Covert to Roth? Here is my situation


W

wangchieh

My situation:
---------------

Age: Early 30's
Yearly income: $70k
Value in Roth IRA: About $20k
Value in Rollover IRA: About $40k

Does it make financial sense to convert my Rollover IRA to a Roth?
 
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W

woessner

Age: Early 30's
Yearly income: $70k
Value in Roth IRA: About $20k
Value in Rollover IRA: About $40k
Does it make financial sense to convert my Rollover IRA to a Roth?
The answer to this question depends entirely on your personal tax
situation. That being said, I belive that, IN GENERAL, the conversion
is a good idea. One caveat:

The conversion will generate a larger-than-normal tax bill. Assuming
your IRA balace contains no after-tax money, the conversion will
increase your taxable income by $40K. A quick, back-of-the-envelope
calculation (1 exemption, standard deduction) says that a $40K increase
in income will raise your tax bill from $11,945 to $22,766.

In order to get the most out of your Roth conversion, you need to be
able to pay the extra taxes WITHOUT dipping in to your retirement
savings. If you're able to do that, I'd say go for the conversion.

--Bill
 
M

Mark Bole

Age: Early 30's
Yearly income: $70k
Value in Roth IRA: About $20k
Value in Rollover IRA: About $40k
Does it make financial sense to convert my Rollover IRA to a Roth?
[...]

The conversion will generate a larger-than-normal tax bill. Assuming
your IRA balace contains no after-tax money, the conversion will
increase your taxable income by $40K. A quick, back-of-the-envelope
calculation (1 exemption, standard deduction) says that a $40K increase
in income will raise your tax bill from $11,945 to $22,766.
Also possibly could trigger alternative minimum tax (AMT).

-Mark Bole
 
J

jIM

Mark said:
Age: Early 30's
Yearly income: $70k
Value in Roth IRA: About $20k
Value in Rollover IRA: About $40k
Does it make financial sense to convert my Rollover IRA to a Roth?
[...]

The conversion will generate a larger-than-normal tax bill. Assuming
your IRA balace contains no after-tax money, the conversion will
increase your taxable income by $40K. A quick, back-of-the-envelope
calculation (1 exemption, standard deduction) says that a $40K increase
in income will raise your tax bill from $11,945 to $22,766.
Also possibly could trigger alternative minimum tax (AMT).

-Mark Bole
The AMT comment got me thinking,,, I rolled over around 10k of a
rollover (former pension plan) into a Roth in January.

when does AMT get triggered? Is it based on income, deductions, or
something else? Rule of thumb is appreciated, knowing every situation
is "different".

gross salary of around 100k each year between two married people (in
Ohio). When would AMT get triggered? Anything once could do to
minimize AMT chances last half of year if it's close?
 
R

Rich Carreiro

jIM said:
when does AMT get triggered? Is it based on income, deductions, or
something else?
Yes. :)
Rule of thumb is appreciated,
There is no rule of thumb, other than "if you exercise lots
of big-in-the-money ISOs you'll have AMT". :)

Because of all the moving parts in AMT, it's hard to say
what can cause it and whether you'll be subject to it.
It's possible for a taxpayer with income as low as $85,000
or so to be in AMT if he has enough children, for example
(that's an actual case).

Your best bet is to crank up last year's copy of whatever
tax software you used and fiddle with some sample returns.

Or grab a copy of Form 6251 from the IRS website and do
it by hand.
gross salary of around 100k each year between two married people (in
Ohio). When would AMT get triggered?
Depends on how many personal exemptions you have, how much state
income tax you have taken out of your pay, and what your real estate
and property taxes are.
 
M

Mark Bole

Dear Moderator: this post from 9 AM PDT seems to have been skipped somehow.

My situation:
---------------

Age: Early 30's
Yearly income: $70k
Value in Roth IRA: About $20k
Value in Rollover IRA: About $40k

Does it make financial sense to convert my Rollover IRA to a Roth?
Not all at once. Adding $40K income (from the traditional IRA, assuming
you have no basis in it) in a single year will require you to make some
hefty estimated tax payments and will be taxed at maximum rates
(although you told us nothing about your filing status, state of
residence, adjustments and deductions, etc).

Also, assuming your traditional IRA is in stocks and bonds, what if the
day you make the conversion happens to be the high point of the market
for the year? That's the amount you'll be taxed on, even if the Roth
drops in value by the end of the year.

A better strategy is to convert maybe $10K/year, quarterly or
semi-annually, over the next four years, to get the benefits of
dollar-cost-averaging. Also, if the tax law doesn't change, there will
be a one-time opportunity in 2009 or thereabouts to spread the income
from a conversion to Roth over two tax years.

