can use MFJ for 2019, and QW for 2020 and 2021. If “yes,” I suppose I will have to bite the bullet and pay the taxes for 2019 using brokerage account funds.

Be careful not to "over convert". The amount you convert each year should be determined late in the year when you have figured what your marginal rate will be for the amount you convert. I know your rate will rise when you can no longer file with QW status, so after that happens you may very well not be converting any longer. Not enough info here to know.

Hmmm ... yes OK ... would I factor in the marginal rate for the amount I convert, or the marginal tax rate I am placed in after adding in the amount converted to my AGI? Sorry for the newbie question.

In either case, I intend to convert the funds to Roth IRA to: (1) reduce my own future RMDs; (2) reduce the tax burden on my two kids after I die (one daughter is age 4 and the other daughter is 7 months old); and (3) not incur the opportunity cost of conversions to Roth IRAs in perpetuity if I left the funds in the Traditional IRA since I will be over the income limits to directly contribute to a Roth IRA.

The other option I thought of is to move the $271,000 funds to my 457 account, but would prefer to leave them at Vanguard for lower costs, more investment options, and consolidated accounts. And, I am thinking I am better off with conversion to Roth IRA for the 3 reasons above.

If it matters, I am currently 38 years old, and I live in California.

My husband was the personal finance wizard between us and I am now learning without him. Any help you can provide is much appreciated. Thank you.

Note that you cannot recharacterize the conversion and you cannot treat it as a failed conversion. It would be a failed conversion if the contributions were excess contributions, but they are not excess contributions. Not qualifying for the deduction does not create an excess contribution, it just means you cannot deduct the contribution. Therefore, the conversion is allowed and must be retained. This is not a disaster if you were planning taxable conversions anyway.

OK, thank you. The combined $12k to the tIRA was always intended to be converted to a Roth. We did this each year.

-GeekGal

Topic Author
GeekGal
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Joined: Fri Aug 09, 2019 1:05 pm

Re: Roth Conversion Conundrum

Post by GeekGal » Tue Aug 13, 2019 1:38 am

LilyFleur wrote:
Mon Aug 12, 2019 2:59 pm
Hi, GeekGal, and welcome to the forum.

Please accept my heartfelt sympathies. You have a lot on your plate now with two children to raise and a full-time job.

I am so appreciate of your ability to plan now for your children's inheritance. Doing Roths now is a great move.

I have been a single mom for about ten years now. I got them both through college, and 2019 is my first year to file taxes as single. (Head of household is way better.) So from my perspective, as I begin my own Roth conversions but at the higher single tax rate (in California), what you are doing looks extremely wise.

I learn new things from this wonderful forum all the time. RMDs--I had no idea how high my income could rise by the time I'm 80. I, too, am concerned about my children's inheritance, and it would be so much easier for them if they have a tax-free pot of money without RMDs.

I'm so grateful to this community for their knowledge and advice.
Thank you for your sympathy. I never thought I would be in this situation, and it is strange, surreal, and heart-breaking for me. But despite feeling overwhelmed and defeated much of the time, I can only look forward and that's why I am thinking ahead to the futures of my kids, and trying to tidy things up financially.
Congrats on your kids graduating from college. :)

retiredjg
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Re: Roth Conversion Conundrum

Post by retiredjg » Tue Aug 13, 2019 6:13 am

GeekGal wrote:
Tue Aug 13, 2019 1:15 am

I am estimating AGI/MAGI as follows:

2019: 176k
2020: 168k
2021: 174k

This puts me in the 24% tax bracket for the next three years using MFJ, QW, and QW for years 2019, 2020, and 2021, although please correct me if I am wrong.
Let's go over this again. I understand that you get to use the married filing jointly bracket and standard deduction for all three years. Do I understand that correctly?

Tax brackets are based on taxable income (after deductions) instead of AGI. So for 2019, if your AGI is $176k then your taxable income will be $151,600 using the standard deduction. That is in the 22% bracket, not 24% bracket. However, it is near the top of the 22% bracket so you would not be able to convert very much at only 22% - only about $16k. The rest would be converted at 24% which is somewhat high.

It appears the other years would also be in the 22% bracket with not a lot of room to convert at only 22%.

I used an RMD calculator* to calculate RMDs on the current balance of my 457, but excluding the $271k tIRA. I expect to have an AGI of at least $250k inclusive of a pension and the RMDs for the current balance of my 457 (excluding the $271 tIRA) based on a 5% ROR . Assuming "single" filing status at age 70.5, I think this correlates to the 35% tax bracket based on current tax brackets.
This seems high to me. Even with a pension, it is unusual to be in the 35% bracket in retirement.

Let's just look at the expected pension alone. In today's dollars.

