Roth Conversion, whos doing it?

[caligas]

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I'm 40, have a big chunk in an old IRA that needs to be rolled over and can't decide about the conversion. I can afford to pay the tax to convert to Roth but my gut tells me to leave it as as traditional. What if I can live modestly in retirement and be in a lower tax bracket (than the 35% id pay on the conversion)?

 

[ssmallz]

I wouldn't do this. If your do a conversion, the conversion is taxed as ordinary income. Assuming your a full time practicing anesthesiologist, that extra income will get taxed at the top rate ~50% including the state tax. By leaving it as a SEP you're betting that when you take the $$ out you will be taxed at less than 50% which is pretty likely given the graduated tax brakets

 

[proman]

If you do it, do it now before the rates go up. But I wouldn't do it. Take the cash you would have spent on taxes and start doing a backdoor Roth.

 

[Idiopathic]

If you do it, do it now before the rates go up. But I wouldn't do it. Take the cash you would have spent on taxes and start doing a backdoor Roth.

what does this mean

 

[deleted126335]

If you do it, do it now before the rates go up. But I wouldn't do it. Take the cash you would have spent on taxes and start doing a backdoor Roth.

👍

In order to do a backdoor Roth, He might have to convert all of his IRAs, or so I was told when I investigated the backdoor Roth in the past.

Don't think I would do it. Of course the unknown is future tax brackets. France income tax hits 41% at under $200,000. If we wind up looking like that, converting now might be a good move.

I do a partial Roth with a 401K.

 

[Gaseous Clay]

This is a good question and most people will tell you NOT to convert to a Roth. I graduated residency in 2010 and maxed out my 457 during residency. The pension plan during residency gave me another $20,000 or so when I left that I rolled over to a Roth. In total, this was a sizable conversion but less than $100 G's. Every article and message board I've come across, they highly discourage a conversion, especially for the high income earner. Interestingly, my Accountant and our group's financial advisor actually recommended the conversion.

I prefer the Roth because like you, I could afford to pay the tax now. There is no minimum age to start withdrawing from a Roth and a Roth can be passed to all heirs completely tax free. I ended up spreading the tax hit over 2 years (only in 2010). Yes, it's never fun owing thousands to Uncle Sam when most people get refunds, but to me, it was totally worth it.

Certainly you're in a different situation since your IRA is probably much larger and you'd have to cough up the entire tax bill in a few months. Not knowing anything about you, it's basically impossible to try to help answer that question for you.

Check out bogleheads.org. It is a great resource and people are very helpful. You can post your vital information on there (age, tax bracket, investments, debt, etc ...) and people will give you great, professional, and FREE advice without having a motive. I've been reading that message board for about 5 years and am quite comfortable managing my own finances.

Hope that helps some.

 

[Gaseous Clay]

what does this mean

You indirectly fund a Roth IRA by first putting your money in a traditional IRA then you roll it over to a Roth. A tIRA has no income limit whereas a Roth does. So put your $5000 into a tIRA then do an immediate conversion to a Roth. Seems silly you have to jump through that step but I see it as a very small bone the gov't is sending our way.

BTW, did people read about how these multi-billion dollar companies like Google basically pay no tax by setting up their off short accounts? I probably pay more tax than Google (and it was something like $10B profit).

 

[caligas]

I do this back door conversion every year for me and my wife. Its a no brainer because the money is "post tax" anyway so it might as well go into a roth where you can get tax free gains. The harder question is whether to convert un taxed 401k funds.

 

[IlDestriero]

I've contemplated doing this with an old 401k for a couple years. It's time to either do it or not. The problem is that I'm looking at ~50k in taxes. I've got it available, but I'm not completely convinced it would not be better used elsewhere. I should have bought some gold coins while I debated my decision.😀
My advisor thinks it's a good idea, but he just wants more of my money. He was obviously surprised at how little he had when we last talked as I had not shared my portfolio with him, only my goals for the money invested there. He has much of my wife's and he must have assumed the same for me. That has put me off as well. I should get an independent evaluation before it's too late and I pay even more in taxes to do it.