At your age, the tax-free earnings from the Roth over the next 20-30
years should be a good deal, so it's more a matter of how, not if.

-Mark Bole
 
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J

joetaxpayer

Mark said:
Not all at once. Adding $40K income (from the traditional IRA, assuming
you have no basis in it) in a single year will require you to make some
hefty estimated tax payments and will be taxed at maximum rates
(although you told us nothing about your filing status, state of
residence, adjustments and deductions, etc).
snip

-Mark Bole
The 25% bracket for single ends at 74200 in 2006, income above that is
taxed at 28%. The OP should consider moving just enough to stay under
the $74.2K. Given an exemption and STD deduction, he should be able to
convert 12K/yr or so.
JOE
 
M

Mark Bole

My situation:
---------------

Age: Early 30's
Yearly income: $70k
Value in Roth IRA: About $20k
Value in Rollover IRA: About $40k

Does it make financial sense to convert my Rollover IRA to a Roth?
Not all at once. Adding $40K income (from the traditional IRA, assuming
you have no basis in it) in a single year will require you to make some
hefty estimated tax payments and will be taxed at maximum rates
(although you told us nothing about your filing status, state of
residence, adjustments and deductions, etc).

Also, assuming your traditional IRA is in stocks and bonds, what if the
day you make the conversion happens to be the high point of the market
for the year? That's the amount you'll be taxed on, even if the Roth
drops in value by the end of the year.

A better strategy is to convert maybe $10K/year, quarterly or
semi-annually, over the next four years, to get the benefits of
dollar-cost-averaging. Also, if the tax law doesn't change, there will
be a one-time opportunity in 2009 or thereabouts to spread the income
from a conversion to Roth over two tax years.

At your age, the tax-free earnings from the Roth over the next 20-30
years should be a good deal, so it's more a matter of how, not if.

-Mark Bole
 
W

Will Trice

Mark said:
(e-mail address removed) wrote:

Not all at once.

Also, assuming your traditional IRA is in stocks and bonds, what if the
day you make the conversion happens to be the high point of the market
for the year? That's the amount you'll be taxed on, even if the Roth
drops in value by the end of the year.

A better strategy is to convert maybe $10K/year, quarterly or
semi-annually, over the next four years, to get the benefits of
dollar-cost-averaging.
Assuming that the conversion does not put the OP into a higher tax
bracket, wouldn't it be best to convert everything (or at least up to
the next tax bracket) at once, and just recharacterize and reconvert the
next year if the value of the account declines?

-Will
 
M

Mark Bole

Will said:
Not all at once.
[...]

Assuming that the conversion does not put the OP into a higher tax
bracket, wouldn't it be best to convert everything (or at least up to
the next tax bracket) at once, and just recharacterize and reconvert the
next year if the value of the account declines?
Yes, although there are some limits on how frequently you can
re-convert. IIRC your assumption does not apply to the OP, however.

Just as you want to buy stock on the day it is priced the lowest, you
want to convert your Traditional to Roth on the day your existing
balance is lowest, all other things being equal. I was simply (perhaps
naively?) trying to apply the general rule of cost-averaging over time
to both problems. I suppose the difference is, with an IRA conversion
you have a limited ability to "do it over" if it is to your benefit at a
later time.

-Mark Bole
 
W

Will Trice

Mark said:
Will Trice wrote:


Yes, although there are some limits on how frequently you can
re-convert. IIRC your assumption does not apply to the OP, however.
Why not?
I suppose the difference is, with an IRA conversion
you have a limited ability to "do it over" if it is to your benefit at a
later time.
If you can reconvert later, why is this a problem?

-Will
 
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J

jIM

Rich Carreiro wrote:

Your best bet is to crank up last year's copy of whatever
tax software you used and fiddle with some sample returns.
I use Turbotax. Would bumping up income start to show it? Where would
I look to see if AMT was being used within Turbotax?

Depends on how many personal exemptions you have, how much state
income tax you have taken out of your pay, and what your real estate
and property taxes are.
The state income tax comment got me thinking... what about state income
tax being "taken out" triggers AMT- too much or too little? We did owe
state quite a bit of money last year (too little taken out).
 
J

jIM

The 25% bracket for single ends at 74200 in 2006, income above that is
taxed at 28%. The OP should consider moving just enough to stay under
the $74.2K. Given an exemption and STD deduction, he should be able to
convert 12K/yr or so.
JOE
where is the cutoff between 28% tax bracket and next one higher? Is
their a web site someone can refer me to for the tax tables?
 
