| When to convert Traditional IRA to Roth IRA |
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peted
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| When to convert Traditional IRA to Roth IRA |
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Question:
My wife and I have about $30K in 2 traditional IRA's. Our combined AGI has been reduced due to her staying home with our son (currently about $125K), so I thought this might be a good time to convert our traditional IRA's to Roth IRA's. I realize I will pay tax now, but that seems like a small price to pay when I can withdraw the earning tax free later down the road.
Will the tax be at my current income tax rate or a special IRA rate. Will the gov't penalize me with a higher tax/fees for this?
What other factors should I consider before converting my traditional IRA to a Roth?
pete
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Wed Apr 26, 2006 6:12 pm |
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JBendar
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| Conversion from regular IRA to Roth IRA |
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Peted:
Listed below is the address of the IRS web site that pertains to the Roth IRA. You might have all your questions answered if you log on to the IRS address. If that doesn't help you, send me a private message with your specific situation, and I will try to assist you (gratis!)
http://www.irs.gov/faqs/faq17-3.html
JBendar 
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Wed Apr 26, 2006 7:18 pm |
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coaster
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The tax will be added to your AGI and taxed according to your marginal tax rate for that AGI in the year that you convert. So you might want to consider whether or not doing this bumps you into a higher bracket. There's no penalty that I'm aware of. The tax is penalty enough!! (Except I think there's a penalty if you take an early distribution within a certain number of years of the conversion.)
Just curious as to why you'd rather pay tax now than later, and if there's any other reasons you want to do this now.
~Tim~
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Wed Apr 26, 2006 7:34 pm |
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peted
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quote:
Originally posted by coaster
The tax will be added to your AGI and taxed according to your marginal tax rate for that AGI in the year that you convert. So you might want to consider whether or not doing this bumps you into a higher bracket. There's no penalty that I'm aware of. The tax is penalty enough!! (Except I think there's a penalty if you take an early distribution within a certain number of years of the conversion.)
Just curious as to why you'd rather pay tax now than later, and if there's any other reasons you want to do this now.
I guess I feel I'm in a better position to pay a bit more now, rather than paying later...when I'm retired and my income is less.
pete
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Wed Apr 26, 2006 8:19 pm |
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coaster
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I guess that's a reasonable motive. And who knows what the tax code will be when you retire. But if it's still a progressive rate like it is now, then you're better off paying tax on income when your income is less.
~Tim~
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Wed Apr 26, 2006 9:49 pm |
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Kiaser
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quote:
Originally posted by coaster
I guess that's a reasonable motive. And who knows what the tax code will be when you retire. But if it's still a progressive rate like it is now, then you're better off paying tax on income when your income is less.
I agree, you can't predict your tax bracket at retirement nor how the tax laws will even apply by that time.
In my opinion, since there's basically no penalty to convert besides having to pay the taxes now, the best time to convert to a Roth is when you know you'll be taxed in a lower tax bracket and it won't put you over the top into another. If you're in a high one already, you may want to give it some time, as you'll have the possibility of getting into a lower bracket in the future (or due to tax law changes).
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Wed Apr 26, 2006 10:59 pm |
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efflandt
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You CANNOT convert if your adjusted AGI is over $100k. Go to http://www.irs.gov/publications/p590/ch01.html#d0e4612 and read down from:
quote:
Converting From Any Traditional IRA Into a Roth IRA
You can convert amounts from a traditional IRA into a Roth IRA if, for the tax year you make the withdrawal from the traditional IRA, both of the following requirements are met.
Your modified AGI for Roth IRA purposes (explained in chapter 2) is not more than $100,000.
You are not a married individual filing a separate return.
Some people convert it after they retire, when income, or hopefully at least tax, may be lower. You can do that as long as it is not part of required distributions after age 70.5. You cannot withdraw a converted amount or its gain for 5 yrs after conversion.
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Wed Apr 26, 2006 11:52 pm |
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coaster
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Thanks for bringing that to our attention. I guess I need to read my references more closely.
But I've never had an AGI over $100K 
~Tim~
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Thu Apr 27, 2006 12:02 am |
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peted
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quote:
Originally posted by efflandt
You CANNOT convert if your adjusted AGI is over $100k. Go to http://www.irs.gov/publications/p590/ch01.html#d0e4612 and read down from:
quote:
Converting From Any Traditional IRA Into a Roth IRA
You can convert amounts from a traditional IRA into a Roth IRA if, for the tax year you make the withdrawal from the traditional IRA, both of the following requirements are met.
Your modified AGI for Roth IRA purposes (explained in chapter 2) is not more than $100,000.
