Roth Conversion Decisions
This is my first post, so please bear with me.
Prior to asking my questions, I will list my retirement accounts:
At Charles Schwab, I have a single person QRP-PSP which is no longer being funded and which has a value of $277K.
At Schwab I have a Roth IRA with a value of $18K.
At Schwab I also have a non-deductible IRA with a value of $64K.
At Vanguard I have a deductible IRA with a value of $130K and,
At Vanguard I have a Rollover IRA with a value of 325K.
My plans are to close down my QRP – Profit Sharing Plan as I do not expect to fund it in the future. I see no benefit to keep it open (unless you do not agree) and by rolling it over to an IRA and combining the $277K with the $64K, I can forget filing my yearly 5500EZ., which I always seem to forget anyhow 😳 Also, I will have one less account.
My next thoughts are with the stock market down, thus the value of my investments in the market, now is a good time to Roth some of my IRA assets. I took off work in 2008 to travel and it looks like I will do the same in 2009 before returning to employment in 2010 (this employment is not related to the QRP-PSP). Consequently, in 2008, I will not have any earned income. I do have some dividend income (money market), I expect (but hope not) some year end dividend and capital distributions from mutual funds and I have harvested some losses from the sales of a few stocks and mutual funds. I do not have a mortgage on my home. I mention all of this because I expect my losses will off-set my gains and that I will have minimal, if any, AGI.
I am single and was reading that I could have income up to $164,550 and still remain in a 28% Federal tax bracket (I reside in Florida where there is no state income tax). I assume that any amount I convert from my Traditional IRA to a Roth IRA will go toward the $164,550. My first question is, since I do not want to convert money in a bracket higher than 28% (unless that is recommended) and to keep the numbers simple, my thought is to convert $164,550 in 2008. The money for the tax on the conversion will not come from the conversion. Is this thinking correct and sound?
My second question is, can I convert all the $64,000 in my Schwab non-deductible IRA account and then $100,550 in my Vanguard deductible IRA ? The reason I ask is because the value of my IRA in Schwab is down a greater percentage than my IRA in Vanguard, so I will pay a bit lower tax (since it is a lower value) than if I converted all my Vanguard funds first (I think…but then it all comes up to $164,550 anyhow so maybe it makes no difference)).
Going forward into 2009 and assuming the recommended path is to Roth $164,550 in 2008, I would have $29,450 more in my IRA to Roth ($130,000 + $64,000 = $194,000 – $164,550 and assuming no change in value). This is where my QRP-PSP comes in and by closing it down rolling the $277,000 into an IRA at Schwab, I will have more IRA assets to Roth in 2009. I have not put much thought toward Rothing my IRA Rollover at Vanguard, other than to keep it ‘pure’ as long as I can for maximum creditor protection.
If you have any questions or need clarification, please ask.
Thank You.
Permalink Submitted by Anovice coatedfabrics on Tue, 2008-09-30 10:29
Is this a site where I can get answers to my IRA questions?
If not, can someone please direct me to one where I may get assistance.
Thank You.
Anovice
Permalink Submitted by Alan Spross on Wed, 2008-10-01 04:49
You may be intending to convert too much in a single year and also too much in total, however, that depends on what you expect your tax bracket to be in retirement. Each dollar converted plus the future earnings removes that much more from your RMD calculation on what remains in your TIRA accounts at age 70.5.
Your tax bracket in retirement depends on your total income including SS, income from taxable investments, part time work, rentals etc. If you expect your marginal rate in retirement to be 28% or more, you may wish to convert perhaps 40% or so of the pre tax funds, keeping in mind that at that point you probably will be reducing your taxable income and marginal bracket by reducing your TIRA values.
Direct rollover of the PSP is a good idea, but you may want to place it in a separate account for unlimited creditor protection, the same reason you want to keep the Vanguard Rollover separate. You may also wish to delay that rollover because it will dilute the portion of your first conversion that is tax free due to the non deductible contributions. In other words, adding 277k of pre tax amounts increases the pre tax total by around 50% or so.