J

joetaxpayer

jIM said:
where is the cutoff between 28% tax bracket and next one higher? Is
their a web site someone can refer me to for the tax tables?
sorry I though I posted this
http://www.fairmark.com/refrence/index.htm

google: 2006 tax rates fairmark

and this was the first hit. limited info, but exactly what we needed for
this exercise. good luck.
JOE
 
J

jIM

sorry I though I posted this
http://www.fairmark.com/refrence/index.htm

google: 2006 tax rates fairmark

and this was the first hit. limited info, but exactly what we needed for
this exercise. good luck.

good web site, thank you. My interpretation of this is if:

married filing jointly

first 15,100 of income is not taxed
income between 15,100 and 61,300 is taxed at a rate of 15%
income between 61,000 and 123,700 is taxed at 25%
income between 123,700 and 188,450 is taxed at 28%

I am unsure of what column "the tax is" means- I think this is the tax
paid on money in previous bracket, because taxation is graduated.

so for purpose of converting to Roth, convert to income hitting
$123,700. If income was already at that level, convert an amount which
income stays below $188,450 (or wait to convert in a year where person
converting earns less).
 
E

Elle

Clarification: You mean do the first conversion in year X,
then recharacterize as needed before the due date of one's
tax return for year X, then convert again for tax year
(X+1), right?
Yes, although there are some limits on how frequently you
can re-convert. IIRC your assumption does not apply to
the OP, however.
Also, before newbies forge ahead thinking conversions and
recharacterizations may still be done fairly willy-nilly, a
caveat: The tax paperwork involved in a recharacterization
can be gosh-awful. This is typically due to a change in
stock etc. value between when the conversion was done and
when the recharacterization is done. As of a few years ago,
the proper IRS-approved method to use to compute the net
conversion was still vague. Examples abound on the net; the
general idea behind them makes sense; and it's not like
we're necessarily talking about huge errors either way. But
the ambiguity of how the calculations were to be done left
me a bit uncomfortable, at least as of a few years ago when
I last did a recharacterization.
 
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R

Rich Carreiro

jIM said:
good web site, thank you. My interpretation of this is if:

married filing jointly

first 15,100 of income is not taxed
income between 15,100 and 61,300 is taxed at a rate of 15%
income between 61,000 and 123,700 is taxed at 25%
income between 123,700 and 188,450 is taxed at 28%
You're reading the table wrong.

First $15,000 of taxable income is taxed at 10%,
Taxable income from $15,100 to $61,300 is taxed at 15%
Taxable income from $61,300 to $123,700 is taxed at 25%
Taxable income from $123,700 to $188,450 is taxed at 28%.
I am unsure of what column "the tax is" means- I think this is the tax
paid on money in previous bracket, because taxation is graduated.
Just read across to make the whole sentence. For example if your
taxable income is between $61,300 and $123,700, the tax is $8,440
plus 25% of the amount of taxable income over $61,300. So if
your taxable income is $90,000, your tax is:
$8,440 + 0.25($90,000 - $61,300)
= $15,615

And keep in mind those tables are with respect to taxable
income (adjusted gross income minus allowable deductions
and personal exemptions).
 
R

Rich Carreiro

jIM said:
The state income tax comment got me thinking... what about state income
tax being "taken out" triggers AMT- too much or too little?
State income taxes and state and local real estate taxes, personal
property taxes, and intangibles taxes are not deductible under the
AMT.
 
W

Will Trice

Elle said:
Clarification: You mean do the first conversion in year X,
then recharacterize as needed before the due date of one's
tax return for year X, then convert again for tax year
(X+1), right?
Yep, thanks for the clarification.
Also, before newbies forge ahead thinking conversions and
recharacterizations may still be done fairly willy-nilly, a
caveat: The tax paperwork involved in a recharacterization
can be gosh-awful.
Really? When I've done the paperwork (three years in a row, )&*^%^%34
bear market), I thought the paperwork to be fairly straight forward,
though I understand your point about the calculations being vague. I
just used something that was reasonable, I figure that will survive an
audit.

-Will
 
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M

MATTY

For most of us im not convinced the conversion is worth it unless you
think you will be in a higher bracket when retired.Not many americans
will have a higher tax bracket with no pay check than they do with
one.At retirement age you can almost take 32,000 every year from ira or
401k money and pay no more than 1500.00 bucks tax on it.With the income
tax brackets being extended each year by about 3,000 bucks in the very
next few years the 15% bracket may be around 75,000.Unless your
min.distrubutions will raise you sooooo high in tax bracket i wouldnt
lop off a huge chunk of my working dough and pay any taxes now i can
delay to later.I dont see it in the cards that any political group or
leader would ever tell the 80 million baby boomers they are increasing
their taxes in the future.Just my opinion!
 

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