Question for tax experts re: Rollover IRA to Roth IRA

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SoonerSunDevil
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Question for tax experts re: Rollover IRA to Roth IRA

Post by SoonerSunDevil »

During 2009 and 2010, I expect to have very little to no income (law school). At some point in 2008, I am going to do a direct rollover from my 401(k) to a Rollover IRA, thus avoiding the creation of a tax liability. Is there anything that prevents me from doing a partial conversion in 2009 from a Rollover IRA to a Roth IRA? I'd hate to have a standard deduction and personal exemption worth about $9,000 in 2009 but not have sufficient income to at least meet this amount. Let's say that my Rollover IRA will be worth $15,000 in 2009. Let's also assume that I have a very minimal income in 2009, say $1,000. Am I allowed to convert $8,000 of my Rollover IRA to a Roth, creating additional income of $8,000? My $1,000 of wages, combined with the tax liability due on $8,000 of income from the conversion, will all be absorbed by the standard deduction and personal exemption. This will create a tax-free conversion from a Traditional IRA to a Roth IRA, avoiding all taxes on distributions from the Roth during retirement.

Finally, my Rollover IRA will be worth $7,000 (Initial $15,000 less $8,000 converted in 2009) in 2010, and at this point I can move this amount to my Roth tax-free, assuming my income plus the amount of the conversion is equal to or less than the standard deduction and personal exemption combined in 2010. Is what I’m describing legal?

By the way, isn't there a quirky law that allows tax-free conversions of Traditional IRAs to Roth IRAs in 2010? If so, I could always take advantage of that law, or more likely, the law will be amended to fix this loophole and I'll have to do what I described above.

Am I overlooking something?

Thanks!


John
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grabiner
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Re: Question for tax experts re: Rollover IRA to Roth IRA

Post by grabiner »

OUJohnNasr wrote:During 2009 and 2010, I expect to have very little to no income (law school). At some point in 2008, I am going to do a direct rollover from my 401(k) to a Rollover IRA, thus avoiding the creation of a tax liability. Is there anything that prevents me from doing a partial conversion in 2009 from a Rollover IRA to a Roth IRA?[ I'd hate to have a standard deduction and personal exemption worth about $9,000 in 2009 but not have sufficient income to at least meet this amount.
That's a great idea.
Let's say that my Rollover IRA will be worth $15,000 in 2009. Let's also assume that I have a very minimal income in 2009, say $1,000. Am I allowed to convert $8,000 of my Rollover IRA to a Roth, creating additional income of $8,000? My $1,000 of wages, combined with the tax liability due on $8,000 of income from the conversion, will all be absorbed by the standard deduction and personal exemption.
This is legal, and if your $1000 is earned income, you may also contribute it to a Roth IRA and shelter it from taxes.
By the way, isn't there a quirky law that allows tax-free conversions of Traditional IRAs to Roth IRAs in 2010? If so, I could always take advantage of that law, or more likely, the law will be amended to fix this loophole and I'll have to do what I described above.
The law doesn't allow tax-free conversions; it just removes the income limit, so that you would be able to convert even in a high tax bracket (but you would pay taxes in that high tax bracket).
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Post by heyyou »

An annual contribution to either IRA has different rules than converting part of a TIRA to a RIRA.

You can do a partial conversion (always a taxable event) of TIRA to RIRA any year, no minimum income required. Currently there is an upper income limit for conversions, but you know about the coming sunset provision. I believe it is the limit that is going away, so convertors will still owe the tax, but it is spread across two years.

You won't owe tax on your two taxable events since your annual income is too low.

Any small amount of earned income can be contributed into an traditional TIRA or a Roth RIRA. Your fund company may have a low minimum deposit, not to be confused with the higher minimum to open an account. You should contribute to the Roth since you won't owe any tax on the after-tax contribution. There is an upper income limit for being eligible for a RIRA or a deductible TIRA.
I read about this at Fairmark.com
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Post by rwwoods »

John, if your income is low enough, and you contribute to a Roth, you may be able to collect the "retirement savings contributions credit". See Form 8880 which you can download from irs.gov. If your AGI is under $30K and you are married filing jointly, you can receive a 50% tax credit for up a $2K contribution. This tax credit will allow you to make a higher Roth Conversion without paying taxes.

