Roth Conversion
Client is 65 and has $403 in IRA. $63k is after tax contributions.Client considering converting entire amount in 2012 and paying taxes from other sources.Client will always be in maximum bracket during retirement.Wants to do conversion in 2012 so money can start growing tax sheltered. With marekt uncertainty and having excess cash now would rather pay now vs. later at a higher bracket.
What are the pro/cons of doing this?
Permalink Submitted by mk foss on Thu, 2012-12-13 17:45
The obvious pro of this strategy is that the client will have no RMDs from the Roth instead of annual payments from the traditional IRA.The downside of any conversion is paying the tax in advance. If tax rates rise as expected, paying the tax with the 2012 return may be the best idea ever. If we switch to a flat tax or VAT, prepaying income tax will not help.
Permalink Submitted by William Hammond on Thu, 2012-12-13 20:42
Makes perfect sense. I think the probablility of a flat tax is nil based on what is happening in Washington.My bigger concern is what happens if the marekt takes a dive.However, client can always do a recharacterization if the value of the portfolio dropped substantially. My original numbers assumed addittional income of $340K in 2012. If the portfolio dropped to $300 in value( a 25% decrease) say in November 2013 he recharacterize it 2013. In January 2014 he could do another conversion and only have to pay tax on $240K. ($300 lower value less $60K in basis). Note he would probably be paying at a 39.5% bracket vs. the 2012 barcket of 35%.In summary if the portfolio drops by $100K the he would save $23,960 which is the difference between $119K ( 2012 taxable gain of $340 X35%=$119k and $95,040 (2013 taxable gain of $240K X assumed higher bracket of 39.6%)state tax would be need to be added for total tax paid.Do you see any probelms with this thought process?
Permalink Submitted by John Jones on Fri, 2012-12-14 17:17
If he is in the maximum tax bracket he has income over $388k. I would posit that the tax rate change is not that material (5% on 400k is $20k) – that the risk of investment loss should be the deciding factor. If it were me, I would not convert all or none, I would do a partial conversion this year and a partial or remaining conversion next year. If he did half this year, half the next, the incremental tax is $10k but he greatly reduces the risk of adverse timing on investments. Maybe even over three years. I defer to others on recharacterization options, but they remain no doubt. Doing it over a few years adds flexibility.
Permalink Submitted by Alan - IRA critic on Thu, 2012-12-13 23:53
The recharacterization deadline is 10/15 of the following year, so November is too late, but the idea is correct. The reconversion waiting time is 30 days after recharacterization if the original conversion was in the prior year. If the original conversion was done in the current year, the waiting period is the longer of 30 days or Jan 1 of the following year. This is particulary useful since Congress may be doing retroactive rate changes next year, but not after Sept.Recharacterization can be partial or total, allowing the remaining amount to stop before spilling over to the next higher marginal rate. Therefore, there is a high degree of flexibility. The main goal remains the same, to convert only when you can do so at a lower rate than you expect in retirement, or is some cases at the same rate. Makes no sense to convert at a higher rate, but of course you are just guessing at your rate in retirement. That rate probably has more to do with your success in asset accumulation including your IRA, such things as avoiding major health issues, job loss or divorce than it does with tax legislation.