Roth vs. Trad IRA Benefits - even from converting LATE?! (like 70 y/o late)

[JAG]

I was talking to my dad the other day and he reflected on his frustration over paying RMD's despite his living costs being much less than he needed to withdraw. I was pleased to know that I knew he had a Traditional IRA without him telling me and thankful that I am investing in ROTH's. I am not a financial advisor, but a DIY investor.

I get it, my dad's problem is a good problem to have, but this article reveals some pretty stimulating information (if you are interested in finance stuff) that supports the use of ROTH's that expand beyond avoidance of cap gain tax on your investments and avoiding RMD's.

https://www.wsj.com/personal-finance/taxes/roth-ira-conversion-tax-c65a41fd?st=nDGXeF&reflink=desktopwebshare_permalink

 

[npaden]

It is very common for people as they hit retirement to do Roth conversions. It's almost all about the tax rate. Use the tax brackets to your advantage.

So many people miss out on having income taxed at low tax rates. One of my co-workers husband is a farmer and they had a terrible year farming last year. Big loss. She took that as an opportunity to convert all of her 401k balances (even the employer side - we just amended our plan to allow in plan Roth conversions) to Roth. Ended up paying tax on the conversion at 10%.

 

[jimh406]

I'm not a financial advisor, but your Dad can probably move some of the RMD into a Roth each year. If he didn't last year, he could put the limit into a Roth for last year until April 15. Otherwise, he can put in for this year both for he and his wife assuming he's married.

 

[westbranch]

I'm not a financial advisor, but your Dad can probably move some of the RMD into a Roth each year. If he didn't last year, he could put the limit into a Roth for last year until April 15. Otherwise, he can put in for this year both for he and his wife assuming he's married.

You are referring to regular Roth contributions which requires wages/earned income. It is specifically prohibited to convert RMDs to Roth. Roth conversions are a whole different game than Roth contributions. Plenty of people do them DIY but if someone doesn't understand them they should work with a CPA or other professionals.

 

[elkantlers]

Buy dirt with the extra money.

 

[LopeHunter]

Is the goal to leave the Roth accounts as a Legacy? Family tax planning can be wrecked if leave Traditional IRA to someone that is in a higher Federal plus State combined marginal tax bracket than you.

An example, you are 62 and will leave to an offspring aged 38. You are at 25% combined marginal tax rate and they are at 35%. You pass away leaving a Traditional IRA. Under current tax law, the offspring must completely take 100% of the balance in 3,650 days. Can take on Day 1 or Day 3,650 or a bit here and there. Your offspring may be getting raises during those 3,650 days. Tax rates might go up. Yet, they have to deplete the IRA and each dollar is taxed with no option for long-term gain treatment. If you convert the IRA to Roth the current tax law does not tax distributions.

Converting to Roth increases your taxable income in that tax year so two things to consider. Medicare starts at 65 and premiums for Parts A and B are partially subsidized but if your taxable income reaches too high then the subsidy reduces. The subsidy test looks backwards tor two tax years. So, if are 62 or older then Medicare consideration is a factor.

Second, if are not leaving a Legacy then no need to consider your marginal tax rate vs offspring. Instead, focus on if is better to pay tax now or in future? I prefer in the future so only do Roth conversions now as is likely will leave a Legacy.

 

[JAG]

You are referring to regular Roth contributions which requires wages/earned income. It is specifically prohibited to convert RMDs to Roth. Roth conversions are a whole different game than Roth contributions. Plenty of people do them DIY but if someone doesn't understand them they should work with a CPA or other professionals.

RMD's aren't regular income, so you are correct.

With the conversion part, you can transfer too much at once and shoot yourself in the foot.

I sent him the article and he's going to start talking with his advisor. I can't wait to hear what they have to say; mainly because I want to learn how they hopefully help him take advantage of this potential opportunity to convert in his 70's.

 

[JAG]

...
Second, if are not leaving a Legacy then no need to consider your marginal tax rate vs offspring. Instead, focus on if is better to pay tax now or in future? I prefer in the future so only do Roth conversions now as is likely will leave a Legacy.

What if he's not leaving a legacy, is there a need to consider marginal tax rate if it's moving from 36 to 24? Likely not if it's a move from 24 to 22.

Is your focus question referring: 'to pay tax now [for the conversion] or in the future [on subsequent rmd's]?'

So, if he converts to a Roth, his heirs don't have to withdraw for ten years. May the heirs roll over into their Roth's and make it their own without tax issues?

 

[npaden]

Is the goal to leave the Roth accounts as a Legacy? Family tax planning can be wrecked if leave Traditional IRA to someone that is in a higher Federal plus State combined marginal tax bracket than you.

An example, you are 62 and will leave to an offspring aged 38. You are at 25% combined marginal tax rate and they are at 35%. You pass away leaving a Traditional IRA. Under current tax law, the offspring must completely take 100% of the balance in 3,650 days. Can take on Day 1 or Day 3,650 or a bit here and there. Your offspring may be getting raises during those 3,650 days. Tax rates might go up. Yet, they have to deplete the IRA and each dollar is taxed with no option for long-term gain treatment. If you convert the IRA to Roth the current tax law does not tax distributions.

Converting to Roth increases your taxable income in that tax year so two things to consider. Medicare starts at 65 and premiums for Parts A and B are partially subsidized but if your taxable income reaches too high then the subsidy reduces. The subsidy test looks backwards tor two tax years. So, if are 62 or older then Medicare consideration is a factor.

Second, if are not leaving a Legacy then no need to consider your marginal tax rate vs offspring. Instead, focus on if is better to pay tax now or in future? I prefer in the future so only do Roth conversions now as is likely will leave a Legacy.

