Advice on coverting Traditional IRA to ROTH


M

martin lynch

Hello. I'm 30 years old. Recently returned to grad school, so for
2007 my annual income will only be $8,400. Since I'm in the lower tax
bracket now, I thought it would be a good idea to convert my
Traditional IRA to a ROTH IRA since the tax penalty won't be as bad.
I have $18,000 in the IRA.

Do I understand this correctly, that $18,000 + $8,400 = $26,400 will
be what determines my tax bracket, which will determine the tax
penalty I pay for the ROTH conversion? Or will the $18,000 in the IRA
be taxed at a capital gains or some other rate?

Thanks
 
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P

Phil Marti

martin lynch said:
Hello. I'm 30 years old. Recently returned to grad school, so for
2007 my annual income will only be $8,400.
Make that "was" only $8,400. Too bad you didn't ask this question while you
still had time to do something in 2007. (No, the April 15 deadline for 2007
contributions doesn't apply to conversions.)
Since I'm in the lower tax
bracket now, I thought it would be a good idea to convert my
Traditional IRA to a ROTH IRA since the tax penalty won't be as bad.
I have $18,000 in the IRA.
Any amount you convert will be taxed as ordinary income, i.e., no special
rate. To estimate the taxes you'll owe if you convert in 2008, use Form
1040-ES (make sure you get the 2008 version).
 
B

Barry Margolin

martin lynch said:
Hello. I'm 30 years old. Recently returned to grad school, so for
2007 my annual income will only be $8,400. Since I'm in the lower tax
bracket now, I thought it would be a good idea to convert my
Traditional IRA to a ROTH IRA since the tax penalty won't be as bad.
I have $18,000 in the IRA.

Do I understand this correctly, that $18,000 + $8,400 = $26,400 will
be what determines my tax bracket, which will determine the tax
Unless any of your contributions did not qualify for tax deductions, in
which case you should subtract those contributions.
penalty I pay for the ROTH conversion? Or will the $18,000 in the IRA
be taxed at a capital gains or some other rate?
IRA withdrawals and conversions are taxed as ordinary income.
 
M

Mark Bole

martin said:
Hello. I'm 30 years old. Recently returned to grad school, so for
2007 my annual income will only be $8,400. Since I'm in the lower tax
bracket now, I thought it would be a good idea to convert my
Traditional IRA to a ROTH IRA since the tax penalty won't be as bad.
I have $18,000 in the IRA.

Do I understand this correctly, that $18,000 + $8,400 = $26,400 will
be what determines my tax bracket, which will determine the tax
penalty I pay for the ROTH conversion? Or will the $18,000 in the IRA
be taxed at a capital gains or some other rate?
There would be no tax "penalty" on the conversion (as in 10% early
distribution penalty), only ordinary tax, as previously noted.

You have the choice to convert less than 100% of the traditional IRA
balance in any given year. From a financial planning viewpoint, be sure
to take into account the following for 2008 and beyond (as mentioned,
you're too late for 2007).

1. With an AGI (adjusted gross income) of only $8,400, you would
typically owe no federal tax. You might want to convert only the amount
that takes you to the top of the 10% tax bracket, but not into 15%. For
single, no dependents, that amount is calculated as $8,950 (std
deduction + exemption) plus $8,025 (taxable income in 10% bracket), or
$16,975 total AGI. If you convert more, then the additional amount will
be taxed at 15%. Even this rate may be good for you, however, if this
is the last year for a long time that you will be below 25% tax bracket
(which is likely once you graduate and go back to work full time).

2. It's recommended to have a source of funds other than the IRA itself
to pay the tax on the converted amount, otherwise the amount withheld
from the conversion to pay the tax *will* be subject to 10% penalty.

3. You don't state how much of your income is from earnings and how much
from investment or other sources, but you might be eligible for the
Earned Income Credit. Raising your AGI by converting "too much" of your
IRA might lose you some or all of this refundable credit.

4. As a student, you might have other education-related tax benefits
that are either gained or lost as you raise your (modified) AGI, thereby
affecting your overall "effective" tax rate.

5. Although the point of an IRA is to save money for retirement, one
side effect of converting to a Roth is that after five years, the
converted amount can be withdrawn with no penalty and no additional tax
even if you are nowhere near retirement age, thereby allowing it to be
part of your emergency fund or other financial requirements (beyond just
tax implications).

If you use tax software, you can create multiple "what if" scenarios for
2008 by using the 2007 software (just mentally adjust all the dates used
by one year). Or, the storefront tax preparation firms will gladly give
you a free consultation on this in the hope of getting your business.