You are not a married individual filing a separate return.
Yes...thanks for the clarification. So if I want to take advantage of the Roth benefits, it makes sense to open a new one and contribute what I can (based on AGI) rather than continue my contribution to the traditional.
Some people convert it after they retire, when income, or hopefully at least tax, may be lower. You can do that as long as it is not part of required distributions after age 70.5. You cannot withdraw a converted amount or its gain for 5 yrs after conversion.
pete
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Thu Apr 27, 2006 5:33 pm |
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Rolo
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quote:
Some people convert it after they retire, when income, or hopefully at least tax, may be lower.
All that does is pay ALL of your tax up-front on the entire balance rather than a little at a time annually.....or am I missing something?
"Expect me when you see me."
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Thu Apr 27, 2006 11:39 pm |
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MattL
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I would probably leave the traditional IRA as is and open a new ROTH IRA and put future money there.
$$$ Debt Elimination
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Fri Apr 28, 2006 4:24 pm |
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efflandt
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Rolo, the reason some people may convert to Roth after (early) retirement is because distributions are "never" required from a Roth IRA. And beneficiaries can get that money tax free.
Regular IRA or 401k has to begin required periodic distribution by age 70.5 and that money is taxed at time of distribution http://www.irs.gov/publications/p590/ch01.html#d0e5444
But what if you retire at age 60 and live into your 90's or over 100? Wouldn't it be nice to have some money still earning tax free gains after all your tax deferred money has all been distributed and taxed? Inflation is not going to halt when you retire, so you may need more later than sooner, if you live longer than expected or start incurring medical bills.
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Sat Apr 29, 2006 12:19 am |
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bong12187
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quote:
Originally posted by Rolo
quote:
Some people convert it after they retire, when income, or hopefully at least tax, may be lower.
All that does is pay ALL of your tax up-front on the entire balance rather than a little at a time annually.....or am I missing something?
Lets see... automatically, you will get hit with 10% penalty. You will then get taxed for the other 27k. Since you are in the high bracket, they automatically tax your for at 36%. This means that you will have to pay a little under 10k. This will leave you about 17,280 for ROTH. Now for comparison, if you were to leave 17,280 at a ROTH fund and it earns you 10% per year and for example purposes you are 30, at age 60, you will have $301,526 (tax free). If you keep the 30k in traditional and all variables are the same, you will have $523,582. There will be no penalty on the traditional IRA withdrawal, but it is still subject to tax.
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Fri May 05, 2006 3:42 am |
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efflandt
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There is no 10% penalty for converting IRA assets to Roth IRA, as long as you do a direct trustee to trustee transfer and specifically tell them not to withhold tax (use taxable money to pay the tax). If tax is withheld from the conversion you could owe tax and penalty on that.
For example for every $10k I convert to the Roth, I pay $2500 out of pocket (adjusted W-4). Suppose that $10k quadruples (gains) to $40k. There is no futher tax liability on that $40k.
If that remained in a regular IRA and same tax bracket in retirement (due to 401k), $10k of that $40k would be taxed, so I would only end up with $30k net. Or if drawn as a lump sum for a car or medical bills, it might bump to a higher tax bracket (less net).
Since contributions are limited, this allows to convert the same amount of money from tax deferred to tax free gain, if you are willing to pay a little tax now instead of likely more later.
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Sat May 06, 2006 4:56 am |
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bong12187
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quote:
Originally posted by efflandt
There is no 10% penalty for converting IRA assets to Roth IRA, as long as you do a direct trustee to trustee transfer and specifically tell them not to withhold tax (use taxable money to pay the tax). If tax is withheld from the conversion you could owe tax and penalty on that.
For example for every $10k I convert to the Roth, I pay $2500 out of pocket (adjusted W-4). Suppose that $10k quadruples (gains) to $40k. There is no futher tax liability on that $40k.
If that remained in a regular IRA and same tax bracket in retirement (due to 401k), $10k of that $40k would be taxed, so I would only end up with $30k net. Or if drawn as a lump sum for a car or medical bills, it might bump to a higher tax bracket (less net).
Since contributions are limited, this allows to convert the same amount of money from tax deferred to tax free gain, if you are willing to pay a little tax now instead of likely more later.
This is true... And for 30k in the account, you might be able to do that with a drawdown of 10k per year. This is true dor the scenario presented at the beginning of this post. However, for those who have hundreds of thousands (or even millions) in the traditional IRA, it would be hard press for anyone to do that. However, if it can be done, then the compounding interest will definitely be to your benefits...
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Sat May 06, 2006 9:10 pm |
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