Converting up to the top of your 15% bracket seems to be a no brainer as long as you have taxable account funds to pay the taxes. More aggressively, you could use up the 25% bracket as well, but that will take further analysis to see how much you should proceed into that bracket. Each conversion you do will be have a small portion that is tax free based on your non deductible contributions you should have reported on Form 8606 when you made them. The IRA has a current value of 64k, but that does not matter, only the amount of actual contributions made that were non deductible are used in the formula. The formula is also not affected by which account you convert since all your TIRA accounts are considered to be in one large pool for tax purposes.
You mentioned the market being down, and that opens up the possibility of various aggressive conversion strategies. For example, you could do two conversions that exceed the total you wish to be taxed on, and then recharacterize the lower performing one. Or if you gained enough, recharacterize less since your gains will be potentially tax free. You can also convert more than you wish, and after the year is over and you see your tax bill and any gains or losses in the conversion Roth, you can select the amount you wish to recharacterize since you can also do partial recharacterizations just as you can do partial conversions of an IRA account. This all depends on how much tax complexity you want to incur because recharacterizations often require an extension or amended return.
You should also convert to a new Roth conversion account rather than adding to your current Roth. That makes it obvious what the earnings are if you wish to recharacterize. If you wish to maintain the unlimited BK protection on the Vanguard rollover, also keep any conversions of that IRA in a separate Roth.
As you can see, your situation can easily become highly complex depending on the strategy you apply with the different accounts. But the key is having a plan that can be re visited each year. There is not enough detail here to begin to estimate your tax rate in retirement and even if complete info is available, you would have to take a guess at your future financial success and also at future tax rate changes.
Converting more is a good idea, since you only have 18k now, the question is how much more and how to spread it over more years so you do not get hit too hard with taxes. Key to this is how much you will make when you return to work in 2010.
Permalink Submitted by Anovice coatedfabrics on Wed, 2008-10-01 23:45
First, thank you for your detailed response.
I think I addressed too many issues in my initial post and was not clear on the more important ones. First, I would like to confirm something from your response: to create a plan that “can be re-visited each year.” How’s this for a plan:
1. I will close out and rollover my QRP-PSP to a Traditional IRA and subsequently to a Roth (I gather I need to go from the QRP to a Traditional before a Roth). In both moves, a separate account with be created for unlimited creditor protection (same reason I kept my Rollover IRA separate at Vanguard). However, per your thoughts, I will not rollover my QRP to a Traditional IRA until I Roth both current IRAs ($64k and $130k). That said, I would like to understand the reason for delaying “that rollover because it will dilute the portion of your first conversion that is tax free due to the non deductible contributions. In other words, adding 277k of pre tax amounts increase the pre tax total by around 50% or so” (doesn’t the same hold true for the $325k at Rollover IRA (from a past 401k) or since it is already in IRA form there is no further dilution? Since I do not understand this, would it be possible to share an example? On my form 8606, line 2, the “total basis in traditional IRAs” is $34,433.
Now, to clarify my previous post:
2. I understand it is difficult to project my tax bracket in retirement and hopefully from a QRP/IRA view, this will be a moot point. My expectations are to Roth all my retirement accounts prior to retirement (in fact in the next 2-3 years when I am not working and at or below a 28% tax bracket. I am hoping not to have any RMD). I also understand and agree with you that I don’t want to convert too much in a single year (if you are referring to exceeding x tax bracket). But, I do not know what you mean by converting “too much in total”. I am not looking for aggressive conversion strategies although I appreciate your attention to them. I am looking to simplify what can be “highly complex” and is quite complex for me.