Topic Author
GeekGal
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Joined: Fri Aug 09, 2019 1:05 pm

Re: Roth Conversion Conundrum

Post by GeekGal » Tue Aug 13, 2019 2:18 pm

retiredjg wrote:
Tue Aug 13, 2019 6:13 am
GeekGal wrote:
Tue Aug 13, 2019 1:15 am

I am estimating AGI/MAGI as follows:

2019: 176k
2020: 168k
2021: 174k

This puts me in the 24% tax bracket for the next three years using MFJ, QW, and QW for years 2019, 2020, and 2021, although please correct me if I am wrong.
Let's go over this again. I understand that you get to use the married filing jointly bracket and standard deduction for all three years. Do I understand that correctly? Yes this is my understanding.

Tax brackets are based on taxable income (after deductions) instead of AGI. So for 2019, if your AGI is $176k then your taxable income will be $151,600 using the standard deduction. That is in the 22% bracket, not 24% bracket. However, it is near the top of the 22% bracket so you would not be able to convert very much at only 22% - only about $16k. The rest would be converted at 24% which is somewhat high.
Thank you for correcting me on the taxable income. I had done the marginal tax rate approximation a month or two ago using taxable income, and yesterday I must have mixed myself up. Appreciate the course correcting. I estimate my taxable income for 2019 at 137k including a month of my husband's wages and payout of his vacation, and will assume ordinary dividends of $10k and interest of $2k, for a total of $149k. I estimate 2020 and 2023 to be about $137k total and $143k total.
I itemized taxes for 2018 since the mortgage interest and SALT were $28k, more than the standard deduction

It appears the other years would also be in the 22% bracket with not a lot of room to convert at only 22%.
Yes, looks like I have a little room in the 22%, but probably will be bumped into 24% if I want to convert the entire $271 tIRA within the next 3 years.



I used an RMD calculator* to calculate RMDs on the current balance of my 457, but excluding the $271k tIRA. I expect to have an AGI of at least $250k inclusive of a pension and the RMDs for the current balance of my 457 (excluding the $271 tIRA) based on a 5% ROR . Assuming "single" filing status at age 70.5, I think this correlates to the 35% tax bracket based on current tax brackets.
This seems high to me. Even with a pension, it is unusual to be in the 35% bracket in retirement.

Let's just look at the expected pension alone. In today's dollars.
I tripled checked ... I think my income with the RMDs and pension at 70.5 will be $235k gross, in 2019 dollars, not accounting for future contributions to my 457 or the $271 tIRA, and assuming a 5% ROR on the 457 funds. I am also assuming I am filing "single" and won't have mortgage interest to deduct or children or childcare to claim at 70.5. Using the standard deduction of $12,200, this puts me at about $223k, which I thought was in the 35% bracket

What am I missing ... thoughts are welcome and most appreciated ...

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FiveK
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Re: Roth Conversion Conundrum

Post by FiveK » Tue Aug 13, 2019 3:49 pm

GeekGal wrote:
Tue Aug 13, 2019 2:18 pm
...this puts me at about $223k, which I thought was in the 35% bracket
Yes, it is.

That suggests some aggressive traditional to Roth conversions between now and then could be worthwhile.

You might redo the projections with a more conservative return, but it appears you are giving this good consideration. See Investment Order for other things you could consider.

Topic Author
GeekGal
Posts: 33
Joined: Fri Aug 09, 2019 1:05 pm

Re: Roth Conversion Conundrum

Post by GeekGal » Sat Aug 24, 2019 10:30 am

GeekGal wrote:
Tue Aug 13, 2019 1:28 am
Alan S. wrote:
Mon Aug 12, 2019 2:00 pm
GeekGal wrote:
Fri Aug 09, 2019 1:52 pm


If it turns out that one or both of your TIRA Contributions are non deductible, you will file a Form 8606 for each spouse reporting whose contribution is non deductible for 2019. Since you couldn't have converted HIS TIRA until you assumed ownership of it, his 6000 of basis is transferred to YOU and the combined 12000 conversion will be reported only on YOUR Form 8606. You will therefore show 12000 of basis on your Form 8606, but as others have noted, the later rollover of his employer plan will result in pro rating of the entire year end 2019 balance and most of the 12000 conversion being taxable, but no more than that. Most of your 12000 basis will be left over and then carried over to later years.


OK ... thank you .. will need to digest this a bit ...


In brief, I think it would be prudent of me to convert some tIRA assets to Roth IRA. I really want to avoid paying taxes on the $12,000 since this money was already taxed. The $12,000 my husband opened the tIRAs with was already taxed money, and intended to be converted to Roth IRAs using the backdoor method. These tIRAs were never meant to be tax deductible.
Question 1: What does
"Most of your 12000 basis will be left over and then carried over to later years" mean?

I spoke to Vanguard and as indicated by you all, they told me I cannot recharacterize the conversion to Roth, and that I cannot recharacterize the contribution (although the representative seemed a bit green and had to check with another team. Not sure how much got lost in translation).

Question 2: What happens if my income for 2019 is less than the limit for straight-away Roth contributions, as I expect it to be? I have already done the back door Roth conversions. Is this problematic?

