With the market down for the time being, was contemplating converting about 20% of my ira. This year may be the best year for me to do it since my taxable income for 2016 will be modest due to muni bond income, and may be the last year for that. Their first call date on the bonds is 6/1/2016 and if they are called, likely will not find anything near what they have been paying me, 4.25%-4.75% so will likely buy bonds or bond funds paying much less. My fa and cpa looking at it, but wanted to know if others were thinking about it too.
Comments
"...a special rule allows Roth recharacterizations to occur on a standalone basis, as long as the conversion is placed in a separate account in the first place.
In fact, this "separate account" rule is so favorable, for larger Roth conversions it becomes another proactive planning strategy unto itself - instead of merely converting into a single standalone Roth IRA (separate from existing Roth IRAs), complete the Roth conversion one investment/asset class at a time into a series of separate standalone Roth IRAs (separate from any existing Roth IRA and each other). By doing so, the investor can actually see the outcome of each individual Roth investment, one at a time, keeping the top performer(s) and recharacterizing the rest, with as much as a 21-month time window to see the investment results before being forced to make a final decision! While ultimately the outcome of whether a Roth conversion is a good deal or not is still driven by tax rates, being able to know the investment results, and cherry pick the top performer after the results are in, can go far in turbocharging the value of an already-beneficial Roth conversion!"
splitting-a-roth-conversion-into-multiple-accounts-to-isolate-investments-for-strategic-recharacterization/
Absoutely not.
Comment ...
By my thinking IRA conversions were just a creative way for the government to advance and to increase the tax revenue stream. Now, let's see if Congress at some point down the road will want to tax the capital appreciation along with income generated that usually takes place inside most Roth IRA's while allowing contributions to be withdrawn tax free much like what now happens with most annuity withdrawals held in a taxable account. The principal is usually allowed to grow tax free inside the annuity wrapper until withdrawals start with the contribution amount not getting taxed upon withdrawal but the apprecation does.
Something to think on as most social security bebefits were not taxed years ago but are today for most folks as government has sought out ways to increase tax revenue.
I personally think, in good time, some form of taxation will take place on Roth Iras.
He decided to convert a good bit of his traditional ira account after doing a 401k rollover into it. He did not give good thought to taxation issues when he did the conversion for part of his ira into the roth. When it came time to pay the taxes … well he was short by a good bit as the taxation (state and federal) amounted to a sum equal to about a third of what got converted, needless to say this was no small sum. So to cover the taxation caused by the roth conversion … you guessed it … he hit his traditional ira up again for a distribution that was taxable just to pay the taxes he owed on the roth conversion.
I suggested that he try to unwind it ... but, by the time I learned what had taken place it was too late.
Yes folks, I am talking about an intelligent person when it came to his profession in the engineering field … but, dumb as they come when it came to this. And, if it happened to him I am sure the same has happened to others. If it were me even thinking of doing a conversion I'd be talking to my accountant and/or tax advisor first. For some, it just might not be worth it to convert. I know I came to a conclusion sometime ago when I looked into it and decided I will pay the taxation as I make withdrawals thus letting my principal work being a larger sum to my favor. My thinking was that it was better to keep a high account balance, take the desired withdrawals and paying the taxation over time rather than in bulk that a conversion requires.
Watch what you do.
Thanks for stopping by.
Sometimes smart well educated people do some really dumb things.
Now, what is question #2?
Skeet
But that doesn't mean that you can't use conversions to your advantage. Many years ago, the IRS allowed ten year income averaging of lump sum pension payments. This was to reduce the impact of an "artificial" bump into a higher tax bracket. Prudently used, as BobC suggests, the Roth conversion can achieve a similar savings. By converting in years when your marginal tax rate is lower, you can increase the net amount (after taxes) that you get out of your traditional IRA. This is especially important for people who would otherwise take just RMD amounts and gradually wind up in higher tax brackets somewhat involuntarily.
