Want to get it right this time: ROTH conversions while starting Soc Sec

Submitted by Ron Smith on Sat, 2014-10-11 19:50

My original plan of working past 70 this year and retiring in Feb 2015 had to be jettisoned due to family health issues. A June 2014 retirement forced a quick visit to the Soc Sec Office and an ill-informed decision to take Soc Sec retro to my 69th BD. (That means a full year of Soc Sec w/ a June retirement.)

Only later did projected 2014 tax returns reveal the potential tax impact that ROTH conversions have on a full year of (85% taxable) SS!

The original SS application (retro to 69th BD) has been withdrawn and the payments have stopped. Soc Sec is set to begin after my 70th BD this year shortly after I pay the $20+K owed to SS.

Pretax funds are available both to pay SS and for an additional ROTH conversion while still being under the 25% threshold. Some ROTH funds will be needed to cover the taxes.

With a mandatory 20% tax withholding, how can I apply after-tax funds (ROTH & $) to pay the taxes?

Thank you!



Submitted by Alan - IRA critic on Sat, 2014-10-11 22:59

There is no mandatory 20% withholding for IRA distributions. The default is 10%, but you can request that withholding not be applied at all. Remember that even though a Roth conversion might spike your tax on SS income for that one year, it will reduce your TIRA balance and possibly save you taxes for many years thereafter. It all depends on where your MAGI falls each year. Also remember that if you reached 70.5 at any point in 2014, you must take your RMD before converting, and then convert additional amounts. Of course, when all the numbers are in, if you do not like them, you can always recharacterize all or part of your conversion. Another factor here is what your 1099 SSA will show for 2014, whether your repayment will be credited before January. Not sure this answers your entire question, which could have many variables.

Submitted by Ron Smith on Sun, 2014-10-12 13:46

TY, Alan, for responding so quickly.I should have been more specific: the pre-tax funds I mentioned are related to my former employment (457 & 401K accts).  (I will check this via call on Monday, but) apparently a 20% mandatory w/h requirement is in place for withdrawals from a 457 & 401K.  Does it matter whether SS is paid from the 457 or the 401K account?IF 20% of a 457/401K withdrawal is w/h, would it work to have a ROTH withdrawal to cover the taxes and to complete the funding of the repayment to SS?  That make leave room for a small ROTH conversion this year while keeping Taxable Income under the 15% max of $73,800.The plan is to repay SS in the next 30 days.  It is my understanding that since my 70th BD occurs later this year that no distribution is required until April 2016.  The plan is to take a distribution by Dec 2015 to avoid two distributions in 2016.I am trying to calculate the present year and future years impact of the decision to receive SS for only a couple months this year rather than going retro, to use pre-tax funds to meet expenses, and to possibly make a ROTH conversion this year.  New to the board, I have not read enough posts to learn the trust and sharing level.  In some situations is it permissible to use “plug” numbers to illustate such impacts?  If so, I may want to share the findings to have a 2nd set of eyes on the calcuations.Thank you, Alan! PS: is there a way to setup paragraphs?  The preview does not show them.

Submitted by Alan - IRA critic on Sun, 2014-10-12 21:27

  • Yes, a 20% mandatory withholding on the pre tax portion of your employer plan distributions applies unless the distributions are RMDs. Your first RMD year for those plans is 2015, so if you wait until 2015 to take the distributions, there is no 20% withholding up to the amount of the RMD. However, you need the money for the SS repayment very soon, so the 20% withholding will apply, and the pre RMD distribution will eat up some of the room for you to do Roth conversions in the 15% tax bracket.
  • ((NOTE: I do not know how to get paragraph space either – I use these bullet points for paragraphs)).  Your understanding about your RMD years is correct. 2015 is your first distribution year, but that RMD can be deferred as late as 4/1/2016. Too bad you cannot wait until January to repay SS and just use RMD distributions that you must take anyway. It does not matter how you pay SS, but if you use other post tax savings or a Roth distribution, you will not have to pay taxes on distributions of pre tax retirement funds. Your Roth distributions are probably tax free, and definitely tax free if your first Roth contribution was prior to 2010.
  • Withdrawing from your Roth to save bracket space would only have a small net benefit because it would avoid the 20% withholding you would have if you withdrew from the 401k. The withholding would force you to take a larger distribution to generate the amount of cash needed. Without the withholding factor it would be an equal offset of taxable income and your remaining Roth balance.
  • You can post theoretical numbers to illustrate a question if you wish.
  • Since you have max DRCs from delaying SS to 70, along with your RMDs from both plans, you may well end up with 85% of your SS taxable in the future as there is no inflation adjustment on the SS AGI thresholds. You could test this out using the latest year tax software you have, or google taxcaster (intuit on line tax program) which is useful for entering basic scenarios. That program is still for 2013, but will probably be changed over to 2014 in another couple weeks.