I have made the decision (right or wrong) to convert as much as I can up to the 28% tax bracket in each of the years 2008 and 2009 (possibly 2010 if I do not return to employment that year). Due to additional factors including inheritance and my belief we have seen the last days of ‘low’ income tax brackets, I see these next few years as my last opportunity to Roth my retirement accounts at a tax bracket of 28% or less. I do have taxable account funds to pay the taxes on all conversions. The question is how many conversion dollars will keep me below the 28% tax bracket? Please refer to my original post for the particulars (no income, no deductions, and losses offset gains); the only income I will have is the conversion amounts. The way I read the 2008 federal tax rates and brackets, a single person with income of $32,550 – $78,550 is in the 25% bracket and $78,851 – $164,550 is a 28% bracket.
• Is it correct that the $164,550 is the number that keeps me within the 28% tax bracket?
• So I can Roth the majority of the Vanguard ($130K) and Schwab IRA ($64K) (minus $29,450) in 2008?
• And in 2009, complete the balance ($29,450) and add $135,400 from the Vanguard Rollover IRA (assuming tax laws and brackets don’t change)?
• At that point, close down the QRP and rollover the funds to a TIRA, then a Roth IRA?
• Then I can begin to Roth those monies (separate account) while completing the Roth of the Vanguard IRA monies (also separate account).
Hopefully I have clarified some things, including my objectives, which will make your recommendations a bit more black and white.
Thank You
Anovice
Permalink Submitted by Al Fry on Thu, 2008-10-02 03:48
You should be talking face-to-face with a financial advisor. This forum is for answering general IRA and other investment questions, not for giving specific esoteric advice for individual situations regarding their options and objectives.
Permalink Submitted by Bruce Steiner on Thu, 2008-10-02 22:32
I had the same response as Al in another active thread, also where the amount involved was substantial.
Permalink Submitted by charles lore on Sat, 2008-10-04 02:17
I wanted to clarify the issue of creditor protection for iras. From reading your discussions it seems to me you are under the impression your Rollver IRA offers unlimited creditor protection. Not Necessarily. Funds rolled into an ira from a QRP have full bankruptcy protection true … creditor protection may be a different thing.
For example lets say you are a doctor and I sue you for malpractice BUT DO NOT DRIVE YOU TO BANKRUPTCY. Further you and your rollover ira reside in a state that has weak creditor protection. The fact that iras protect in bankruptcy( fed law) will not help you here. A court may let me get at your ira just as it may let me get your other funds.
Point is CREDITOR protection on IRA’s are a function of STATE law. Not Federal. Florida I would think gives strong protection but check on LISI.. Leimberg’s site. In NY there is good protection and no distinction between rollover iras and contributory ira.
Now a point on your basis confusion Think of cream in coffee rule. Once cream is in coffee they cannot be separated. Once basis is in ira it cannot be separated. All iras are aggregated and any dollar that comes out has a pro rata portion basis.
If I have a 100,000 ira in the aggregate and 30,000 of that is basis… each dollar I pull out is 70 cents ordinary income and 30 cents basis Now I roll an addition 100,000 from a QRP into my ira. Well 30,000/20000 means 85 cents of each dollar is ordinary income and 15 cents basis.. hence dilution.
Permalink Submitted by Alan Spross on Sat, 2008-10-04 03:23
I agree with the prior post on creditor protection.
It should also be noted that none of the various forms of protection apply to spousal creditors in a divorce action OR to the IRS in the event of a levy of an IRA account.
Permalink Submitted by Anovice coatedfabrics on Sat, 2008-10-04 20:58
Now a point on your basis confusion Think of cream in coffee rule. Once cream is in coffee they cannot be separated. Once basis is in ira it cannot be separated. All iras are aggregated and any dollar that comes out has a pro rata portion basis.
If I have a 100,000 ira in the aggregate and 30,000 of that is basis… each dollar I pull out is 70 cents ordinary income and 30 cents basis Now I roll an addition 100,000 from a QRP into my ira. Well 30,000/20000 means 85 cents of each dollar is ordinary income and 15 cents basis.. hence dilution.[/quote]
Thank you for the example as well as your thoughts on creditor protection. My confusion is no longer 😀