Off Topic – Conversion of TIRA to Roth IRA in 2010
L1: Off Topic – Conversion of TIRA to Roth IRA in 2010
My SEPP will be ending in March of 2010 and I am considering the benefits of converting some of it to a Roth IRA. The income limits for conversion of TIRAs to Roths come off in 2010 but that is not why I would be doing it.
In my case, there has been about a $200k loss of principal from my IRA during the 2008 bear market. I’ve been through other bear markets and my account always recovers the paper losses incurred during the most recent bear market. I assume that it will do so again, although exactly when this will occur is not known.
Be that as it may, I am looking at the profligate spending of the current administration and am thinking that there WILL be a day of reckoning for this behavior. When that day comes, the government will have three and only three choices: it can cut benefits, raise revenues, or both.
My thought is that the deficit spending will be so huge that they will have no choice but to cut spending and increase taxes. If so, then protecting my wealth from future aggressive taxation via a conversion to a Roth IRA could make very good sense.
The question then becomes, how best to achieve that goal. One way would be to pay the taxes I owe on my IRA money now and avoid the likely higher tax rates of tomorrow. Given that I have about $475k in my IRA now, I will need to come up with some sort of conversion scheme that converts some of this TIRA money to Roth IRA money over time. I don’t know the most efficient way to do this, so will turn to a CPA for advice and guidance on this issue.
My thought now is that I could convert X amount per year for the next 5-10 years and then stop converting. That could still leave me with some TIRA money and some Roth IRA money. The trick here is the amounts converted. I am thinking roughly 15% per year or about $72k. That would convert 1/2 of my TIRA to a Roth in about 6-7 years. That may not be fast enough to escape the coming tax increases, however. Any faster will increase my taxable income to the point that I will be in a higher bracket that could eliminate any benefit to this conversion.
I do have about$90k in a taxable account that could be used for paying the tax owedon the TIRA account as it is converted. I kind of hate to give this money up because it is after tax money and serves us as a cash cushion against potential emergencies in the future.
If any of you have been tossing this idea around, please respond with your thoughts on this issue.
2009-10-09 00:47, By: Ed_B, IP: [18.104.22.168]
L2: Off Topic – Conversion of TIRA to Roth IRA in 2010You have considered most of the nuances to this situation. One point that you may not be aware of is the fact that 1/2 of the CONVERSION INCOME from 2010 will be includable as taxable income in 2011 and 1/2 in 2012, with the applicable taxes due 4/15 of the years thereafter.
Doing ROTH CONVERSIONS from 59 1/2 thru 70, combined with deferring SS until age 70 will increase SS by 32%, of which only 85% is taxable, should also be considered in the calculations.2009-10-09 01:16, By: dlzallestaxes, IP: [22.214.171.124]
L3: Off Topic – Conversion of TIRA to Roth IRA in 2010Ed,While there is no crystal ball, there IS plenty of flexibility with Roth conversions because of the unique backward looking recharacterization deadline. This is particularly true with 2010 conversions. The extended due date of 10/17/2011 is the deadline for any combination of the following:1) Recharacterizing all or any part of your 2010 Roth conversions2) Opting out of the 2 year deferral for reporting conversion income. For example, by the extended due date in 2011 you will know if tax rates have gone up in 2011 or not, and have an idea about 2012. You will also know your tax bracket and tax bill for 2010 and almost know it for 2011. You could then decide how much to recharacterize and whether to opt out and report the remaining conversion amount in 2010, avoiding any tax rate increase for 2011 and 2012. If married, a spouse can make a different decision about opting out, allowing one spouse to report in 2010 and the other in 2011 and 2012. That way, the marginal bracket for all 3 years is used. Many people doing incremental conversions each year will opt out of the deferral and just continue going year by year as they did prior to 2010. I prefer the idea of conservatively converting a modest amount at a time, but revisiting the plan every single year. Right now I am converting up to the top of the 15% bracket each year, but expect to still end up at best with only about 30% of total in a Roth IRA. If a VAT tax appears on the horizon, I would stop even sooner, but my guess is that a VAT tax would end up being in lieu of an even higher income tax rate increase, ie marginally helping the pre tax assetsand hurting the Roth assets.As DLZ indicated, I am also collecting a small spousal SS benefit and banking the 8% delayed retirement credits on my own SS record.2009-10-09 20:03, By: Alan S., IP: [126.96.36.199]
L4: Off Topic – Conversion of TIRA to Roth IRA in 2010Alan:There’s no crystal ball? EEK!! This is the time when I need one the most. I can see from your comments that I REALLY need to run this past a good CPA so thata good over-all strategy that includes all of these factors can be formulated.My wife also has a TIRA but has no plans to convert it to a Roth.Your comment concerning a VAT is interesting. Can you explain how a VAT diminishes the value of a Roth vs. a TIRA? Isn’t a VAT essentially a national sales tax such that all money spent is hit by it? If so, then is when that money was taxed as income (early for Roth or later for TIRA) relevant?2009-10-09 22:26, By: Ed_B, IP: [188.8.131.52]
