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I have a substantial amount in IRA's and am retired in the sense that I am living off of my investment and rental income. I will not tap into my IRA funds for at least another 15 years.

With this situation what do you think about converting an amount of my IRA to a ROTH IRA?

I would do this in a controlled amount each year in order to minimize the effective tax rate I would be subject to in each year of conversion.

I would employ this strategy because - my tax rate today versus 15 years from now will only differ due to federal changes - not income changes.

This would allow some of my annually drawn funds - the amounts from my ROTH IRA to be tax free. This would also allow all of my gains on the ROTH IRA funds from now until draw date to be tax free.

Am I missing something?? Does this make sense to you. Please advise
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I will not tap into my IRA funds for at least another 15 years.

Why not? Your marginal federal tax rate is likely pretty low from what you say. Instead of living off what I assume are taxable investment income, why not take money out of your IRAs up to the 25% tax bracket?

I would do this in a controlled amount each year in order to minimize the effective tax rate I would be subject to in each year of conversion.

You should consider the marginal rate that you pay on the amount you convert, not the effective rate. IOW, if you convert $10k, would you pay $1000, $1500, $2500, etc.

In general, it sounds like a good idea. I would keep an eye on the taxes you pay and try to keep those no higher than 25%, lower than that if you can.

-murray
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I have a substantial amount in IRA's and am retired in the sense that I am living off of my investment and rental income. I will not tap into my IRA funds for at least another 15 years.

So you are 56 or younger? Because if you're not 56 or younger, you will be required to start tapping your IRAs in the year you turn 70 1/2, which would be less than 15 years.

With this situation what do you think about converting an amount of my IRA to a ROTH IRA?

It's a good strategy to minimize future tax bills if you can ensure that you (1) won't need to withdraw the converted amount until you are at least 59 1/2, or the conversion has aged for 5 years, whichever is sooner (2) you don't move yourself into a higher tax bracket snd (3) you can pay the additional tax from other income/investments, without having to tap into the IRA

Am I missing something?? Does this make sense to you. Please advise

No, you aren't missing anything. It's a strategy that I plan on employing when I retire in a few years.

AJ
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Instead of living off what I assume are taxable investment income, why not take money out of your IRAs up to the 25% tax bracket?

Because the OP said that they are living off of my investment and rental income. In order to stop the investment and rental income from coming in, the OP would presumably have to sell their investments/rental properties, likely resulting in capital gains taxes. The sale of investments/rentals would require the OP to find new investments that would not provide income, or else the IRA withdrawal will be additive to both income and taxes. This would all result in the OP paying more in taxes, not less.

Additionally, depending on how the OP has the money invested, the investment income may be taxed at a lower rate than the IRA withdrawals would be taxed at, so it would make no sense to substitute IRA withdrawals for this investment income.

Since the OP already is generating enough income to live on, and pay taxes from, there is no need to substitute IRA withdrawals for investment/rental income. The OP's idea of converting from traditional to Roth IRAs is more likely to result in lower tax bills than starting early IRA withdrawals that are not needed for income.

AJ
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I have a substantial amount in IRA's and am retired in the sense that I am living off of my investment and rental income. I will not tap into my IRA funds for at least another 15 years.

With this situation what do you think about converting an amount of my IRA to a ROTH IRA?


I think it's not enough information about your financial situation and plan to comment(but plenty of other posters will). Things like if you qualify for social security & when ? are you married ? do you have children ? do you want to leave them anything ?
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No, you aren't missing anything. It's a strategy that I plan on employing when I retire in a few years.

It's a strategy that I am doing right now, and for the last couple of years. Convert just enough to fill up to the top of the 15% bracket. Don't want to go over, because no income tax on LTCG or dividends **IF** you are in the 15% bracket. One dollar over and it all gets taxed.

Once 70 1/2 appears on the horizon, you want to take a close look at the RMD you'll face. Better for the growth to be in a ROth than a regular -- all other things being equal.
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Because the OP said that they are living off of my investment and rental income. In order to stop the investment and rental income from coming in, the OP would presumably have to sell their investments/rental properties, likely resulting in capital gains taxes.

As pointed out, there's not enough information. The investment income could be cashing in on the investments in a taxed account.

The goal shouldn't be to minimize taxes paid each year but rather get the money out of a traditional IRA at the lowest tax rate. This could be done through conversions or withdrawals.

-murray
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murray,

I was doing the annual small conversions. It was a lot of work balancing dividend income, a little pension and other income to get an amount for the conversion to not increase my taxes.

A couple years ago, I realized I would not need the IRA money. Our taxable account easily handles everything.

Now we are considering using the Qualified Charitable Distribution (QCD) option, page 40, 2012 IRS Pub 590 if it is still in effect.

In some respect, we wasted money paying taxes that we probably did not have to pay simply because there were still parts of our retirement that we had not put enough thought into.