 

[deleted126335]

]This is a good question and most people will tell you NOT to convert to a Roth. I graduated residency in 2010 and maxed out my 457 during residency. The pension plan during residency gave me another $20,000 or so when I left that I rolled over to a Roth. [/B] In total, this was a sizable conversion but less than $100 G's. Every article and message board I've come across, they highly discourage a conversion, especially for the high income earner. Interestingly, my Accountant and our group's financial advisor actually recommended the conversion.

I prefer the Roth because like you, I could afford to pay the tax now. There is no minimum age to start withdrawing from a Roth and a Roth can be passed to all heirs completely tax free. I ended up spreading the tax hit over 2 years (only in 2010). Yes, it's never fun owing thousands to Uncle Sam when most people get refunds, but to me, it was totally worth it.

Certainly you're in a different situation since your IRA is probably much larger and you'd have to cough up the entire tax bill in a few months. Not knowing anything about you, it's basically impossible to try to help answer that question for you.

Check out bogleheads.org. It is a great resource and people are very helpful. You can post your vital information on there (age, tax bracket, investments, debt, etc ...) and people will give you great, professional, and FREE advice without having a motive. I've been reading that message board for about 5 years and am quite comfortable managing my own finances.

Hope that helps some.

The assumption is that the advice on this board is aimed at people in the top tax bracket. Add in the fact that many of live in high tax states and hope to retire to low income tax states (Florida anyone?). If I were finishing residency at the tax rate of a typical resident, I absolutely would convert. If a backdor Roth were available to me now without paying the taxes on a substanial conversion of an existing IRA, it is no brainer to do the Roth.

 

[countingdays]

If you think backdoor Roths will be available in the future, it's probably worth converting your ira to a roth even if your taxes are higher now than they will be in retirement. The tax savings on your future free roth conversions justfies the tax loss on your current ira (unless it's huge or unless backdoor roth's are taken away)

 

[dA pilot]

. If a backdor Roth were available to me now without paying the taxes on a substanial conversion of an existing IRA, it is no brainer to do the Roth.

Some 401k programs allow a rollover of a traditional ira into their 401k plan. If this is available to you, you can rollover your traditional ira into your 401k (no need to pay taxes right now) and then do the back door roth ira. This way you will not have any pre tax ira basis.

 

[deleted126335]

Some 401k programs allow a rollover of a traditional ira into their 401k plan. If this is available to you, you can rollover your traditional ira into your 401k (no need to pay taxes right now) and then do the back door roth ira. This way you will not have any pre tax ira basis.

Thanks for the thought, but the investment options in my 401k are rather disappointing in comparison to my IRA.

 

[pgg]

I'll have a lot less taxable income in 2013 so I may do this next year.

Otherwise I don't really see the point, since every $1 that's converted from a traditional IRA to a Roth IRA is another $1 in earned/taxable income now. I sure don't expect to be in a higher bracket retired than I am now, and rolling over today would incur an immediate tax loss (money that won't be able to compound for the next 25 or 30 years).

Is there something I'm missing? The tIRA --> Roth trick seems to me to be useful mainly to low-bracket earners.

 

[countingdays]

I'll have a lot less taxable income in 2013 so I may do this next year.

Otherwise I don't really see the point, since every $1 that's converted from a traditional IRA to a Roth IRA is another $1 in earned/taxable income now. I sure don't expect to be in a higher bracket retired than I am now, and rolling over today would incur an immediate tax loss (money that won't be able to compound for the next 25 or 30 years).

Is there something I'm missing? The tIRA --> Roth trick seems to me to be useful mainly to low-bracket earners.