L3: Off Topic – Conversion of TIRA to Roth IRA in 2010Dlz:Thanks for the reply. If a partial conversion of a TIRA to a Roth is done in 2010, do the applicable taxes HAVE to be split over 2011 and 2012 or is that allowed but not mandated? This would seem to be to be a benefit for anyone doing a 1-time conversion. If a stream of partial conversions were done, it might be simpler to pay the taxes due in the tax yearof the conversion… if it is allowed, that is.I have to confess that I am torn between the choices available for SS benefits andtaking IRA distributions. If I delay SS, then I need to take more tax deferred money from my IRA than I would have to do if I took the early benefit. Maximizing the tax deferral seems a reasonable goal but perhaps that is less true at this age than in previous years. Alternatively, delaying the SS until age 70 does result in a larger monthly check but fewer of them when considering that a person’s lifespan is pretty much a fixed but unknown number. As a middle of the road kind of guy, I want to retain as much flexibility as possible. To do that, it seems that taking the early SS benefit and investing it for the 8 years between ages 62 and 70 would be best. If I am in good health at that point, I can always withdraw my application for benefits, return the money, and apply for the higher benefit. If I am not in good health, then I continue to take the lower benefitand keepall of the money received to that point. In either of these cases, I will be living off of the money in my IRA while the SS benefit is saved and invested. I suppose that a 3rd alternative is to take the lower SS benefit, use it for living expenses, delay taking money from my IRA, and give up the possibility of withdrawing my application for the lower benefit and reapplying for the higher one. That maximizes the benefit of tax deferral at the expense of a lower monthly SS benefit.All this is definitely enough to make a person’s head swim. 2009-10-09 22:15, By: Ed_B, IP: [184.108.40.206]
L4: Off Topic – Conversion of TIRA to Roth IRA in 2010Yes, you can either report ALL of your ROTH CONVERSION in 2010, or split the amount. I’m not sure whether you have to elect to split it, or elect not to split it. I’d have to check that aspect.2009-10-09 22:30, By: dlzallestaxes, IP: [220.127.116.11]
L5: Off Topic – Conversion of TIRA to Roth IRA in 2010The default is the two year deferral of 2010 Roth conversions. You have to specifically opt out of the deferral to report the entire conversion in 2010. You must make the same decision for ALL your 2010 conversions, but your spouse can make a different decision on all of their conversions, if any. If one spouse has a higher % of basis in their IRA, that is the one to convert first because more dollars go to the Roth per tax dollar paid. I expect that all these options will result in a beefed up and complex Form 8606 for 2010. There are also provisions the accelerate taxation ofconversion incomeif youdistribute any of the 2010 converted funds prior to 2012.Again, the decision to opt out or not can be made as late as October, 2011, when you know everything about your 2010 return and also about 2011 tax rate increases, if any.With respect to a VAT, you are correct that it would be a form of national sales tax, probably with some exemptions to prevent it from being to regressive. Compared to the current income tax system, a VAT would have these affects on the two IRA types:1) Roth – your Roth would only be income tax free, but distributions would have to be increased to pay for the VAT costs. It makes the Roth only partially tax free – a negative.2) TIRA – two affects here. It also makes everything more expensive meaning that greater TIRA distributions would also need to be taken subject to tax, but since the VAT would probably prevent a larger income tax increase, these two cancel each other out for the TIRA – ie a push. One reason to convert is the expectation of tax increases that would only affect the TIRA. Therefore, while the VAT does affect the TIRA, it also hits the Roth equally, which you don’t expect when you convert. And a VAT is only one possibility, but right now the leading one per most pundits.2009-10-10 01:33, By: Alan S., IP: [18.104.22.168]
L6: Off Topic – Conversion of TIRA to Roth IRA in 2010Alan S. Question. Why would distributions from a TIRA or a Roth IRA be affected by a VAT – assuming the VAT is implemented as a national sales tax?My understanding of a national sales tax is that is would affect purchases, just as state sales tax do. thanks2009-10-10 01:45, By: bobmac, IP: [22.214.171.124]
L7: Off Topic – Conversion of TIRA to Roth IRA in 2010Since a VAT basically results in the price of everything being increased by the amount of the VAT, it means that IRA accounts of all kinds will need to be distributed faster than otherwise to pay these bills.TIRA distributions will be taxed on these extra amounts and Roth IRAs will not be, so if you want to avoid extra income tax, that means that the distributions to pay for the VAT would come from your Roth if you have one. Drawing done your Roth to pay a VAT tax is not a whole lot better than hitting it with an income tax, it just has another name.To take this to an extreme just for illustration purposes, suppose the VAT was large enough to replace the income tax entirely. At that point your Roth would be of no more value than your TIRA, since distributions from each would be treated the same.Therefore, if a small VAT is introduced just to supplement the income tax, perhaps to prevent the income tax from going up more than it otherwise would, we have a situation where the value of the TIRA improves relative to the Roth. The TIRA avoids even higher income taxes, while Roth distributions for spending are higher than they otherwise would be.In summary, with a small VAT, you would convert somewhat less than with no VAT. As the VAT grew larger in relation to the income tax, you would convert less and less, and if the VAT replaced the income tax, there would be no sense to convert anything, and you would not be happy having paid income taxes on the conversions you did in the past that turned out not to have eliminated your tax liability.2009-10-11 02:49, By: Alan S., IP: [126.96.36.199]
L8: Off Topic – Conversion of TIRA to Roth IRA in 2010Alan:That pretty well summed up the possibilities as far as the implication for both Roth and TIRA in various VAT scenarios. If the VAT were to replace the income tax entirely, then keeping everything in the TIRA would be the way to go. Unfortunately, political wrangling will be intense when these ideas are discussed and it will be very difficult to know in advance which pathwill bechosen.One observation that I will add here is that it would be very unusual for politicians to elimanate a tax of any kind, so the possibility of the VAT replacing the income tax seems quite remote. The possibility that they would add a VAT and that it would increase over time seems far more likely. They really do have to do something like this because they have already spent the money. Now they need to figure out how to collect it.2009-10-11 03:22, By: Ed_B, IP: [188.8.131.52]