One change that IMHO was made strictly to benefit higher earners and not generate new taxes (rather the opposite) was the creation of the backdoor Roth. The income limit on conversions could easily have been removed without creating this backdoor by prohibiting the conversion of post-tax money. Allowing conversion of post-tax money generates no immediate tax revenue and eliminates the possibility of future taxation of the earnings on those contributions. I do not foresee this for at least two reasons:
1) Unlike SS, where the original law did not say that benefits were tax free, tax free earnings of Roths is their entire raison d'être. Taxation of Roths (unlike SS) is not a condition subject to interpretation or modification.
2) Pragmatically, many people (myself included) are not required to keep any records regarding Roth earnings. If you don't make nondeductible contributions you won't be filing 8606's. Strangely enough, it seems that custodians are not required to generate 5498s (showing end of year balances) for Roth accounts. Congress might want to tax Roth earnings (but see #1), however people don't know what those earnings are.
http://www.marketwatch.com/story/estate-planning-with-a-roth-ira-2015-02-11
A withdrawal from a Roth IRA is tax free at any age. A Roth IRA can serve a dual purpose as a tax free, penalty free emergency fund source prior to age 59.5. I have on occasion utilized the once a year rollover provision where by I have distributed emergency funds from my Roth IRA and then return those funds within 60 days.
As I understand it, you can withdraw initial investment w/o penalty at any time (as with Roths in general), but any gains are subject to a 5-year waiting period. As a precaution, I've always approached these with the idea I wouldn't w/d either principal or earnings for at least 5 years.
Consideration: The IRS tracks the converted amounts by date for purposes of the 5-year restriction, so were you to "co-mingle" two different conversions, it could get a but confusing - though the fund companies have ways of computing withdrawals from these for tax purposes should it be necessary. (I've read that a "first-in/first-out" method is used when they compute such "co-mingled" withdrawals). Again, for simplicity, I prefer not to mix the different conversions. Our '09 conversion amounts are kept together (at 3 different houses) and completely separate from the newer one at a 4th house. I'd be loath to mix the two converted sums until the second has met the 5-year provision.
One recent IRS change that may argue against such later life conversions is the provision Junkster & others have posted allowing you to shield from taxes up to 25% of your Traditional IRA amount after age 70.5 if you invest it into a deferred annuity. Since the amount allowed (25%) depends on your total in the Traditional IRA at the time, a Roth conversion may reduce this allowable amount for some investors. The latest Kipplinger's has a good article on this new provision should you want to Google it.
My gut feeling (unrelated to the above details) is that a 10-20% pullback in any asset class would not be enough to compel me to do a conversion. A 50% pullback would be more compelling - and that was the case in both our '09 & '15 conversions.
First let me repeat something I've oft said before - you, not the fund companies, are responsible for nearly all tax tracking. Even with the new laws that require the funds to report your capital gains directly to the IRS, those laws require the funds to sometimes report incorrect numbers (such as for wash sales across accounts, even at the same brokerage). So it really is your job to track and file correctly.
If your distribution is qualified (5 years since you opened your first Roth, and you're over 59.5, dead, or disabled), then all Roth moneys are qualified. If you opened one Roth a decade ago, and just opened another Roth at a different broker, that second broker isn't going to know that your Roth is qualified - that's up to you.
For nonqualified distributions, the ordering rules are:
1) Group all the Roth IRAs together into one pile (sum all distributions regardless of which Roth they came from; group all regular contributions in all Roths together; group all conversions together - but remember their dates - regardless of which Roth they're in). So keeping your conversions in separate accounts may help you remember the dates of those conversions, but you'll still need to know how much in each of those accounts represents the conversion amount as opposed to earnings.
2) Regular contributions come out first (not taxable)
3) Conversion amounts (could be subject to 10% tax if under age 59.5 and converted less than five years ago - but oldest conversions come out first)
4) Earnings (I don't even want to go here, though the funds' bookkeeping could be of some help with this, as could segregating conversions)
The key point with respect to Hank's post is that keeping the accounts isn't a complete solution - you still need to keep track of dates and amounts of conversions.