Roth conversion is only useful in high bracket earners. <110-130ish single or 170-180ish married can go straight into a roth, no need to do a back door conversion. Or they can use a traditional ira for a tax deduction.
The roth conversion is good above that level because you've already paid taxes on your ira and can't deduct the contribution, so you might as well do a free roth conversion to avoid being taxed again on withdrawal. The advantage isn't so much in the conversion of old iras since, like you said, your taxes may be higher now than in retirement. The advantage is the free conversion of iras in the future.
Rollover to a 401k like dA Pilot said may be the best of both worlds by letting you avoid the tax bill today on converting past iras while allowing you access to backdoor roths in the future, at least until they are taken away by a broke government.

 

[caligas]

One theory is that regardless of individual circumstances tax rates will be super high in the future due to our debt problems and thus the Roth allows you to pay now while rates are relatively lower.

A counter theory is that we could go to a more consumption based tax in the future and rates could go down.

Ultimately my gut tells me not to give money to the government any sooner than necessary.

 

[countingdays]

One theory is that regardless of individual circumstances tax rates will be super high in the future due to our debt problems and thus the Roth allows you to pay now while rates are relatively lower.

A counter theory is that we could go to a more consumption based tax in the future and rates could go down.

Ultimately my gut tells me not to give money to the government any sooner than necessary.

I like having some portion, maybe 20% or so, in a roth ira or roth 401k. Taxes will probably fluctuate and your withdrawals will probably fluctuate in retirement. I like the idea of withdrawing money mostly from a roth when taxes are high and from a tax deferred 401k if/when taxes are lower.

Inheritance taxes are heading up even more than ordinary income, so avoiding that is nice.

True, if we switch to a VAT, then you'll be double taxed. I wish we would switch to a VAT, but it isn't going to happen.

Another advantage to a roth is that you are effectively increasing the maximum contribution allowed per year by 28-35%.

 

[reanimatore]

This is a good question and most people will tell you NOT to convert to a Roth. I graduated residency in 2010 and maxed out my 457 during residency. The pension plan during residency gave me another $20,000 or so when I left that I rolled over to a Roth. In total, this was a sizable conversion but less than $100 G's. Every article and message board I've come across, they highly discourage a conversion, especially for the high income earner. Interestingly, my Accountant and our group's financial advisor actually recommended the conversion.

I prefer the Roth because like you, I could afford to pay the tax now. There is no minimum age to start withdrawing from a Roth and a Roth can be passed to all heirs completely tax free. I ended up spreading the tax hit over 2 years (only in 2010). Yes, it's never fun owing thousands to Uncle Sam when most people get refunds, but to me, it was totally worth it.

Certainly you're in a different situation since your IRA is probably much larger and you'd have to cough up the entire tax bill in a few months. Not knowing anything about you, it's basically impossible to try to help answer that question for you.

Check out bogleheads.org. It is a great resource and people are very helpful. You can post your vital information on there (age, tax bracket, investments, debt, etc ...) and people will give you great, professional, and FREE advice without having a motive. I've been reading that message board for about 5 years and am quite comfortable managing my own finances.

Hope that helps some.

I have recently started more aggressively educating myself on finance management now that I'm actually starting to pull a paycheck (although the more I learn the more I realize that I should have started long ago). The bogleheads forum is great. Another useful source of info is whitecoatinvestor.com, which is a blog written by a physician and geared towards physicians at all stages in their careers.

 

[ssmallz]

Maybe I'm not understanding the math so please correct me if I'm wrong but I'm just not sure how it makes any financial sense for attendings to convert a SEP to a Roth IRA.

Lets say you're an attending pulling in 250k/year, for simplicity lets assume thats after all deductions and accounting shenanigans. Lets say you want to convert 50k from your sep into a roth. Since you didn't pay taxes during the years in which you contributed to your sep, you now get taxed on that contribution as ordinary income which is about 40% so you lose 20k on the conversion. On the plus side though, this money now grows tax free and when you take it out you no longer have to pay taxes.

OTOH, lets say that same physician didn't roll that money over but instead kept it in the SEP. The money still grows tax free and eventually the physican retires. Now he decides to withdraw 50k from the SEP and the withdrawal is taxed as ordinary income but since the physcian is retired, his total income 50k. He's taxed 10% on the first $8700, 15% up to 35k, and 25% up to 50k for a total tax bill of ~$8500.

