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Author: Pooksterish One star, 50 posts Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75838  
Subject: Roth conversion questions Date: 4/12/1998 10:45 PM
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Hi out there,

Can anyone help with these questions? Thanks!

If I convert my IRA to a Roth in 1998 I understand that I get to pay the tax on it over 4 years. But the question is, does the amount of the conversion get claimed as income over 4 years, or does the tax liability itself get divided by 4 years? In other words, if I convert $20000 of IRA funds to a Roth, do I claim $5000 of that per year as income, or do I have to claim the whole $20000 as income in 1998 and then pay the tax liability over the 4 years? The difference is the possibility that, if claimed in one year, it would push me into a higher tax bracket.

Also, does the WHOLE amount have to be claimed as income, or just the contribution amount and not the gains?

Thanks for any help.

Pooksterish
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Author: SnootFool Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2772 of 75838
Subject: Re: Roth conversion questions Date: 4/12/1998 11:35 PM
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<<If I convert my IRA to a Roth in 1998 I understand that I get to pay the tax on it over 4 years. But
the question is, does the amount of the conversion get claimed as income over 4 years, or does the
tax liability itself get divided by 4 years? ... The difference is the possibility that, if claimed in one year, it would push me into a higher tax bracket.>>

It's the *income* (a distribution, in IRSese) which is ratably spread over the next 4 years (98,99,00,01), NOT the taxes per se. Thus, as you have noted, you could find yourself in a new tax bracket if you foolishly (small 'f') convert a large amount and are close to the 15%/28% bracket line this year or will be close in one of the subsequent 3 years, due to raises and/or unexpected income (capital gains/dividends/lottery winnings/etc.). My advice (free & worth every penny you paid) is 'festina lente', which is Latin for 'Make haste slowly.' IOW, take a close look before you leap; Roth IRAs are a great deal (for most folks) but NOT worth a tax hike if you can avoid it by converting slowly.

<<...Also, does the WHOLE amount have to be claimed as income, or just the contribution amount and not the gains?>>

The amount claimed as income, I believe, is the sum in your traditional IRA which has not already been taxed. IOW, ALL of your earnings (these are tax-deferred, remember) & the portion of contributions which were tax-deductible when added originally. This latter sum is your 'basis' and can be found on line 2 of IRS form 8606 of your tax return, which should be lying around someplace nearby round about now, since it's mid-April. Hope this helps. Chris S.

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Author: SnootFool Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2773 of 75838
Subject: Re: Roth conversion questions Date: 4/13/1998 12:15 AM
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Pooksterish-

Oops- I goofed. 1998 is a special case. If you do convert to a Roth in '98 & then spread income over 4 years as required, then 99/00/01 income is irrelevant. Just make sure your 1998 income (with 1/4 distributions added) will keep you in the desired bracket & you should be OK. (Unless, of course you elect to convert additional $$ in those future years, which would be a horse of a different color). You might want to check Tax Strategies board at TMF for more info/other postings. My apologies for the mix-up. CAS.

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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: 2776 of 75838
Subject: Re: Roth conversion questions Date: 4/13/1998 8:25 AM
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Pooksterish ,

<<If I convert my IRA to a Roth in 1998 I understand that I get to pay the tax on it over 4 years. But the question is, does the amount of the conversion get claimed as income over 4 years, or does the tax liability itself get divided by 4 years? In other words, if I convert $20000 of IRA funds to a Roth, do I claim $5000 of that per year as income, or do I have to claim the whole $20000 as income in 1998 and then pay the tax liability over the 4 years? The difference is the possibility that, if claimed in one year, it would push me into a higher tax bracket.

Also, does the WHOLE amount have to be claimed as income, or just the contribution amount and not the gains?>>

If you convert a traditional IRA to a Roth IRA in 1998, then all previously untaxed contributions and all earnings within that account MUST be declared as income and be subject to tax at ordinary income tax rates. Under existing law, that income MUST be declared ratably in each of the tax years 1998 through 2001 (i.e., one-fourth in each of those years), and taxes will be paid based on your total taxable income in those years. A pending technical correction to Roth law will make this declaration method voluntary instead of mandatory. If and when that change is passed, you will then have the option of declaring all income in 1998 instead of being forced to spread it over a four-year period. Conversions in 1999 and later will be declared as income in the year of that conversion.

Regards……Pixy



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Author: Pooksterish One star, 50 posts Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2778 of 75838
Subject: Re: Roth conversion questions Date: 4/13/1998 12:07 PM
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SnootFool: "If you do convert to a Roth in '98 & then spread income
over 4 years as required, then 99/00/01 income is irrelevant. Just make sure your 1998 income
(with 1/4 distributions added) will keep you in the desired bracket & you should be OK."

Dear SnootFool,

Thanks, but I don't see why income from 99/00/01 would be irrelevant. If I'm claiming 1/4 of the conversion in those years as income, wouldn't that add to the income in those years, possibly pushing someone into a new tax bracket?

