Taxes on a Roth Conversion
I have 300,000 in a Rollover IRA. I want to convert it to a Roth. My adjusted gross income this year will only be about 15,000. I was thinking of converting 130,000 of it.
According to Fairmark.com (http://www.fairmark.com/rothira/howmuch.htm)
“Some people worry that if they move into a higher tax bracket, all of their income will be taxed at a higher rate. That’s not the case. Only the part of your income that falls in the higher bracket gets taxed at the higher rate. If you are otherwise in the 15% bracket and have $1,000 of income that’s in the 25% bracket, you’ll pay $250 of tax on that extra $1,000 but still pay lower rates on the rest of your income. For more on this topic, see Your Tax Bracket.”
I just called the IRS. They said if I have 15,000 AGI and I convert 130,000, I will be in the 28 percent tax bracket. According to him, what Fairmark says above is untrue. All the money would be taxed at the same 28% tax bracket.
My question is: Who is correct, Fairmark or the IRS? Second question, Should I only convert appx. $17,000 and stay within the 15% tax bracket?
Permalink Submitted by Alan Spross on Fri, 2008-08-29 23:45
Fairmark is correct, and the IRS probably misunderstood your question to come up with that answer.
First of all, your tax bracket is based on your taxable income, not your AGI. From the numbers, you are apparently single, and could convert around 27,000 and stay totally within the 15% bracket plus your state rate.
However, we do not have nearly enough information in order to make any recommendation. Generally, you should not convert any amount on which you will pay a higher tax rate than your expected marginal tax rate in retirement. But there are many other variables to consider. Also, in most cases, you should not consider converting ALL of your TIRA. Your first dollars of conversions are the best ones because they will usually be at a lower rate and will provide you with flexibility in taking distributions, ie tax diversification. In retirement, in some cases you might tap your TIRA in addition to RMDs and in other cases, you may be better off tapping your Roth.
Permalink Submitted by Joe Williams on Fri, 2008-08-29 23:46
I guess I’m still confused. I thought you fiqure out your AGI first then add the roth conversion income on top of that…no? When you get a chance, any feedback you can give me on the other questions would be a great help too
Permalink Submitted by Joe Williams on Fri, 2008-08-29 23:54
This is to alan-oniras:
I will make 10,000 to 15,000 in capital gains this year. But, I am currently unemployed with no income. I thought it would be a good time to convert at least some of my money. If I convert 27,000 and make 10,000 in capital gains, wouldn’t I go beyond the 15% bracket??
Permalink Submitted by Alan Spross on Sat, 2008-08-30 01:35
You get to deduct your personal exemption and standard or itemized deduction from your AGI to determine your taxable income. For a single person, the standard deduction and exemption is about 9,000. In addition to that, if your capital gains are long term, they have a -0- tax rate for 2008-10 if they are in your 15% or lower bracket. But even if you exceed the top of the 15% bracket, your LT gains are still only taxed at 15%. Therefore, you could probably convert 41,500 as follows:
AGI 51,500 less 9,000 exemption and std deduction = 42,500 taxable.
10,000 at LT rate of 15%, 24,500 at 15% and 8,000 at 10%.
These numbers are rounded, and again are for illustrative purposes. I do not have enough info to be totally sure you should proceed. You also need to determine if the gains or short or long term. If short term, you would convert 10,000 less to keep everything out of the 25% bracket.
Permalink Submitted by [email protected] on Sat, 2008-08-30 05:59
To see for yourself about the tax rate as taxable income increases, do the math – step by step, incremental – and you will see what the rate is for every dollar.
Permalink Submitted by Joe Williams on Sat, 2008-08-30 17:54
Thank you all for taking the time to give me imput. I think the IRS was well aware of what I was saying, but gave me the wrong information. That is not the first time that’s happen to me.
To alan-iras: Thank you for the detailed reply. I guess I don’t totally understand how my taxes are fiqured out. I use turbo tax and it is pretty much fiqured out for you. I do have the money in mutual funds to pay the tax liability, but right now the market is so far down, I’m just hoping it comes back enough for me to not take a lose on my money when I sell to pay the taxes.
I will have some short term gains, but only about $2,000 worth. Most will be long term gains with some dividends. But, being single with no real debt except for a mortage and equity loan, I don’t have many deductions
Anyway, thanks again for your help. I’ll try my best to fiqure out what I might owe based upon the guidance you have given me.