My primary concern for initially doing the conversions: a big increase in taxable income at RMD time. Using our current values of income and the trad IRA balances, our equivalent income for $1,000 raises to $2,400. That RMD bump is money we do not need for expenses. Extrapolate the numbers and it does cause a huge bump in taxes and AGI. The AGI will increase the taxes on dividends in our taxable account.

I would say the OP needs to look at all options and what the true need for the money is. Depending on the amounts involved, talk with a tax professional.

Gene
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Don't want to go over, because no income tax on LTCG or dividends **IF** you are in the 15% bracket. One dollar over and it all gets taxed.

No.

One dollar over and that dollar gets taxed. All of the income in the lower bracket still gets taxed at the lower bracket rate - including LTCG and dividend income at no tax.

--Peter
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All of the income in the lower bracket still gets taxed at the lower bracket rate - including LTCG and dividend income at no tax.

Well, no. The LTCG and dividends are included in the taxable income, but the rate for them depends on your tax bracket.

http://www.bogleheads.org/wiki/Qualified_dividend
http://www.1040.com/federal-taxes/income/dividends/
http://en.wikipedia.org/wiki/Qualified_dividend

For most people it doesn't matter, because most non-retired people with investments are well above the top of the 15% bracket.

Turbo tax was quite clear on this. I well know because I had to do some fancy footwork to stay in the 15% bracket the last 2 years.

Play with it in TurboTax (for 2012). Enter $10,000 of dividends and other income to get taxable income of $70,699 (married-joint). Then add $2 more income to bump the T.I to $70,701. The tax jumps a whole lot, because the entire $10K of dividends is now taxed.
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Well, no. The LTCG and dividends are included in the taxable income, but the rate for them depends on your tax bracket.

Sorry, Ray, but I've gotta pull rank on you on this one. I'm a tax professional and I KNOW how this works.

Play with it in TurboTax (for 2012). Enter $10,000 of dividends and other income to get taxable income of $70,699 (married-joint). Then add $2 more income to bump the T.I to $70,701. The tax jumps a whole lot, because the entire $10K of dividends is now taxed.

If so, there's something wrong with Turbo Tax. Given your numbers, the tax itself should go up by 15 cents on one dollar and 25 cents on the second dollar.

If you have any Social Security income, the additional income would also come into play in determining how much of the Social security income is included in taxable income. Worst case would have an additional $2 * 85% or $1.70 added to taxable income, which would increase the tax by another 43 cents. So all up, the tax would go up by 15+25+43 or 83 cents on that extra $2 of income.

Tell you what, I'll check on my tax program tomorrow when I'm at work, and I'll let you know the correct tax amounts. And if you've still got your copy of Turbo Tax hanging around, I invite you to do the same. (Because I really doubt Turbo Tax would get this wrong.)

--Peter
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Turbo tax was quite clear on this. I well know because I had to do some fancy footwork to stay in the 15% bracket the last 2 years.

Play with it in TurboTax (for 2012). Enter $10,000 of dividends and other income to get taxable income of $70,699 (married-joint). Then add $2 more income to bump the T.I to $70,701. The tax jumps a whole lot, because the entire $10K of dividends is now taxed.


I'm with Peter on this, you had something else going on. I just faked up a return in my copy of TT Deluxe 2012. $10,000 in Dividend income, the rest in LTCG income. At $70,700 Taxable Income, tax owed was $0. At $70,704 it was $1. I couldn't get it to show tax at the intermediate numbers because of the built-in rounding that the IRS allows.
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One thing to keep in mind if you are doing all the tax planning as MFJ- eventually one of you will be filling single and it changes the picture.
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Peter, I don't mind a pro pulling rank & telling me I'm all wet. That challenges me to dig in and figure it out from the ground up.

So I went to 2012 TurboTax and plugged in various scenarios. Imagine my shock to discover that [some] stuff I'd been reading on the internet was wrong!

It's not as bad as I thought, and it's not as good as I understood Peter to say.

After playing with Turbotax and carefully reading the IRS forms, the truth appears to be this:
1) Compute your taxable income without dividends[*].
2) The amount of dividends[*] that are taxed at 0% is that amount which brings your taxable income to the top of the 15% bracket. (70,700 in 2012, 72,500 in 2013, for MFJ)
3) All dividends above that are taxed at 15%.
2a) If your taxable income without dividends is already more than 70,700, then all the dividends are taxed at 15%.

[*] Strictly: long-term capgains plus qualified dividends.
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After playing with Turbotax and carefully reading the IRS forms, the truth appears to be this:
1) Compute your taxable income without dividends[*].
2) The amount of dividends[*] that are taxed at 0% is that amount which brings your taxable income to the top of the 15% bracket. (70,700 in 2012, 72,500 in 2013, for MFJ)
3) All dividends above that are taxed at 15%.
2a) If your taxable income without dividends is already more than 70,700, then all the dividends are taxed at 15%.

[*] Strictly: long-term capgains plus qualified dividends.


Very nice summary. I can't find anything to correct. (Although high income folks should be aware that starting for 2013, if you get into the 39.6% bracket, the tax rate on your qualified dividends and long term capital gains goes up to 20%. That high income threshold is $450k for MFJ and $400k for singles.)