Since both a roth and sep grow tax free it should be largely irrelevant whether or not the dollars are taxed on the way in or the way out assuming tax equivalent principle deposits are made.

Based on the math you save almost 12k in the example by keeping a SEP vs converting to a roth. The only scenerio I can see where a roth conversion would make sense is if you have a sep from an old job and are currently a resident makeing 50k where it makes sense to add some more income at favorable tax rates as a hedge against increased marginal tax rates in the future. For attendings already being taxed at 40+%, it seems unlikely that the lowest marginal tax rates will increase above that level making it less valuable to "lock in" the current tax rate as a hedge against increasing taxes....but then again if you believe we are headed for socialism and 60% taxes for all, then maybe it's not such a bad idea to lock in those 40% tax rates.

Am I missing something?

 

[Idiopathic]

BTW, did people read about how these multi-billion dollar companies like Google basically pay no tax by setting up their off short accounts? I probably pay more tax than Google (and it was something like $10B profit).

no all i hear about is how terrible the current economic climate is for businesses and how democrats want to tax them to death

 

[caligas]

Maybe I'm not understanding the math so please correct me if I'm wrong but I'm just not sure how it makes any financial sense for attendings to convert a SEP to a Roth IRA.

Lets say you're an attending pulling in 250k/year, for simplicity lets assume thats after all deductions and accounting shenanigans. Lets say you want to convert 50k from your sep into a roth. Since you didn't pay taxes during the years in which you contributed to your sep, you now get taxed on that contribution as ordinary income which is about 40% so you lose 20k on the conversion. On the plus side though, this money now grows tax free and when you take it out you no longer have to pay taxes.

OTOH, lets say that same physician didn't roll that money over but instead kept it in the SEP. The money still grows tax free and eventually the physican retires. Now he decides to withdraw 50k from the SEP and the withdrawal is taxed as ordinary income but since the physcian is retired, his total income 50k. He's taxed 10% on the first $8700, 15% up to 35k, and 25% up to 50k for a total tax bill of ~$8500.

Since both a roth and sep grow tax free it should be largely irrelevant whether or not the dollars are taxed on the way in or the way out assuming tax equivalent principle deposits are made.

Based on the math you save almost 12k in the example by keeping a SEP vs converting to a roth. The only scenerio I can see where a roth conversion would make sense is if you have a sep from an old job and are currently a resident makeing 50k where it makes sense to add some more income at favorable tax rates as a hedge against increased marginal tax rates in the future. For attendings already being taxed at 40+%, it seems unlikely that the lowest marginal tax rates will increase above that level making it less valuable to "lock in" the current tax rate as a hedge against increasing taxes....but then again if you believe we are headed for socialism and 60% taxes for all, then maybe it's not such a bad idea to lock in those 40% tax rates.

Am I missing something?

I think you are probably right. The way to win with the conversion is if tax rates go way up in the future or if you are using the Roth for estate planning (roth allows kids to receive the money tax free)

 

[countingdays]

You are right that it doesn't make sense considering only that 50k.

The advantage comes when you start doing Free roth conversions from now on. It won't take long before the tax savings from your backdoor roths is >12k.

 

[IlDestriero]

The advantage is that the 50k that you convert to tax free growth now should be worth 100 or 150k when you take it out 20+ years from now.

 

[pgg]

You are right that it doesn't make sense considering only that 50k.

The advantage comes when you start doing Free roth conversions from now on. It won't take long before the tax savings from your backdoor roths is >12k.

Isn't the only way to do a tax-free conversion is if the traditional (pre-tax) IRA is now worth LESS than what you contributed?

Ie, if you put 100K in a traditional IRA, pre-tax, over some period of time, and now it's worth $90K, only $10K can be converted tax-free into a Roth, right? If you converted more, it'd be ordinary income. (With double payroll taxes due too, right?)

