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Author: froggies Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 267388  
Subject: Take a crack at this Roth rollover tax puzzler? Date: 4/4/2013 11:38 AM
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I need some good tax-related advice with an unusual situation. Can anyone help?

I have about $250,000 in a 403b account. I earned that from my job at a university. I quit that job three years ago and haven't sought work since. The money is still in a 403b, administered by Fidelity.

Meanwhile my wife has started working and earns more than $325,000 a year. We pay a lot of income tax to Uncle Sam and to the state of California.

I want to roll 403b money over into an IRA, either a Roth IRA (which only became possible relatively recently) or a traditional IRA.

My wife's retirement is more than 25 years away. My wife will receive a relatively rich retirement if she stays in her current work: she will receive more than 50% of her highest annual income as a pension, and she also has a 401k.

Given this future, the advantages of rolling my $250,000 in Roth IRA money are obvious. The disadvantage is also obvious: I would have to pay state and federal taxes immediately to convert the money from a 403b to a Roth.

My income now and for the next few years is going to be $0: I am not seeking work. The 403b is in my name. Is there any way we could use this fact to our advantage? One idea that leaps to mind is to do "married filing separately" for the tax year of the rollover. My income is $0. I can't imagine I would pay a lot of tax in this scenario.

If this is not allowed: what would you do in my case? Is it worth it to save up the $75,000 or $100,000 to pay the taxes to roll over my 403b to a Roth IRA? Or would I be better off investing that money and paying Uncle Sam in our retirement?

Lots of considerations. Thanks for listening, and thanks for any ideas you can offer!
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Author: 2gifts Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 261305 of 267388
Subject: Re: Take a crack at this Roth rollover tax puzzl Date: 4/4/2013 11:53 AM
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Similar to the previous poster, I would recommend you ask this question on the Tax Strategies board where the tax pros hang out. Here's a pointer for you http://boards.fool.com/tax-strategies-100155.aspx?mid=306210...

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Author: Fuskie Big funky green star, 20000 posts Top Favorite Fools Old School Fool Ticker Guide SC1 Red Winner of the 2010 Rule Breakers Challenge Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 261306 of 267388
Subject: Re: Take a crack at this Roth rollover tax puzzl Date: 4/4/2013 12:51 PM
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The benefits of a Roth IRA are predicated on the idea that you will be earning more when you are ready to take distributions than you do now, so that the tax liability on your income is less today than it will be tomorrow. You say your wife is retiring in 25 years but not whether you intend to return to work after 3 years or how long until you plan to retire.

You should have been eligible to roll your 403b over to a Traditional IRA (TIRA) after you left your job 3 years ago. You would have to roll it over to a TIRA first, then have the option of converting it to a Roth IRA (RIRA). And Until you convert to a RIRA, there is no tax liability. Fidelity is an good financial institution and can help you with all of these operations if you want to continue to maintain your retirement savings with Fidelity.

If you don't plan to return to work for a while or at all, there may be no rush to convert to a RIRA. If you earn $0 today and $0 over the next three years, your situation won't have changed much. And given DW's earned income level, you are probably already in the upper tax bracket, so that scenario will not change for you. Note that I am not a tax specialist (or any kind of specialist), but it seems to me that your financial picture is relatively stable, so other than rolling over to a TIRA, you don't have an immediate need to convert to the Roth IRA.

On the other hand, if you do plan to go back to work and do expect to be earning a sizable amount of money, you may want to move in this direction now. In any case, I would work with a tax accountant or even an adviser at Fidelity to determine what your actual rollover tax liability would be so you can determine if you have the cash to pay what you would owe.

Either way, you can invest the money in your TIRA or RIRA as you see fit. You will not be taxed annually on your earnings but your retirement distributions will be taxed as income when they occur.

Fuskie
Who notes that you cannot take your tax liability out of the amount you are rolling over to the RIRA as that would be considered an early distribution and carry a penalty on top of the tax liability...

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Author: NoblyNaive CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 261308 of 267388
Subject: Re: Take a crack at this Roth rollover tax puzzl Date: 4/4/2013 2:16 PM
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"Is it worth it to save up the $75,000 or $100,000 to pay the taxes to roll over my 403b to a Roth IRA?"