Regarding QLACs - what is new is that this allows you to defer taking withdrawals (annuity payments) until age 85 on part of your traditional IRA, as if the QLAC weren't even in the IRA. Thus your RMDs from age 70.5 to age 85 are reduced. But those annuity payments starting at age 85 (or whatever age you pick) are still counted as taxable withdrawals, and could push you into higher tax brackets in your extra-golden years. In other words, this allows you to defer withdrawals another decade or so, but it doesn't exempt the money from taxes when (and if) it is ultimately paid out.
QLACs don't give you a way to avoid taxes (unless you die early), so I'm not sure they are a reason to avoid Roth conversions. The Roth conversions give you a lot of control over how much income you have in different years (you can smooth out your income and thus pay taxes in lower brackets). QLACs pile it all up in later years.
Since your RMDs from 70.5 to 85 are reduced with a QLAC, you might be able to withdraw more than your RMDs from your TIRAs without moving into a higher bracket. You could even convert that excess to Roths. And we're back where we started (except that you have a guaranteed stream of income if you live a long life, which I think is a good thing.)
From the above link: "Unlike the 5-year rule for contributions, in the case of conversions, each conversion amount has its own 5-year time period (Treasury Regulation 1.408A-6, Q&A-5(c)), and thus with multiple conversions there may be multiple different 5-year periods underway at once. When withdrawals occur from conversion amounts, they are deemed to be withdrawal on a first-in, first-out basis under IRC Section 408A(d)(4)(B)(ii)(II), which effectively means the oldest conversions (most likely to have finished their 5-year requirement) are withdrawn first, and the most recent conversions are withdrawn last. (Overall, the ordering rules from Roth IRAs stipulate that withdrawals are after-tax contributions first, conversions second, and earnings third.)"
I would always agree with you that investors need to maintain accurate records. And I won't dispute your point that the burden falls 100% on the individual. I use a really good App for tracking/managing all this stuff & back it up to a second device as well as to Apple's Cloud. This should be fine as long as "the lights don't go out" on these storage methods. If they did ... I do believe we've retained paper records, but sorting through them would be much more difficult.
On the QLAC point ... no argument there. You can "shield" a portion of your IRA assets and earnings longer from the RMD requirement (and therefore taxes) using a QLAC, but can never escape taxes completely, except by dying (a somewhat extreme measure). As converting entails paying taxes up-front, it's a balancing act as to when you'd rather pay the taxes.
Simplest case where the broker can't help: you make normal contributions at one broker (say $20K over several years). You do a Roth conversion at a second broker, say $10K in 2013. Now you withdraw $10K from that second account.
No penalties, since the ordering rules say that the $10K came out of the normal contributions, which are never taxable (or subject to penalty). The second broker doesn't know this, it only knows about the conversion account.
Another case, this one just using conversions: convert $10K at one broker in 2009, and convert $10K at a second broker in 2013. Now you withdraw $10K from the Roth at the second broker.
The grouping rule (that you quoted: group all conversions together, then order by date) says that regardless of which Roth account you take that $10K from, it will be regarded as coming from the 2009 conversion (and thus be tax-free, since it is past the 5 year requirement).
The second broker doesn't know that. It thinks your withdrawal is subject to penalties (you converted less than five years ago).
I think what you're doing with record keeping is great. I long ago stopped holding physical papers (and spent a long, long time scanning in documents). But I do need to do something about offsite storage. I'm thinking about dropping a USB drive into my safe deposit box (and checking that USB drive memory every year or so).
I know, I know, safe deposit box. How quaint. But at least I won't be worried about hackers.
I plan to continue with my traditional ira and take my distributions in amounts and at a measured pace somewhat inline with the income generated and the capital appreciation received on my principal until I turn 70.5 and then start rmds. Rmds are just the minimum, you can take more if you wish. And, if the distribution money is not needed for wellfare then it can then be invested in my taxable account, which I am doing with a good part of it.