This is something that can easily be overlooked even for people that don't have a lot of money in retirement accounts. My wife's mother passed away and we had been helping her financially for the last several years. My wife was helping her with her finances and just told me that she had some money in some mutual funds but failed to mention that they were in a traditional IRA. The last 5 years of her life she did not owe enough to pay taxes at all. 0% tax rate. We should have had her use up that Traditional IRA during that time but I didn't even know that it was an IRA.

When her mom passed my wife inherited the $18,000 of IRA and they were going to set it up to start making RMDs to my wife. Since it wasn't very much we just decided to cash it out since there were not any penalties associated with it and we were going to be in the same tax bracket now as we were going to be during the next 10 years. There was a few crazy things that year with our taxes and we had the qualified business income deduction still and I was shocked to see that including that $18,000 as income that year increased our taxes a little over $9,000! It was a 52% tax rate as it was phasing out the QBI deduction and a few other things.

If we had thought to have her mom convert it the tax would have been $0.

Very glad it wasn't a lot of money, and if it had been we would have probably looked into it more, but just a cautionary tale that even if you only have a little bit in an IRA you should probably look at converting it before you die.

 

[jimh406]

You are referring to regular Roth contributions which requires wages/earned income. It is specifically prohibited to convert RMDs to Roth. Roth conversions are a whole different game than Roth contributions. Plenty of people do them DIY but if someone doesn't understand them they should work with a CPA or other professionals.

I wasn't speaking of a conversion but the annual contribution limits. Once the RMD is taxed and is in your bank account, you can do what you want with it. If you want to put some of it into a Roth, you can according to numerous articles on the internet.

But, like I said, I'm not a financial advisor, but this seems pretty simple.

 

[JAG]

This is something that can easily be overlooked even for people that don't have a lot of money in retirement accounts. My wife's mother passed away and we had been helping her financially for the last several years. My wife was helping her with her finances and just told me that she had some money in some mutual funds but failed to mention that they were in a traditional IRA. The last 5 years of her life she did not owe enough to pay taxes at all. 0% tax rate. We should have had her use up that Traditional IRA during that time but I didn't even know that it was an IRA.

When her mom passed my wife inherited the $18,000 of IRA and they were going to set it up to start making RMDs to my wife. Since it wasn't very much we just decided to cash it out since there were not any penalties associated with it and we were going to be in the same tax bracket now as we were going to be during the next 10 years. There was a few crazy things that year with our taxes and we had the qualified business income deduction still and I was shocked to see that including that $18,000 as income that year increased our taxes a little over $9,000! It was a 52% tax rate as it was phasing out the QBI deduction and a few other things.

If we had thought to have her mom convert it the tax would have been $0.

Very glad it wasn't a lot of money, and if it had been we would have probably looked into it more, but just a cautionary tale that even if you only have a little bit in an IRA you should probably look at converting it before you die.

That's a great precautionary tale/example, thank you for sharing.

 

[LopeHunter]

What if he's not leaving a legacy, is there a need to consider marginal tax rate if it's moving from 36 to 24? Likely not if it's a move from 24 to 22.

Is your focus question referring: 'to pay tax now [for the conversion] or in the future [on subsequent rmd's]?'

So, if he converts to a Roth, his heirs don't have to withdraw for ten years. May the heirs roll over into their Roth's and make it their own without tax issues?

You have 10 years to withdraw the Roth funds that were passed to you at death by a non-spouse. These withdrawals leave the Roth and can’t be rolled to your personal Roth or Trad IRA. These withdrawals have left the IRA ecosystem. You can use the funds taken from that Roth as a distribution to pay for tax due if you wanted to convert your Trad IRA to a Roth or could spend any other way you desire.

 

[JAG]

Thanks! Makes sense.
Trust and verify link: https://www.bankerslife.com/insight...o-inherited-iras-for-spouses-and-non-spouses/

 

[JAG]

More exciting details geek from my finance musings to evaluate whether to convert Traditional IRAs to Roths. The key term is 'tax arbitrage' and how it manifests itself in the following example:

Jane and Fred each have traditional IRAs with $100,000. These are invested identically and double over 10 years [to $200,000]. The tax rate is 30%, so Jane pays $30,000 of tax to convert to a Roth IRA and has $70,000 to invest. At the end, she has $140,000 to withdraw tax-free.​

https://www.wsj.com/personal-financ...5?st=dmRDqW&reflink=desktopwebshare_permalink​

Meanwhile, Fred doesn’t do a conversion, and his $100,000 pot grows to $200,000. But when he withdraws it, he owes $60,000 of tax. That leaves him with $140,000 after tax, the same as Jane.​

An unlocked article from the WSG is embedded in the example above.

 

[David Gough]

I wasn't speaking of a conversion but the annual contribution limits. Once the RMD is taxed and is in your bank account, you can do what you want with it. If you want to put some of it into a Roth, you can according to numerous articles on the internet.

But, like I said, I'm not a financial advisor, but this seems pretty simple.

You need earned income to contribute to either type of IRA, just as an FYI. Sometimes that kicks retired people from putting the money into a Roth.

 

[jimh406]

You need earned income to contribute to either type of IRA, just as an FYI. Sometimes that kicks retired people from putting the money into a Roth.

Thanks.

 

[Treeshark]

The key term is 'tax arbitrage' and how it manifests itself in the following example:

This example assumes tax rates stay the same, right? That’s the gamble.

 

[JAG]

Yes, the example has its limits. The intent is to compare apples to apples and uses a fake tax percent to demonstrate how it works.

If you are just starting out with a Traditional Ira, it is a gamble as to what the rates will be when you retire or initiate the conversion.

However, it is not a gamble because you know what the tax rates are before you decide to initiate the conversion to a Roth.