IRA Conversion Help
My wife left her job (age 35), and we want to roll/move her pension into a IRA. Her current amount is $43000.00 I know that if we “roll” it over to a Traditional IRA, that there are no taxes on it, if we get a check mailed to her and put it into a Roth IRA, than we will get a 20% federal tax on it roughly $6800.00. My question is, are we better off rolling it over into a Traditional IRA, or taking the 20% hit and put it into a Roth IRA. We are not sure which one would the most beneficial for us in the long run.
My understanding is that if she rolls over her pension into a Roth IRA, then the taxable amount will be considered income, and it could bump is up a tax bracket and have to pay hefty taxes on it.
Thanks for any help or info you can give us!
Permalink Submitted by Alan Spross on Wed, 2012-06-20 21:15
If both the 43,000 pension and your wife’s existing traditional IRAs are fully pre tax, then you should do a direct rollover into a rollover TIRA account. That will avoid withholding and taxes. From there you can determine whether she should convert to a Roth IRA given a total analysis of the various factors. Even if conversion is beneficial, she would likely convert partially over a period of years. For example, she might convert only enough to avoid inflating your joint tax bracket to keep the cost of the conversion down.
If you are sure that a full conversion is beneficial, then she can request a direct rollover to a Roth IRA. This will also avoid 20% withholding but of course will generate a tax bill that you would have to address by increasing other withholding or pay quarterly estimates. She does not have to receive a check to get the funds rolled to a Roth IRA.
If she has non deductible contribuitions in her IRA already OR if the pension includes any after tax contributions, then different approaches are necessary if you want to separate the basis between TIRA and Roth IRA accounts. Please advise if these after tax amounts exist and the approximate %.
Permalink Submitted by Danny White on Wed, 2012-06-20 21:30
What if she had the check mailed to her with her old company withholding the 20% then putting the remainder in a ROTH IRA? Is the full $43000.00 considered income, or only the amount they withheld?
Thanks
Permalink Submitted by Alan Spross on Wed, 2012-06-20 23:33
The 20% would be 8,600 (not 6,800). The entire 43k would be taxable income and to eliminate the tax bill and the 10% penalty on the tax bill, she will have to come up with the 8,600 difference to complete the rollover.
1) If the entire 43k is deposited into a TIRA within 60 days, there will be no tax or penalty. However, the 8,600 will not be recovered until you file your return.
2) If the 43k is rolled to a Roth IRA instead, the entire amount will be taxable, but no penalty. In this case, the 8,600 will serve as a deposit against your total tax liability. In other words, 20% has been paid and your actual tax rate could be more or less than 20%. The 20% just serves as a deposit.
3) If the net received (34,400) is rolled to a Roth IRA without replacing the 8,600, then the taxable income will be 43k (34,400 plus 8,600) and the penalty will only apply to the 8,600.
She can also split the rollovers between TIRA and Roth, eg 21,500 each. If the 8,600 is made up then only 21.500 will be taxable, there will be no penalty and the 8,600 will be recovered when you file.
Another summary of the above:
1) The 10% penalty would only apply to the amount NOT rolled over, whether you keep it or the IRS received it as withholding
2) The taxable amount would be the total 43,000 less any amount rolled to a TIRA.
This is why direct rollovers are recommended. Direct rollovers eliminate any withholding.
Permalink Submitted by Mat Ericsson on Tue, 2012-06-26 00:23
In my tax bracket, I am not allowed to contribute directly in to a Roth IRA. Someone gave me an idea a year ago that I can put $5k into a nondeductable traditional IRA and then immediately convert it to a Roth IRA each year. Can I still do that? When I do my taxes next year, I would just declare no capital gains and therefore no taxes from the conversion, is that correct? Is there a minimum amount of time I need to leave it in the nondeductable traditional IRA? Thanks.
Permalink Submitted by Alan Spross on Tue, 2012-06-26 00:33
You can still do this with no minimum time between the contribution and the conversion. The longer you wait the more likely that the value will drop below your 5,000 basis or that earnings will accrue that will be taxable when you convert.
Of course, the largest pitfall here is that this only works effectively if you have no other balance in a traditional IRA, SEP or SIMPLE IRA. Other pre tax balance will result in the conversion being taxable on a pro rated basis. This is all calculated on Form 8606, which is the on which you report the non deductible TIRA contribution AND the conversion.
Example: You have a TIRA worth 15,000 and no basis from non deductible contributions. You then make your first non deductible contribution and your IRA is now worth 20,000. Any amount you choose to convert will be 75% taxable. If you convert 5,000, then 3,750 would be taxable.