IRA Question - Am I Missing Something?

[Deleted]

Dec 22, 2012 12:45:36 GMT -5 LoveTrains said:

Dec 22, 2012 12:42:19 GMT -5 @iheartcosmos said:

So the solution is to put $5k at once into a new traditional Ira opened for this purpose and immediately convert, rather than continuing to fund an existing Ira?

YES.

Take your $5,000 for this year, put in a new non-deductible traditional IRA, and convert it immediately. Now you have a Roth IRA with $5,000 and that $5,000 grows tax free - meaning you don't have to pay taxes on the gains.

It should be pretty easy to do that, most companies allow you to open an IRA with $5,000. You can even just put the $5,000 in a money market or have it sit in cash before you convert it.

The key is to do that EACH year that the tax code allows anyone to convert a traditional IRA into a Roth. It is essentially circumventing the income cap rules for the Roth.

But that only works on an (essentially) tax-free basis if you don't already have traditional IRA funds, right? We have to keep all of our non-401(k) investments in Fidelity because of my husband's job, but in a world where we were allowed to have accounts anywhere we wanted I don't think I could get around these rules by opening a brand new IRA with (say) Vanguard and pretending that my Fidelity Traditional IRA doesn't count because it is a different account?

[LoveTrains]

Dec 22, 2012 12:43:45 GMT -5 v said:

Dec 22, 2012 12:42:19 GMT -5 @iheartcosmos said:

So the solution is to put $5k at once into a new traditional Ira opened for this purpose and immediately convert, rather than continuing to fund an existing Ira?

So confusing.

If you want to join me in crying about how confusing it is, I recommend perusing this article:

www.forbes.com/sites/josephsteinberg/2012/12/12/warning-about-roth-ira-conversions-often-misunderstood-irs-rule-can-cost-you-money-and-aggravation/

Huh. I just read that article. That doesn't make any sense at ALL to me now. So disregard my previous post because it sounds like that is actually not allowed? But what that guy is saying really doesn't make any sense to me. I guess consult the professionals and follow their advice.

I guess I am just thankful that H and I can still contribute to Roths.

[Deleted]

Dec 22, 2012 12:42:19 GMT -5 @iheartcosmos said:

So the solution is to put $5k at once into a new traditional Ira opened for this purpose and immediately convert, rather than continuing to fund an existing Ira?

So confusing.

Unfortunately, that won't work. Having different IRA accounts does not matter. The percentage rule still applies.

[Deleted]

I love that the answers to Cosmos's question are basically yes, no, yes, no...

THIS IS TOO CONFUSING!

[LoveTrains]

Dec 22, 2012 12:49:07 GMT -5 v said:

Dec 22, 2012 12:45:36 GMT -5 LoveTrains said:

YES.

Take your $5,000 for this year, put in a new non-deductible traditional IRA, and convert it immediately. Now you have a Roth IRA with $5,000 and that $5,000 grows tax free - meaning you don't have to pay taxes on the gains.

It should be pretty easy to do that, most companies allow you to open an IRA with $5,000. You can even just put the $5,000 in a money market or have it sit in cash before you convert it.

The key is to do that EACH year that the tax code allows anyone to convert a traditional IRA into a Roth. It is essentially circumventing the income cap rules for the Roth.

But that only works on an (essentially) tax-free basis if you don't already have traditional IRA funds, right? We have to keep all of our non-401(k) investments in Fidelity because of my husband's job, but in a world where we were allowed to have accounts anywhere we wanted I don't think I could get around these rules by opening a brand new IRA with (say) Vanguard and pretending that my Fidelity Traditional IRA doesn't count because it is a different account?

Yes, from the article you posted it sounds like that only works if you don't have any traditional IRA accounts with money in it that was pre-tax.

[mokes]

Dec 22, 2012 12:33:23 GMT -5 v said:

If 2/3 of my IRA is pre-tax, can I immediately convert only the $5500 from next year (for instance), in which case I'd have to pay income tax on 2/3 of that $5500?

Why do they make this so hard???

Yes.

Here's an article that I think explains it pretty simply: www.forbes.com/sites/ashleaebeling/2012/01/20/the-serial-backdoor-roth-a-tax-free-retirement-kitty/

[mokes]

Dec 22, 2012 12:49:07 GMT -5 v said:

Dec 22, 2012 12:45:36 GMT -5 LoveTrains said:

YES.

Take your $5,000 for this year, put in a new non-deductible traditional IRA, and convert it immediately. Now you have a Roth IRA with $5,000 and that $5,000 grows tax free - meaning you don't have to pay taxes on the gains.

It should be pretty easy to do that, most companies allow you to open an IRA with $5,000. You can even just put the $5,000 in a money market or have it sit in cash before you convert it.

The key is to do that EACH year that the tax code allows anyone to convert a traditional IRA into a Roth. It is essentially circumventing the income cap rules for the Roth.

But that only works on an (essentially) tax-free basis if you don't already have traditional IRA funds, right? We have to keep all of our non-401(k) investments in Fidelity because of my husband's job, but in a world where we were allowed to have accounts anywhere we wanted I don't think I could get around these rules by opening a brand new IRA with (say) Vanguard and pretending that my Fidelity Traditional IRA doesn't count because it is a different account?

Right. The taxes are based on the total pre-tax amounts across all IRAs. It doesn't matter if you have multiple accounts.

If you your IRA is mostly pre-tax funds, and you want to be able to convert in the future without incurring additional tax liability, what you can do is roll over your IRA into a 401k. Then basically start over with the IRA. Every year, add nondeductible money to the IRA, and then convert it. No additional tax liability.

