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Author: finchumk Big funky green star, 20000 posts Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 76237  
Subject: IRA allocation questions Date: 11/12/2001 3:29 PM
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Since I became self-employed recently, I'm curious about the different IRA's. None of the books I've consulted seem to address the questions I have. Correct me if I'm wrong, but my understanding is that the amount that you can invest in a SEP is a certain percentage of your income. You may also invest in a Roth, as long as the total amount invested between the two does not exceed that fixed percentage of your income.

My question is: After investing your money between the two IRA's as I described, is it allowable to then convert the money in the SEP over to a Roth? Yes, I know it would be a taxable event. But, it seems that would be to your advantage, tax-wise. I guess you'd have to combine all those Roths periodically. Any rules against this?
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Author: WPatch Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 32473 of 76237
Subject: Re: IRA allocation questions Date: 11/12/2001 5:18 PM
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Since I became self-employed recently, I'm curious about the different IRA's. None of the books I've consulted seem to address the questions I have. Correct me if I'm wrong, but my understanding is that the amount that you can invest in a SEP is a certain percentage of your income.

o.k.

You may also invest in a Roth, as long as the total amount invested between the two does not exceed that fixed percentage of your income.

Wrong. Assuming you have enough earned income and fall in the income limits, you may contribute $2,000 into the Roth this year, independent of any income percentage.

My question is: After investing your money between the two IRA's as I described, is it allowable to then convert the money in the SEP over to a Roth? Yes, I know it would be a taxable event. But, it seems that would be to your advantage, tax-wise. I guess you'd have to combine all those Roths periodically. Any rules against this?

If you modifed AGI is less than $100,000, the SEP IRA is a traditiional IRA which can be converted into a Roth. Unless you are planning to take earnings out tax free within 5 tax years, there is no reason not to combine Roths.

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Author: finchumk Big funky green star, 20000 posts Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 32474 of 76237
Subject: Re: IRA allocation questions Date: 11/12/2001 5:30 PM
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Me:You may also invest in a Roth, as long as the total amount invested between the two does not exceed that fixed percentage of your income.

Wrong. Assuming you have enough earned income and fall in the income limits, you may contribute $2,000 into the Roth this year, independent of any income percentage.

Thanks for the correction.

My question is: After investing your money between the two IRA's as I described, is it allowable to then convert the money in the SEP over to a Roth? Yes, I know it would be a taxable event. But, it seems that would be to your advantage, tax-wise. I guess you'd have to combine all those Roths periodically. Any rules against this?

If your modifed AGI is less than $100,000, the SEP IRA is a traditiional IRA which can be converted into a Roth. Unless you are planning to take earnings out tax free within 5 tax years, there is no reason not to combine Roths.

I don't hear about this sort of thing very often, but it seems like it would make a lot of sense to just get the tax over with now, as you do with Roths, rather than paying tax on the much larger amount many years down the road. Why mess around with other IRA's when you can just convert to a Roth and give the IRS their pound of flesh at the beginning and get it over with?

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Author: JAFO31 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 32476 of 76237
Subject: Re: IRA allocation questions Date: 11/12/2001 6:25 PM
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<<<<I don't hear about this sort of thing very often, but it seems like it would make a lot of sense to just get the tax over with now, as you do with Roths, rather than paying tax on the much larger amount many years down the road. Why mess around with other IRA's when you can just convert to a Roth and give the IRS their pound of flesh at the beginning and get it over with?>>>>

The bigger issue is tax rate now versus tax rate at retirement.
x = amount invested, .28 FIT bracket, 4.0 = total return over 24 years (being roughly 6%)


(x - .28x) * 4.0 = 2.88x

(4.0x) - .28(4.0x) = .72(4.0x) = 2.88x

End amount is the same if tax rate is the same, because of the commutative properties of multiplication.

The other issue is the ability to pay tax now without decreasing amount invested (i.e., tax paid without using assets already in the account).

Regards, JAFO

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Author: finchumk Big funky green star, 20000 posts Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 32484 of 76237
Subject: Re: IRA allocation questions Date: 11/12/2001 11:15 PM
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JAF031: End amount is the same if tax rate is the same, because of the commutative properties of multiplication.

Hmmm, I could have sworn that the last time I ran it on a interest calculator, that the Roth produced a higher final figure. Yet, when I ran it again today, they came out the same. Nevermind...

Purdue must be so proud to have given me a math degree :-)



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Author: ptheland Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 32486 of 76237
Subject: Re: IRA allocation questions Date: 11/13/2001 2:17 AM
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There's another risk with Roths that's not often mentioned, but I believe to be very real. Roth withdrawls will be tax free only as long as Congress doesn't change its mind. How long were Social Security benefits tax free? Then Congress finds they need to raise revenue and finds a target in this formerly tax-free income source. Then they get hit a second time (raising the max amount taxable from 50% to 85%). Even the latest tax cuts didn't consider reducing the tax on social security.