Question 3: The following is me thinking out loud regarding my options regarding the $271 tIRA conversion (thoughts, corrections, etc. are welcome):

Option 1: Convert all $271k in the tIRA and pay the taxes in 2019.
Pros: Short-term: Leaves nothing in the tIRA; no taxes due on the $12k. Long-term: Reduces future RMDs and provides for tax diversification in retirement by creating sizeable amount in a Roth IRA, particularly since I expect my taxable income in retirement to be higher than my taxable income now.
Cons: Significant tax bill since $271k will be included as income and I will pay ordinary income tax on this large amount (although MFJ for 2019, so this is favorable tax category as opposed to HoH which I will likely use after my QW status expires).

Option 2: Convert the $271k over the next three years. Would I keep paying taxes on the $12,000 basis each year (proportionally less as the $271k balance decreases) until the $271 tIRA is fully converted?
Pros: Short-term: Phased conversion spreads tax liability on conversion of $271k over three years. Long-term: Reduces future RMDs and provides for tax diversification in retirement by creating sizeable amount in a Roth IRA, particularly since I expect my taxable income in retirement to be higher than my taxable income now.
Cons: Depending on how it works, I may be paying taxes over and over again on the $12,000.

Option 3: Roll the $271 tIRA into my 457b (they accept rollover tIRA) in 2019 and keep it there for all of 2019, and then roll some out (roll-out is allowed for my plan per customer service) in 2020 and the some more out in 2021 since I will be filing as QW. I could strategize how much to roll out each year (and see how much beyond 2021 makes sense depending on how much room I have in the lower rate marginal tax brackets).
Pros: Short-term: The tIRA would have virtually no funds left at the end of 2019 (except maybe $20 which I would convert to Roth), and thus I would not pay taxes on the $12,000. Long-term: Reduces future RMDs and provides for tax diversification in retirement by creating sizeable amount in a Roth IRA, particularly since I expect my taxable income in retirement to be higher than my taxable income now.
Cons: Would not convert any amount of the $271k tIRA in 2019, meaning I would be converting a higher amount in 2020 and 2021 if I wanted to convert all $271k within years 2020 and 2021 - essentially losing out on the possibility to convert and pay less taxes using the MFJ status for 2019. Potentially higher fees with 457 company versus Vanguard, but this would be marginal and for a short term.



Thanks to you all again for your insight and expertise. Much appreciated.

BarbK
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Re: Roth Conversion Conundrum

Post by BarbK » Sat Aug 24, 2019 11:37 am

OP - You are not paying taxes over and over again on the $12K non-deductible IRA when you do Roth Conversion.

Here's an example using rounded #'s for Ease.

On Dec 31, your IRA balance including the $12K was $200K - so the $12K is 6% of it.

If you convert $50K, then 6% of the $50K will not be taxed (because it already was taxed), that is $3k

So you will be taxed at $47K, and your Cost basis of the deductible IRA goes down to $9K for future years.

retiredjg
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Re: Roth Conversion Conundrum

Post by retiredjg » Sat Aug 24, 2019 11:53 am

GeekGal wrote:
Sat Aug 24, 2019 10:30 am
Question 1: What does [/color]"Most of your 12000 basis will be left over and then carried over to later years" mean?
You have already paid tax on this $12k because it was never deducted from your taxable income. If the Roth conversion that you have already done is pro-rated at the end of this year, you don't get "credit" for the taxes already paid all in one year. The "credit" gets spread out over a number of years until the IRA is empty. Don't worry. You will not pay tax on this money (or any other money) a second time if you do your paperwork right. I am confident you can do this paperwork right.


Question 2: What happens if my income for 2019 is less than the limit for straight-away Roth contributions, as I expect it to be? I have already done the back door Roth conversions. Is this problematic?
No. This is not a problem at all.


Option 1: Convert all $271k in the tIRA and pay the taxes in 2019.
I don't think this is a good choice because it will increase your taxable income a lot. A little of your conversion would be taxed at 22%, most will be taxed at 24%, and I think some might even get pushed into the 32% bracket (but I didn't do the math). There is no need to do this unless you just want to get it out of the way even if you end up with less money.

Option 2: Convert the $271k over the next three years.
Your best choice in my opinion. More of the $271k would get taxed at 22%, less at 24% and none at 32%.

Cons: Depending on how it works, I may be paying taxes over and over again on the $12,000.

It does not really work this way. If you convert $271k in 1 year you will pay tax on $271k minus $12k = $259k. If you convert the $271k in 3 years, you will still pay tax on $259k. No matter how you do it, you will always get credit for having paid tax on the $12k.

This brings up something I had not thought of. You might want to put your bond allocation in that account so that your $271k does not grow a lot in over the next couple of years.


Option 3: Roll the $271 tIRA into my 457b (they accept rollover tIRA) in 2019 and keep it there for all of 2019, and then roll some out (roll-out is allowed for my plan per customer service) in 2020 and the some more out in 2021 since I will be filing as QW. I could strategize how much to roll out each year (and see how much beyond 2021 makes sense depending on how much room I have in the lower rate marginal tax brackets).
There is no benefit in doing this if you intend to convert the entire $271k in the next 3 years. That would be a lot of work with no benefit.

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