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Post by SoonerSunDevil »

Thanks to everyone who has responded thus far, I really appreciate it. I do not know if I will be able to convert the entire amount of my Rollover to a Roth IRA in 2009 and 2010, but I am sure going to try!

Thanks again,

John
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Post by mudfud »

OUJohnNasr wrote:Thanks to everyone who has responded thus far, I really appreciate it. I do not know if I will be able to convert the entire amount of my Rollover to a Roth IRA in 2009 and 2010, but I am sure going to try!
Hi John,

Even if you convert beyond the $9000, the next $7000 (?) or so will be taxed at 10%, so it could still be worth it.

Mud
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Post by SoonerSunDevil »

mudfud wrote:Hi John,

Even if you convert beyond the $9000, the next $7000 (?) or so will be taxed at 10%, so it could still be worth it.

Mud
Hi Mud,

I've thought about doing that, but I have a reservation about converting from the Traditional IRA to the Roth IRA while paying taxes. Although the tax rate and taxes due would be small, I'm not convinced that those in Congress won't eventually change the tax laws regarding Roth IRAs. I'd hate to pay taxes on a conversion from a Traditional IRA to a Roth IRA only to find out that my Roth IRA will now be subject to taxation upon withdrawal of funds during retirement as a Traditional IRA is.

If I'm able to convert tax-free in 2009 and 2010, and Congress later changes the law regarding the taxation of Roth IRAs, then I have gained nothing by doing the conversion. I have only lost the benefit of the standard deduction and personal exemption for those tax years, which would go unused if I don't convert in 2009 and 2010, respectively.

Maybe I'll take a tax class or two in law school and see if there isn't a better method to avoid taxation on my hard-earned retirement money :)

John
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don't forget tuition credits

Post by rockH »

As a law school student, you will be eligible for IRS tuition credits...if you use the Lifetime Learning Credit its good for a tax credit of up to $2,000 each year (20% of up to 10,000 in tuition). Note: its a tax credit not a deduction...dollar for dollar reduction in tax liability! This should allow you to realize a lot more income without paying any taxes during your tuition paying years.

I know a grad student doing that this year, converting Rollover IRA to Roth, and also selling some mutual funds with capital gains to reinvest in similar funds (resetting basis at higher current prices), with all tax liability wiped out by the education credits.

Most students have little or no income or investments so can't take full advantage of these credits. It's a great deal if you can.

RockH
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Re: don't forget tuition credits

Post by SoonerSunDevil »

rockH wrote:As a law school student, you will be eligible for IRS tuition credits...if you use the Lifetime Learning Credit its good for a tax credit of up to $2,000 each year (20% of up to 10,000 in tuition). Note: its a tax credit not a deduction...dollar for dollar reduction in tax liability! This should allow you to realize a lot more income without paying any taxes during your tuition paying years.

I know a grad student doing that this year, converting Rollover IRA to Roth, and also selling some mutual funds with capital gains to reinvest in similar funds (resetting basis at higher current prices), with all tax liability wiped out by the education credits.

Most students have little or no income or investments so can't take full advantage of these credits. It's a great deal if you can.

RockH
Hi RockH,

I cannot believe I forgot about the Lifetime Learning Credit! I feel especially embarrassed because I used this last year and my effective tax rate was 0%. :) However, I was only able to use $1,800 or so of the credit, but you can't beat having an effective tax rate of 0%!

On a related matter, I made a $4,000 contribution to my Roth IRA in January, and I think I'm going to recharacterize (is that the correct term?) that contribution to a Traditional IRA and then convert the Traditional IRA to a Roth sometime in 2008 or 2009 when I do my Rollover IRA conversion to a Roth IRA.

Am I missing something with this line of thinking? I can take the immediate tax break by contributing to the Traditional IRA, and then convert the Traditional IRA to a Roth IRA tax-free in a year or two because of the Lifetime Learning Credit coupled with my low income during school. Any objections to doing things as I propose?

Thanks,

John
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