What makes the most sense depends on the % of pre- and post-tax funds we're talking about. ETA: And of course the funds available to you through the 401k.

[Deleted]

This has been a very helpful post. Now I wish I had been putting money into a money market account all year instead of directly into the traditional IRA. I still have $2000 to go for 2012 year, so I just opened a new traditional account in etrade and I'm just putting the whole amount in once I get my bonus.

[SJ]

V I think you have a correct understanding.

You can contribute $5500 in 2013 and then immediately convert $5500. You will pay taxes on 2/3 of $5500 because 2/3 of your total Traditional iRA pool is pre-tax. The IRS doesn't let you cherry pick which $5500 you are converting (ie you cannot say I am converting $5500 of post-tax dollars) but rather your percentage. That being said you can convert as little or as much as you want.

You cannot get around the percentage rule by using multiple accounts.

[Deleted]

Dec 22, 2012 13:06:34 GMT -5 @iheartcosmos said:

This has been a very helpful post. Now I wish I had been putting money into a money market account all year instead of directly into the traditional IRA. I still have $2000 to go for 2012 year, so I just opened a new traditional account in etrade and I'm just putting the whole amount in once I get my bonus.

But if you're only paying taxes on the gains, you're still better off.

You would have been better off converting right away because then you wouldn't have had gains to tax, but owing tax on 10% because you made 10% over the course of the year is way better than paying tax on only 0.8% because you only earned 0.8%. Right? Am I missing something?

[Deleted]

Dec 22, 2012 13:10:04 GMT -5 v said:

Dec 22, 2012 13:06:34 GMT -5 @iheartcosmos said:

This has been a very helpful post. Now I wish I had been putting money into a money market account all year instead of directly into the traditional IRA. I still have $2000 to go for 2012 year, so I just opened a new traditional account in etrade and I'm just putting the whole amount in once I get my bonus.

But if you're only paying taxes on the gains, you're still better off.

You would have been better off converting right away because then you wouldn't have had gains to tax, but owing tax on 10% because you made 10% over the course of the year is way better than paying tax on only 0.8% because you only earned 0.8%. Right? Am I missing something?

V is right.

[SJ]

Dec 22, 2012 13:10:04 GMT -5 v said:

Dec 22, 2012 13:06:34 GMT -5 @iheartcosmos said:

This has been a very helpful post. Now I wish I had been putting money into a money market account all year instead of directly into the traditional IRA. I still have $2000 to go for 2012 year, so I just opened a new traditional account in etrade and I'm just putting the whole amount in once I get my bonus.

But if you're only paying taxes on the gains, you're still better off.

You would have been better off converting right away because then you wouldn't have had gains to tax, but owing tax on 10% because you made 10% over the course of the year is way better than paying tax on only 0.8% because you only earned 0.8%. Right? Am I missing something?

V is right. I'd also rather have the gains.

M do you have any pre-tax money in IRA's? I think you phased out of Roth eligibility fairly recently right? In that case I would not not hesitate much at all to convert.

[Deleted]

Dec 22, 2012 13:19:05 GMT -5 SJ said:

Dec 22, 2012 13:10:04 GMT -5 v said:

But if you're only paying taxes on the gains, you're still better off.

You would have been better off converting right away because then you wouldn't have had gains to tax, but owing tax on 10% because you made 10% over the course of the year is way better than paying tax on only 0.8% because you only earned 0.8%. Right? Am I missing something?

V is right. I'd also rather have the gains.

M do you have any pre-tax money in IRA's? I think you phased out of Roth eligibility fairly recently right? In that case I would not not hesitate much at all to convert.

Last year. We converted all our previous IRAs to Roth, except H has some money in a traditional that was a distribution of a profit sharing plan that his company is no longer participating in. That was distributed in 2012. He has not made his 2012 contributions yet though since be hasn't gotten his bonus yet (hoping for Monday!)

I've contributed $3000 this year so far. I have about 6% gains in this account.

I need an accountant stat.

[SJ]

I would just put the remaining $2000 into the account that has $3000 in it, convert. You will only pay taxes on whatever is >$5,000.

DH will be a little more complicated because of the rollover

[Deleted]

Here's a calculator to help you run numbers: partners.leadfusion.com/tools/motleyfool/rothira02/tool.fcs. It gives some quick and dirty feedback on whether you should convert. As Sarajoy suggested, it is wise to convert only $10K/yr going forward at the higher tax brackets. I would not convert entire IRA, however I don't think that was your concern, right?

[hlke]

OP, if you are already maxing the 401ks, then I'd do the Traditional/ROTH conversion with the next $10k, then invest in taxable accounts. FP is right, not accountant.

[Deleted]

Dec 22, 2012 18:18:30 GMT -5 @choco said:

Here's a calculator to help you run numbers: partners.leadfusion.com/tools/motleyfool/rothira02/tool.fcs. It gives some quick and dirty feedback on whether you should convert. As Sarajoy suggested, it is wise to convert only $10K/yr going forward at the higher tax brackets. I would not convert entire IRA, however I don't think that was your concern, right?

Thanks Choco. What do you think is a realistic tax percentage to plug in for retirement?

[Deleted]

I am being conservative and assuming that tax rate before and after retirement will stay the same ;-) I'm dreaming and using 45.8% for both (max of 35% Fed rate plus state).

[Deleted]

Btw, thank you OP for this thread. I've always seen a ROTH conversion as the entire IRA balance and never thought I could convert only future funds. I was wrong in my initial response and I am with team FP now. Whenever I approached our CPA with this question, it was always under the criteria of converting entire balance so I now understand why he was also opposed to it. Yay MM!