Are you implying, with that statement, that you can rollover/convert the entire amount (let's say $250K) to a Roth in one year? I did not know you could do this. I thought to max you could roll over per year was...

2012 Roth $5000 + $1000 (if over age 50) = $6000 max.
2013 Roth $5500 + $1000 (if over age 50) = $6500 max.

Also, I thought that the money converted from a TIRA to a RIRA had to be in the TIRA for at least two years before the conversion.

I am not a tax professional. Just parroting back what I've heard in my own little journey of the last few months. I've been moving AFTER-tax money from a 401(k) directly to a RIRA. If I understand correctly, I have no tax or penalty on the original after tax money; taxes, but no penalty, on the earnings (growth) of the after tax.

If there is a way to move a big chunk of money (like $100K or $250K) from a 401(k) to a TIRA and then (even after a 2 year wait) plunk the entire amount into a RIRA, I would find that very personally interesting, indeed.

Jeff

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Author: pauleckler Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 261309 of 267388
Subject: Re: Take a crack at this Roth rollover tax puzzl Date: 4/4/2013 2:26 PM
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2012 Roth $5000 + $1000 (if over age 50) = $6000 max.
2013 Roth $5500 + $1000 (if over age 50) = $6500 max.


These are the limits for contributions of new cash to the accounts. They do not apply to sums being rolled over from an existing qualified retirement account.

Yes, you can rollover very large sums from a 401K or pension account to an IRA. Roth sometimes has limits on conversions.

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Author: Fuskie Big funky green star, 20000 posts Top Favorite Fools Old School Fool Ticker Guide SC1 Red Winner of the 2010 Rule Breakers Challenge Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 261310 of 267388
Subject: Re: Take a crack at this Roth rollover tax puzzl Date: 4/4/2013 3:25 PM
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I believe OP could roll over his entire TIRA to a RIRA, or he could break it into 3rds for each year that he plans to have no income. There used to be limitations high income earners, but those rules were eliminated.

Here's a great article that steps you through the process of calculating the tax advantages and liabilities:

http://taxes.about.com/od/retirementtaxes/a/Roth-IRA-Convers...

For the purpose of this situation, all the funds are tax deductible because they came from a rolled over 403b account and were not individual cash contributions, which would have been subject to income limitations.

Be aware that you are allowed to perform only one rollover per year per IRA account.

The article continues:

Converting to a Roth IRA makes sense in the following situations, in my opinion:

1. You have funds (outside of a retirement account) to fully pay the tax for converting to a Roth.

2. The value of your traditional IRAs has fallen, and converting now is more affordable.

3. You expect to be in roughly the same tax bracket or in a higher tax bracket in retirement than you are in currently.

4. You can utilize losses or deductions or credits to help offset the tax impact of a Roth conversion.


From what OP has said, I think items 3 applies but he will have to decide if any of the others do.

Converting to a Roth IRA does not make sense, in my opinion, in the following situations:

1. You do not have cash funds sufficient to fully pay the tax of the Roth conversion.

2. You expect to be in a lower tax bracket in retirement than you are in currently.

3. You may need to tap into your IRA funds in the next five years and you are or will be younger than age 59.5 when you need to tap into these funds.


This brings up an important point which I neglected previously. When you make a cash contribution to a Roth IRA, because the contribution amount is not tax-deferred as in a Traditional IRA, you can withdraw the value of that original contribution (but not any earnings in excess of that contribution) at any time tax and penalty free. But when you convert from a TIRA to a RIRA, those funds have to be held in the Roth for 5 years before you can take distribution without incurring a penalty.

Fuskie
Who still encourages discussing options with a tax professional given the volume of of the retirement savings plan and the unique household situation...

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Author: froggies Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 261311 of 267388
Subject: Re: Take a crack at this Roth rollover tax puzzl Date: 4/4/2013 4:19 PM
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Thanks everyone, the information so far is great. I'll offer a bit more detail in a minute.