And kudos to you for checking it out yourself.

--Peter
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As pointed out, there's not enough information.

I would say that there's enough information to have a discussion of the concept of converting from a Traditional to a Roth a little at a time, which seemed to be what the OP was looking for.

The investment income could be cashing in on the investments in a taxed account.

Then I guess you and I have different definitions of 'investment income'. To me, 'investment income' is income that is derived from investments, without selling the underlying investment. If one needs to sell the underlying investment, then one is digging into capital, which I don't count as 'investment income', but rather, 'realizing capital gains/losses'.

The goal shouldn't be to minimize taxes paid each year but rather get the money out of a traditional IRA at the lowest tax rate. This could be done through conversions or withdrawals.

What was said about taxes was Since the OP already is generating enough income to live on, and pay taxes from, there is no need to substitute IRA withdrawals for investment/rental income. The OP's idea of converting from traditional to Roth IRAs is more likely to result in lower tax bills than starting early IRA withdrawals that are not needed for income.

Not sure how that was interpreted as 'minimizing taxes paid each year', since either a withdrawal or a conversion from a Traditional IRA would result in the same amount of taxes being paid (assuming that the same amount is withdrawn/conversted). However, what happens to the amount withdrawn or converted does have an impact on future taxes. Since the OP already stated they didn't need to tap the IRA for need additional income, presumably, a withdrawal would get re-invested, hopefully generating future tax bills, due to capital gains and/or taxable investment income. In comparison, converting to a Roth would shield any capital gains or investment income from future taxes.

AJ
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Although high income folks should be aware that starting for 2013, if you get into the 39.6% bracket, the tax rate on your qualified dividends and long term capital gains goes up to 20%

FWIW, the effective tax I paid on long term gains 2 years ago was 22% due to AMT & phase out of deductions, at least according to TT.

-murray
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Am I missing something??

You need to also look at what the likely tax brackets will be of however inherits the retirment accounts.
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In comparison, converting to a Roth would shield any capital gains or investment income from future taxes.


AJ - this is the heart of my wanting to employ a strategy of converting from a traditional IRA to a Roth.

I'm only 50 so there will be no withdraws from my IRA's for quite a while. The responses were all very helpful. But at the heart of the strategy is this:

Traditional IRA balance of $200K, for simplicity lets assume it grows in value (investment growth & Dividends) by $100K between now an when I start to withdraw. I will pay taxes on the $300K as its withdrawn from the IRA.

Roth Conversion - of the $200K I pay taxes on the $200K now at conversion(I would do this over a few years and minimize the tax rate.) Am I correct that the $100K of growth in the Roth IRA, would not be taxable, even when I eventually with draw it??


Is my understanding correct??
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Traditional IRA balance of $200K, for simplicity lets assume it grows in value (investment growth & Dividends) by $100K between now an when I start to withdraw. I will pay taxes on the $300K as its withdrawn from the IRA.

Roth Conversion - of the $200K I pay taxes on the $200K now at conversion(I would do this over a few years and minimize the tax rate.) Am I correct that the $100K of growth in the Roth IRA, would not be taxable, even when I eventually with draw it??


Yes, but it doesn't matter, due to the fact that multiplication is commutative.
The tax you'll pay now is money that *could* be growing but won't be because you don't have it anymore.
Convert now: At 25% rate: you'll have 150K in the Roth. If that grows by 50% that's 225K

Don't convert: 200K growing by 50% = 300K. Minus 25% tax = 225K

But if you don't convert *and* you're in the 15% bracket when you retire: 300K minus 15% tax = 255K
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Is my understanding correct??

Yes.

I would do this over a few years and minimize the tax rate.

This is the key. If you end up paying a higher tax rate when doing the conversion than you would if you just let everything ride and withdrawn it from the traditional, you will cost yourself money.

Of course, then the question becomes, what do you think your individual tax rates will be in the future, compared to what they are now?

AJ
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I can't see any reason or ability to convert to a Roth. My wife and I make over 200K so my taxes would kill me.
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I can't see any reason or ability to convert to a Roth. My wife and I make over 200K so my taxes would kill me.

If the conversion is a 'back-door' Roth conversion of a non-deductible IRA contribution that was made only a day before - there should be little/no tax consequences, as you have already paid taxes on the contribution, and in 1 day (especially if you were planning on doing the conversion) you are likely to have little or no gain on the contributed amount. This is a way for taxpayers with incomes that are too high to contribute to a Roth to be able to make contributions each year.

However, unless you don't have any other traditional IRAs, because of the pro-ration that occurs when calculating taxes on conversions, you will likely pay taxes on a large portion of the converted amount. One way to 'not have any other tradtionsl IRAs' is to convert all of your traditional IRAs, which could be a pretty big tax hit, as you point out. Another way to 'not have any other traditional IRAs' would be to move all of your IRAs to your current employer's 401(k) plan, because a 401(k) is not an IRA, and therefore, is not counted as part of the pro-ration calculation.

AJ
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