I saw little reason that justified or would encourage me to do the roth conversion. It seemed, to me, that it was a creative way for government to advance and increase tax receipts.
You'll pay no additional taxes now, since it is the withdrawal that's getting taxed, regardless of where the money winds up (taxable account or Roth). But by putting that money into a Roth, the earnings will not get taxed later (unlike earnings in a taxable account).
http://www.schwab.com/public/schwab/resource_center/expert_insight/ask_carrie/retirement/can_you_contribute_to_an_ira_if_you_dont_have_a_job.html
You don't need earned income to do Roth conversions.
The point to remember is only convert a Roth account that has outperformed during the conversion period which is typically 16 months, but can be as much as 22 months (Jan (of year account was created) - Oct (extension on tax deadline of year taxes are due).
I would have no problem paying taxes for a Roth conversion that has outperformed (tax free gains) during the conversion period equal to or greater than my tax rate.
that you were currently taking distributions from your traditional IRA ("I plan to continue with my traditional ira and take my distributions"),
that these are not RMDs since you're not yet 70.5 ("until I turn 70.5 and then start rmds"), and
that you don't need to spend all this money (" it can then be invested in my taxable account, which I am doing with a good part of it")
The distribution money that it sounds like you're investing in your taxable account can instead be invested in a Roth IRA (so long as it isn't needed to satisfy RMD requirements). Just call it a conversion. You don't need taxable compensation to contribute money that came from an IRA distribution.
No you read me correctly.
I have my system worked out that I feel is a good fit for me and I plan to follow it. The roth would just create another account for me to manage at age 67. Don't need nor do I want another account.
As for my son, age 29, I have him in a roth ira as this option was not available for me when I first opened my ira account back in the 80's.
Now for some they might favor the conversions ... and, that is fine by me.
To each, their own.
Roth opened in 2000
Made a conversion from IRA to Roth in 2013
Take distribution from Roth in 2016
Is the 2013 conversion subject to the 10% penalty?
I am not sure how to interpret the five year rule, if it is 5 years after the Roth is opened or 5 years after the conversion.
Thanks
https://www.kitces.com/blog/understanding-the-two-5-year-rules-for-roth-ira-contributions-and-conversions/
Derf
Thanks for stopping by.
In short answer, I am thinking that the five year rule is going to apply to both. Here is a link to information that will explain this.
https://www.kitces.com/blog/understanding-the-two-5-year-rules-for-roth-ira-contributions-and-conversions/
So to answer the question of whether the distribution is qualified, conversion dates don't matter; only the initial Roth date matters.
Since you asked about a 10% penalty, we can assume this person isn't over 59.5 (otherwise there would be no penalty, period). In other words, this is an example of a nonqualifed distribution. Dates don't matter if you don't meet the age (or death, disability, etc.) rule.
Now we get to the question I think you had in mind - what taxes apply. As a general rule, any withdrawal that is taxable is subject to the extra 10% tax since this person is under age 59.5.
If you're withdrawing the whole amount, we don't need to use the ordering rules to figure out whether you're withdrawing contributions, conversions, and/or earnings. We just need to know which parts are taxable.
1. Distributions from regular contributions are never taxable (you already paid tax on this money).
2. Distributions from conversions made with pre-tax money are subject to the 10% tax if the conversion was less then five years ago (five year rule for conversions), but not regular tax (you paid that when you converted)
3. Distributions from conversions made with post-tax money (nondeductible contributions to the TIRA that you converted) are never taxable - you already paid taxes on this money when you contributed it to the original TIRA and had you not converted, you could have pulled that money out of the TIRA without penalty.
4. Earnings - as I've written before, this is not something I've delved into. My understanding, such as it is, is that all earnings in a nonqualified distribution (as here) are taxable, and thus also subject to the 10% early withdrawal tax.
Note that earnings on conversions that are withdrawn within five years are still subject to tax even if the owner died. (Death eliminates the 10% penalty, but the five year conversion rule survives death.)