The ability to convert a 401k/403b plan to Roth IRA monies regardless of income seems extraordinary to me, to the point of being an unintended loophole. Roth contributions are ordinarily quite limited per year and phased out for high earners, yet this is a mechanism by which you can dump a huge sum into a RIRA even after you're wealthy.

I was not aware that you could convert to a Traditional IRA and then subsequently convert to a Roth. I was also not aware that I could repeatedly convert portions of my Traditional IRA to Roth over a course of years. That's very useful to know, because I'm not sure of where the money will come from.

I see two advantages to the Roth for high-income/high-asset people, one of which hasn't been mentioned yet. Under Roth, you pay no tax on withdrawal, which everyone knows. But if the article I read is correct, the income you withdraw does not contribute to "income" you take at retirement and will not push you into higher marginal tax brackets. This seems significant, especially if taxes go up in the future, which seems the direction the country is headed.

I believe the Roth's unique advantages may not exist forever, as lawmakers recognize that they're giving away the farm, but people with assets already in place will be permitted to the terms they were promised.

As for our situation:
* Mrs. Froggies' income is stable and will only go up as she continues her work. Disregarding inflationary effects, I expect she'll be making 1/3rd- 2/3rds more than she is now by the time she retires, maybe more.

* I will "retire" (become eligible to take contributions) around the same time that Mrs. Froggies does. We are roughly the same age.

* I would consider going back to work but frankly the design of the federal and state tax codes are extremely powerful disincentives to productively applying my hard-won skills. We are raising a family now. There is no need or incentive for me to return to work anytime soon. Mrs. Froggies' income will always be 3X-8X what I can be guaranteed to make. My skills may be better applied to tending to my son, working in our garden, investing our money, and musing over thought-provoking retirement savings questions like these.

* We will not need access to any of my Roth monies for 5 years and we will not need to take early distributions. We have various insurance such that even unexpected disability or death will leave us financially in very good shape.

* Hard to know what sort of tax professional I should talk to. My experiences to date are that I can get more and better information in places like the Fool. I have not found a tax professional that is sufficiently creative or knowledgeable or independent to handle questions like these well. The people I've talked with tend to be storehouses of obsolete information and/or have something they want to sell me. Suggestions welcomed.

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Author: pauleckler Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 261313 of 267388
Subject: Re: Take a crack at this Roth rollover tax puzzl Date: 4/4/2013 7:16 PM
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Roth is a great program in many ways, but for conversions, the income taxes paid for the conversion can be forbidding. To convert a million dollar 401K may sound attractive, but fed, state, and local taxes can take a very hefty bite.

Personally I would not convert when your fed tax rate is over 25% (unless you are convinced your tax rate will be much higher later.) I'd wait for a better tax deal to decide when to pay. Do convert every dollar you can at 15% or less. You will probably never see a better deal.

For small sums, conversions are not a big deal. And of course if your Roth has 30 yrs to grow, you hope your funds will become very large by the time you retire.

But note that when tax rates are the same pretax IRA is mathematically identical to after tax Roth (when the investments grow at the same rate of return). You need to estimate your tax rates vs now to make good decisions.

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Author: Fuskie Big funky green star, 20000 posts Top Favorite Fools Old School Fool Ticker Guide SC1 Red Winner of the 2010 Rule Breakers Challenge Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 261315 of 267388
Subject: Re: Take a crack at this Roth rollover tax puzzl Date: 4/5/2013 12:57 AM
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I believe the Roth's unique advantages may not exist forever, as lawmakers recognize that they're giving away the farm, but people with assets already in place will be permitted to the terms they were promised.

I think just the opposite. Who gives the most money to politicians? The people who have the most money. But people who have large sums of money usually don't want to move their assets into a Roth because they don't expect to be making the same kind of cud as they are now.

As for who to turn to professionally for tax advice, I would start with whomever does your taxes. If you use software, then see if they have a service through which you can purchase a consultation.

Fuskie
Who hesitates to give any kind tax advice because he doesn't have any qualifications to do so, but if he were in your shoes, he would probably assume that on an individual basis, if he was not planning on returning to work, then taking distributions of only what you need in retirement would be a more effective way to minimize tax liability than converting large sums of cash to a Roth IRA now...

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