Is this correct - IRA conversion

[nessa]

Hey friends! Another question for you. I've (finally) decided that having a Roth IRA will be worth it for me. I currently have: money in I Bonds (long term funds); 401k with my employer (bulk of my retirement fund), and a traditional IRA through Vanguard.

I am ready to convert part of my traditional IRA to a Roth IRA and let it sit til I need it. I did some math and I think paying tax on the conversion will about equal what my federal refund has been, so it will be a zero sum when I do my taxes, and I'm fine with that.

So, is this how I do it?
1) open a Roth IRA with Vanguard
2) convert xx$ from traditional to Roth
3) When I file my 2023 taxes I will figure out and pay the taxes on the amount I converted based on my tax bracket

Or, do I need to pay taxes at the time I convert the money?

[bacchi]

Since you get a refund, you can delay paying taxes until tax season without a penalty. Vanguard will send you an 8606 in the spring.

You'll be paying taxes on the conversion at the marginal bracket, however. If you're still working, and it sounds like you are, that might not be the wisest thing to do. Usually, conversions are done in the retired stage when earned income is minimal.

[reeshau]

You could also switch your 401k contributions to Roth, if your plan has that as an option.

[MDM]

If your withholding gets you into any of the Safe harbors then you don't need to make an estimated tax payment.

See Traditional versus Roth - Bogleheads for the math that matters.

[secondcor521]

Vanguard will send you an 8606 in the spring.

It'll be a 1099-R in January.  I know what you meant, but it might have confused the OP.

(8606 is an IRS form that has three parts to it which one fills out and attaches to one's tax return in certain circumstances.)

[nessa]

@secondcor521 LOL everything confuses this OP LOL

@MDM thank you for the links, reading them now!

@reeshau I do have that option with my work's 401k but my 401k contributions are lowering my taxable income (which I think is favorable?)

@bacchi I started with a traditional IRA exactly for the tax reason (I'll be in a lower bracket when I stop working full time and won't pay as much tax on those withdrawals) but I'm coming around to the idea that having the money sit in a Roth IRA for over 5 years before I touch it has a slight advantage "if/when" I need some of that investment before 59 1/2.

SECOND QUESTION: When I do open up a Roth IRA, can I just invest it in the same stuff I have in my traditional (VTSAX, VTIAX, VSGBX) or is that redundant. SHould I find "different" things to invest the Roth monies in?

[secondcor521]

SECOND QUESTION: When I do open up a Roth IRA, can I just invest it in the same stuff I have in my traditional (VTSAX, VTIAX, VSGBX) or is that redundant. SHould I find "different" things to invest the Roth monies in?

I think it's best to determine your asset allocation first, then decide where to place assets.

On the second part, this might be useful:

https://www.bogleheads.org/wiki/Tax-efficient_fund_placement

[plog]

So, is this how I do it?...

Yes that's what you do.  But I suggest just calling Vanguard and tell them what you want to do.  They'll be able to answer questions and maybe even do everything needed right there for you.

I've (finally) decided that having a Roth IRA will be worth it for me.

1. How did you come to that decision?  2.  Why is conversion they way to achieve this?

I did some math and I think paying tax on the conversion will about equal what my federal refund has been, so it will be a zero sum...

Perhaps in one manner, but not in the way that matters most.  This whole retirement account game is about minimizing taxes, not zeroing out what you owe in one particular year.  Your refund really shouldn't matter in this, but what tax bracket you will be converting into.  You should only convert from traditional to roth an amount that will not push you into a higher tax bracket for the conversion.  If have 15000 to convert and are 4000 from the top of the 12% bracket you should only convert 4000, otherwise you will be paying 22% on that other 11000.   

[zolotiyeruki]

Perhaps in one manner, but not in the way that matters most.  This whole retirement account game is about minimizing taxes, not zeroing out what you owe in one particular year.  Your refund really shouldn't matter in this, but what tax bracket you will be converting into.  You should only convert from traditional to roth an amount that will not push you into a higher tax bracket for the conversion.  If have 15000 to convert and are 4000 from the top of the 12% bracket you should only convert 4000, otherwise you will be paying 22% on that other 11000.

^^^ This is the best answer.

There are several situations where a Roth makes a lot more sense:
1) you can stay in the 12% tax bracket
2) you're past the income limit for deductible IRA contributions, but still within the income limit for Roth IRA contributions, and you've already maxed out your 401k contribution
3) you somehow calculate that your spending (and correspondingly, your income and therefore tax rate) in retirement will be higher than while employed

[Sandi_k]

There are several situations where a Roth makes a lot more sense:

3) you somehow calculate that your spending (and correspondingly, your income and therefore tax rate) in retirement will be higher than while employed

This is us. I have spent 30+ years optimizing our savings, and contributing to retirement. When I retire, I will have a pension that replaces ~ 85% of my salary. However, those tools that I've used to lower my taxable income will no longer be available to me:

- No pension contribution.
- No 403(b)/457 contribution.
- No pre-tax health premium
- No pre-tax LT/ST Disability, parking, FSA accounts.

So my taxes will go UP in retirement. Add to that calculation the current plan that US tax rates are set to revert to the old brackets in 2026....and yep, conversions look pretty smart to us - especially since I can pay the taxes - as we convert - from my W-2 job, via overwithholding.

This year we plan to convert ~ $28k in DH's SEP-IRA to Roth. Next year, we'll take 50% of the remainder and convert. And in 2025, the last of it will be converted.

I have also changed my pre-tax contributions into a 457 plan into the NEWLY available Roth 457. I am hoping to get another $40k or so into Roth accounts for me between now and retirement in late 2025.

So yes - there absolutely are circumstances where tax rates and amounts can be higher in retirement. I encourage you to do an analysis given your current income, and the estimated income in retirement, WITHOUT all of the tax shelters we are all so fond of....