In 15-20 years, with baby boomers in full retirement mode and social security straining to meet it's promises, all that tax free Roth money is going to present a pretty tempting target.

--Peter

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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 32487 of 76237
Subject: Re: IRA allocation questions Date: 11/13/2001 7:36 AM
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If you modifed AGI is less than $100,000, the SEP IRA is a traditiional IRA which can be converted into a Roth. Unless you are planning to take earnings out tax free within 5 tax years, there is no reason not to combine Roths.

There is no real need to ever keep Roth IRAs separate even if withdrawals are made within five years of a conversion. Roth withdrawal ordering rules treat all Roth IRAs as if they were only one giant IRA. The first money out is always considered annual contribution money regardless of which IRA is used for the withdrawal. The next money out when annual contribution money is gone will be conversion contributions from the oldest to the latest. When that's gone, the next money out will be earnings.

Regards..Pixy

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Author: jrr7 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 32488 of 76237
Subject: Re: IRA allocation questions Date: 11/13/2001 10:14 AM
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finchumk,

This might explain what you were seeing.

Joe and Mary are planning for retirement. Their salaries are the same.

Joe decides to use a Roth IRA, and Mary decides to use a traditional IRA, maxing it out ($2000 under current tax law). They both invest in the same asset. We'll asume that income tax is always 30%.

Joe contributes $2000 of take-home pay to the IRA each year. Mary writes the IRA company a check for $2000, but come next April she gets back $600 of that from the government (due to the tax deduction). So her out-of-pocket cost is only $1400.

At retirement, Joe's IRA has $2,000,000 worth and Mary's has $2,000,000. But Mary has to pay taxes on that when she withdraws (not all at once, we hope) so the traditional IRA isn't worth as much as the Roth.

It makes sense that Joe's is worth more, because he put more take-home pay into it.

If Joe, on the other hand, had only been able to afford to put away $1400 of take-home pay, his IRA payout would have been the same as Mary's.

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Author: gopete One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 32517 of 76237
Subject: Re: IRA allocation questions Date: 11/14/2001 7:13 PM
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Hi Pixy --- What if one of the Roths is a 1998 conversion and you're using the four year tax spread; wouldn't combining into a single
Roth mess this up? --- gopete

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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 32527 of 76237
Subject: Re: IRA allocation questions Date: 11/15/2001 8:20 AM
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Gopete asks:

What if one of the Roths is a 1998 conversion and you're using the four year tax spread; wouldn't combining into a single
Roth mess this up?


I think you must be asking whether converting another IRA would mess up your schedule for the 4-year spread of declarable income on a conversion made in 1998. If so, then converting another IRA before this year is out would certainly add more income, possibly push you into a higher bracket, and mean more taxes regardless of bracket creep.

OTOH if all you mean is merging a conversion Roth with another Roth, then that has no impact at all. Your declarable income for the last year of the spread this year remains the same as do the ordering rules for any withdrawal from a Roth IRA. For information on the latter, see this discussion in our IRA area: http://www.fool.com/money/allaboutiras/allaboutiras07.htm

Regards..Pixy

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Author: fling Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 32585 of 76237
Subject: Re: IRA allocation questions Date: 11/19/2001 3:38 PM
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>>Joe contributes $2000 of take-home pay to the IRA each year. Mary writes the IRA company a check for $2000, but come next April she gets back $600 of that from the government (due to the tax deduction). So her out-of-pocket cost is only $1400.

At retirement, Joe's IRA has $2,000,000 worth and Mary's has $2,000,000. But Mary has to pay taxes on that when she withdraws (not all at once, we hope) so the traditional IRA isn't worth as much as the Roth.<<

So the question is whether the $600 a year that Mary has extra to invest in a taxable account (where, in addition to the capital gains upon selling, also has taxable dividends and capital gains distributions) makes up for the differences in the IRA balances after taxes. That probably depends on a lot of things, including tax brackets, what investment is chosen, and how long till retirement. I'm not sure how to model this in a spreadsheet.

Note that if Joe's income is too high to deduct a traditional IRA contribution but low enough to still make a Roth contribution, it's a no-brainer for the Roth.

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Author: jrr7 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 32587 of 76237
Subject: Re: IRA allocation questions Date: 11/19/2001 4:08 PM
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There also web-based calculators that let you enter projections for the income return (taxable) and unrealized capital gains (tax-deferred) for the aftertax investment due to the tax deduction.

I wrote a spreadsheet to do the same thing, even allowing you to set the average and standard dev. of your return.

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