-Mark Bole
 
J

joetaxpayer

martin said:
Hello. I'm 30 years old. Recently returned to grad school, so for
2007 my annual income will only be $8,400. Since I'm in the lower tax
bracket now, I thought it would be a good idea to convert my
Traditional IRA to a ROTH IRA since the tax penalty won't be as bad.
I have $18,000 in the IRA.

Do I understand this correctly, that $18,000 + $8,400 = $26,400 will
be what determines my tax bracket, which will determine the tax
penalty I pay for the ROTH conversion? Or will the $18,000 in the IRA
be taxed at a capital gains or some other rate?
The conversion deadline was yesterday (12/31). This is one of the things
I remark that those who see their 'tax guy' or any financial advisor in
March each year will miss out on this type of year end planning strategy.
You plan to finish grad school and return to work in '08?
I'd suggest you look at http://www.fairmark.com/refrence/index.htm
to see the rates for 2008, a standard deduction of $5,450 and exempton
of $3,500, total $8,950 'zero rate'. Next $8,025 is taxed at 10%.
You should still make your 2007 Roth deposit, you have until April 15 to
do that.

JOE
www.blog.joetaxpayer.com
 
D

dpb

martin said:
Hello. I'm 30 years old. Recently returned to grad school, so for
2007 my annual income will only be $8,400. Since I'm in the lower tax
bracket now, I thought it would be a good idea to convert my
Traditional IRA to a ROTH IRA since the tax penalty won't be as bad.
I have $18,000 in the IRA.

Do I understand this correctly, that $18,000 + $8,400 = $26,400 will
be what determines my tax bracket, which will determine the tax
penalty I pay for the ROTH conversion? Or will the $18,000 in the IRA
be taxed at a capital gains or some other rate?
Basically, less any deductions. If you are going to be in school at a
low earning level for more than the one year, you could even split it
into two transfers to ensure remain in lowest bracket providing some
margin for the unexpected.

--
 
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R

removeps-groups

IRA withdrawals and conversions are taxed as ordinary income.
What about if you made a non-deductible IRA contribution and filed
form 8606. When you convert that IRA into a Roth, do you still add it
to your income? Reason I ask is I read somewhere that in 2010 they
will eliminate the income limits to contribute to a Roth and convert a
traditional IRA to Roth.

Also, is it possible to convert a Rollover IRA or a 401K into a Roth?
 
B

Benjamin Yazersky CPA

Hello. I'm 30 years old. Recently returned to grad school, so for
2007 my annual income will only be $8,400. Since I'm in the lower tax
bracket now, I thought it would be a good idea to convert my
Traditional IRA to a ROTH IRA since the tax penalty won't be as bad.
I have $18,000 in the IRA.

Do I understand this correctly, that $18,000 + $8,400 = $26,400 will
be what determines my tax bracket, which will determine the tax
penalty I pay for the ROTH conversion? Or will the $18,000 in the IRA
be taxed at a capital gains or some other rate?

Thanks

Too late-had to be done by yesterday (Dec 31, 2007)

For future planning, you should also consider your state's tax
implication of doing the conversion.




___________________________________
<<< Benjamin Yazersky, CPA [NJ & NY] >>>
-----> real address on hobokeni or hobokenx <-----





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A

Arthur Kamlet

What about if you made a non-deductible IRA contribution and filed
form 8606. When you convert that IRA into a Roth, do you still add it
to your income? Reason I ask is I read somewhere that in 2010 they
will eliminate the income limits to contribute to a Roth and convert a
traditional IRA to Roth.
The taxable portion as determined by form 8606, will be
taxed as ordinary income.


Also, is it possible to convert a Rollover IRA or a 401K into a Roth?


The rollover IRA is just an IRA that was formed by a rollover, and
can certainly be coverted to a roth if all the other rules are met.


In doing so, you may lose some benefits of a rollover IRA
including unlimited bankruptcy protection and ability to
possibly move the rollover IRA to a qualified employer plan.


And the new law will now allow direct transfer of a 401k to
a Roth IRA.
 
B

Barry Margolin

What about if you made a non-deductible IRA contribution and filed
form 8606. When you convert that IRA into a Roth, do you still add it
to your income?
Didn't I address that in part of my message that you snipped? I said
that you subtract the non-deductible contributions.

This assumes that you're converting the entire IRA. If you do a partial
conversion, it's pro-rated.
 
M

Mark Bole

Barry Margolin wrote:
[...]
Didn't I address that in part of my message that you snipped? I said
that you subtract the non-deductible contributions.
This thread seems to have several responses that repeat information
already provided in previous responses...not sure why.

-Mark Bole
 
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M

martin lynch

Oh, and I should mention that I will be taking standard (non-itemized)
deduction.
 

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