Submitted by Ron Smith on Tue, 2014-10-14 16:29

  1. TY, Allan (1st for the bullet/paragraph clue)  
  2. It is so easy to get my eye off the ball especially while moving from having a paycheck and thinking I was becoming “educated” about the “Retirement Savings Time Bomb” (read a decade or so ago) to the point at I am retired and the numbers become REAL – and emotional – “have I saved enough?” & “how do I do this right?”.  
  3. TY for verifying (1st bullet) that since any 2014 pre-tax distribution would NOT be an RMD, then the 20% mandatory tax would apply.  Yes (to last bullet) 85% of our SS will be taxable going foward, so the key is minimizing the tax that will be driven by RMD per this article Forbes article “Use a ROTH Conversion to Reduce Future Tax Bills”  More about that later.
  4. THEORETICAL NUMBERS #1 – MAX PRE-TAX REDUCTION: We have $175 in pre-tax 457/401k funds, along with some 403b funds available as a housing allowance from ministry for 25 years.  
  5. Do the 457/401k funds need to be reduced as much as possible this year while staying under the 15% tax bracket?  Would a reasonable goal be to reduce the basis of RMD as well as the tax rate on Soc Sec (that will be 85% taxable) going forward?
  6. If so, what is the best way to repay the $25K is due Soc Sec for pymts received retro to 69th BD due to withdrawal of Soc Sec application?
  7. With a mandatory 20% tax, on a non-RMD, would the best alternative be to w/d $25K ($20K after taxes) and use $5K from a ROTH to pay Soc Sec, rather than w/d $31,2K to net the full Soc Sec pymt?  
  8. Would it be more important to reduce the pre-tax fund “just” by $25, leaving more room for a ROTH conversion under the $73,800 threshold for the 15% bracket?
  9. Thank you, Allan, for your help understanding the process and the options, as well as for your patience with the long post.

Submitted by Alan - IRA critic on Tue, 2014-10-14 18:20

  • 5. Yes, you should use up your 15% bracket space in full if you expect to spill into the 25% bracket if most future years. Even if you will need the funds fairly soon, it is beneficial to convert to a Roth up to the 15% bracket max, since if you need to take a Roth distribution shortly thereafter, it will be tax and penalty free. Reduction of future RMDs may or may not be enough to prevent 85% of SS benefits from being included in AGI. That depends on your total AGI and how much is in excess of the point where SS becomes all taxed at 85%.
  • 6. If you do not have other funds to repay SS, it sounds like you will need to take a distribution from your pre tax plans. Of course, that will use up your space to convert to Roth this year, but it will reduce future RMDs and your SS benefits will be higher for life. I suppose if you could get a short term loan, that might be another option to repay SS and free up 25k more room to convert. Your RMD for 2015 might then be applied to the loan.
  • 7. Doing this will reduce the amount lost to tax withholding which will also be taxable itself. To the extent you take more from the Roth may free up space to convert back to the Roth, so that part cancels out, but your withholding will be reduced if you take more from the Roth. Don’t know if that means you would owe more in April or just get a smaller refund.
  • 8. As indicated above, if you reduce your income by taking a Roth distribution, you will have more room to convert. But you can get 5k out of your Roth for every 4k from the pre tax source due to the 20%. Since your tax liability is targeted to be the same if you have more room to convert this year by having withdrawn from the Roth, the difference will be that you will have less money paid in for 2014 to offset your 2014 tax liability. While that difference will be reconciled in April, you should also have more cash flow next year to pay those taxes since you will be receiving SS the entire year and you will have RMDs from the pre tax accounts. Then next year you will also have a similar drill in determining how much of your 2015 RMD to take in 2015 and how much to defer to early 2016. Starting in 2016, these variables are eliminated and planning is much reduced.

 

Submitted by George Chryssanthou on Mon, 2016-12-12 17:29

Do I have to withdraw it?What is the risk of leaving it to the employer to manage it? The employer was Chase and they handle it.

Submitted by Alan - IRA critic on Mon, 2016-12-12 17:46

If you have been retired for most of this year and you reach 70.5 this year, it will typically be better to have your RMD paid out this year even though you could defer it up to 4/1/2017.  The plan should have notified you by now about how they plan to handle your RMD distribution. You do NOT have to roll your 401k over to an IRA, but if you do then the RMD for 2016 must be paid out to you and cannot be included in the IRA rollover. Note that the employer MUST address your RMDs but as far as managing your actual investments in the plan, that may be an option for you. They are not going to manage it for nothing unless they specifically have a plan to do that for ex employees. You should find out what the cost is if there is one.

Submitted by George Chryssanthou on Mon, 2016-12-12 18:00

Can I roll it over to a Roth IRA, and do I pay any taxes or they are paid by my employer/mine when I was employed?

Submitted by Alan - IRA critic on Mon, 2016-12-12 18:06

Unless the balance is small, doing a rollover to a Roth IRA of a large amount is probably not wise since it would be taxable. Usually, a 401k balance is all pre tax, but you might have made after tax contributions at some point. If you find that your plan holds after tax contributions (should show on your statement), you can split a rollover into two parts with the pre tax amount going to a TIRA and the after tax amount to your Roth IRA. There would be no taxes due for that. Does your plan hold much in actual Chase stock shares or a Chase stock fund?

Add new comment

Log in or register to post comments