P

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Author: Pooksterish One star, 50 posts Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2779 of 75838
Subject: Re: Roth conversion questions Date: 4/13/1998 12:11 PM
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Pixy: "If you convert a traditional IRA to a Roth IRA in 1998, then all previously untaxed contributions
and all earnings within that account MUST be declared as income and be subject to tax at ordinary
income tax rates."

Dear Pixy,

Thanks for your help. One more thing: I'm trying to figure out the logic behind making someone pay taxes on the converted amount that is income to the traditional IRA (as opposed to the contributions made to it). Since income grows tax free in both a traditional IRA and a Roth IRA, why should one have to pay tax on this income during a conversion? This sounds like a penalty to me. What am I missing?

Thanks,
P


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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: 2787 of 75838
Subject: Re: Roth conversion questions Date: 4/13/1998 2:58 PM
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Pooksterish,

<<One more thing: I'm trying to figure out the logic behind making someone pay taxes on the converted amount that is income to the traditional IRA (as opposed to the contributions made to it). Since income grows tax free in both a traditional IRA and a Roth IRA, why should one have to pay tax on this income during a conversion? This sounds like a penalty to me. What am I missing?>>

You're missing the key point. You're paying the taxes upfront in the Roth so everything - earnings included - come out of the Roth tax free. In the traditional IRA the earnings grow tax deferred, not tax free. When you begin withdrawals, you pay taxes. Ergo, on conversion, you also pay taxes. If everything were exactly equal (tax rates and rates of return), there would be no difference in the amount you can take from a traditional IRA and a Roth IRA. In one you postpone taxes (the traditional) and in the other you pay taxes now to avoid them later (the Roth).

Regards…..Pixy




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Author: JeanDavid Big gold star, 5000 posts Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2790 of 75838
Subject: Re: Roth conversion questions Date: 4/13/1998 6:26 PM
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<Since income grows tax free in both a traditional IRA and a Roth IRA, why should one have to pay tax on this income during a conversion? This sounds like a penalty to me. What am I missing?>

I am not TMF Pixy, but what you are missing is that income does not grow tax-free in a traditional IRA. The taxes on that income are deferred until you take the money out, but then your normal tax rate (not capital gains rate) applies. If you take the money from your traditional IRA now to put into a Roth IRA, far from a penalty, you receive a dispensation from paying the 10% excise tax on premature withdrawals (assuming you are under 59 1/2).

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Author: SnootFool Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2826 of 75838
Subject: Re: Roth conversion questions Date: 4/14/1998 5:48 PM
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Pooksterish-

Mea culpa. You are correct, of course regarding tax consequences of Roth conversion money making a difference in 99/00/01 as well as 1998. I got confused (hey, it was 1:30AM!) over another Roth-related money issue, namely the 100K AGI limit for eligibility to convert during a given year. Once you satisfy the 100K restriction for '98 then your income for the next 3 years IS irrelevant BUT only with regard to the eligibility question. The IRS WILL kick you into a new & higher tax bracket in a heartbeat if your crystal ball is foggy and you make too much money to stay in the 15% bracket in '99/00/01. For more info, pls see
http://www.fairmark.com/IRAs/Roth which is a *GREAT* website devoted to the Roth IRA (Thanks, KAT in Chicagoland!)

CAS.

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Author: SnootFool Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2827 of 75838
Subject: Re: Roth conversion questions Date: 4/14/1998 6:16 PM
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Pooksterish-

You wrote- <I'm trying to figure out the logic behind making someone pay taxes on the converted amount that is income to the traditional IRA (as opposed to the
contributions made to it). Since income grows tax free in both a traditional IRA and a Roth IRA, why should one have to pay tax on this income during a conversion? This sounds like a penalty to me.>

Technically, income grows tax-*free* only in a Roth, Traditional IRAs grow tax-*deferred* until distributed. Unfortunately for all of us, the IRS considers a Roth conversion an authorized distribution, which of course, is a taxable event. (Whether you consider taxes a penalty is a philosophical issue, at the IRS a *penalty* would be 10% additional clams-Ouch)
Just think of the taxes as the soaking you get running from a good shelter (the traditional IRA) to a Great one (the Roth). You (& most folks), living in the 15% bracket now, will more than make up the loss in the LONG RUN (20-30+ years), assuming you pay the taxes from $$ outside your IRA (this last bit is *critical* too).
Remember, your goal is to Foolishly invest your way into a higher bracket by retirement time! You are 'locking in' your current 15% bracket on every Roth contribution. Neat trick.
Chris S.

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Author: LasVegasFool One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2830 of 75838
Subject: Re: Roth conversion questions Date: 4/14/1998 9:23 PM
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>Thanks for your help. One more thing: I'm trying to >figure out the logic behind making someone pay
> taxes on the converted amount that is income to the >traditional IRA (as opposed to the
> contributions made to it). Since income grows tax >free in both a traditional IRA and a Roth IRA,
> why should one have to pay tax on this income during >a conversion? This sounds like a penalty to
> me. What am I missing?

Traditional IRA's are generally deductible, Roth's aren't. In the long run, deductible contributions and taxed income comes out the same as taxable contributions and nontaxed income, *IF* you put in the same true amount. (However, with Roth, you get to put in more true $.)

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