It makes no sense to me to take any of my as-yet untaxed IRA funds, convert to a Roth, and pay my top marginal rate on all that NOW, since those accounts aren't down.

In 2013 I'll be in a tax-free exclusion zone (Afghanistan) for most of the year, so I'm going to stop funding my pre-tax TSP and put the max $17500 in my Roth TSP (the .mil's Roth 401(k)), and late in the year I may do a Roth conversion since I'll be in a much lower bracket. That may be the one time in my attending years the Roth option makes sense.

 

[ssmallz]

The advantage is that the 50k that you convert to tax free growth now should be worth 100 or 150k when you take it out 20+ years from now.

Right but don't forget that the SEP grows tax free too and since the money you defer in taxes also grows tax free that should offset the tax free growth on the roth b/c your intitial deposit will be higher.

This is obviously a grossly simplified example but it makes the #s easy so....

50k deposited into a SEP and growing tax free for 1 year @ 15%, then taxed at 40% = $34.5k after net

50k taxed @ 40% now is 30k, then growing tax free for 1 year @ 15% = 34.5k net too

So the only advantage of the tax free roth growth would be if your taxes are lower now then when you plan on dispersing the money.

 

[ssmallz]

You are right that it doesn't make sense considering only that 50k.

The advantage comes when you start doing Free roth conversions from now on. It won't take long before the tax savings from your backdoor roths is >12k.

What do you mean by free roth conversions? It was my understanding that you had to pay taxes on the $$ you converted from a SEP to a roth so it's not really free

 

[countingdays]

What do you mean by free roth conversions? It was my understanding that you had to pay taxes on the $$ you converted from a SEP to a roth so it's not really free

For example, I put 10k in a traditional ira last year for my wife and me. I didn't invest it, just immediately converted to a roth. There were no capital gains to tax and I already paid the income tax since we're above the income limit to take a tax deduction on a traditional ira. The conversion isn't really free since i already paid the taxes, but it's kinda free since there's no additional cost. Now that money grows tax free and can be withdrawn tax free.
It's basically the same as just buying a roth except we don't qualify for a roth, only a backdoor conversion from a traditional ira.
If you put after tax money in a traditional ira, you will be double taxed. The roth conversion avoids that.

 

[ssmallz]

For example, I put 10k in a traditional ira last year for my wife and me. I didn't invest it, just immediately converted to a roth. There were no capital gains to tax and I already paid the income tax since we're above the income limit to take a tax deduction on a traditional ira. The conversion isn't really free since i already paid the taxes, but it's kinda free since there's no additional cost. Now that money grows tax free and can be withdrawn tax free.
It's basically the same as just buying a roth except we don't qualify for a roth, only a backdoor conversion from a traditional ira.
If you put after tax money in a traditional ira, you will be double taxed. The roth conversion avoids that.

I wasn't aware of that, thank you for clearing it up....definatly something to consider

 

[reanimatore]

For example, I put 10k in a traditional ira last year for my wife and me. I didn't invest it, just immediately converted to a roth. There were no capital gains to tax and I already paid the income tax since we're above the income limit to take a tax deduction on a traditional ira. The conversion isn't really free since i already paid the taxes, but it's kinda free since there's no additional cost. Now that money grows tax free and can be withdrawn tax free.
It's basically the same as just buying a roth except we don't qualify for a roth, only a backdoor conversion from a traditional ira.
If you put after tax money in a traditional ira, you will be double taxed. The roth conversion avoids that.

Exactly, this is the "backdoor Roth". However, if you already have pre-existing traditional IRAs you get gouged with the "pro-rata" rule that will tax your conversion. If you don't already have a non-taxed, traditional IRA you can open a traditional Non-deductible IRA (ie with your already taxed income) and then immediately convert to a Roth tax-free.

Check it out if you aren't already familiar with this:

http://whitecoatinvestor.com/retirement-accounts/backdoor-roth-ira/