Author Topic: Confirming now is time for Roth IRA conversion  (Read 2563 times)

signhere

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Confirming now is time for Roth IRA conversion
« on: January 08, 2016, 03:44:56 AM »
Apologies in advance for asking something that should be obvious based on all the info out there. I'm fairly certain of the answer (I should convert now) but just want one of you experts to ease my mind.

I am over the Roth income limit and can only contribute to traditional 401k.

I started contributing in 2014 and maxed out through 2016 for a total of 16,500. After the recent market pullback my income/market gain has been minimal, around $600.

My understanding is that now is a good time for me to convert because i will pay taxes (I'm in 33% bracket) on my minimal gains today but my growth/withdrawal will be tax free when I retire.

I'm in my mid 20s and will never withdraw before retirement so it has plenty of time to grow.

Is this correct?

I also have around 120,000 in 401k but I assume this is not relevant at all here for tax or any other purpose.

Thanks very much!!!




Vagabond76

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Re: Confirming now is time for Roth IRA conversion
« Reply #1 on: January 08, 2016, 04:31:35 AM »
There is not a lot of information here to make a good recommendation. One thing that is rarely considered on this site is that the growth, possibly over decades, in a Roth is tax-free. That benefit alone could be worth way, way more than the immediate tax deduction of a traditional.

It is incomplete to compare tax rate now versus tax rate later. One has to compare tax rate now versus (tax rate on contribution later + 0% times growth). The younger an investor is, the more likely one is to attain significant growth.

fa

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Re: Confirming now is time for Roth IRA conversion
« Reply #2 on: January 08, 2016, 05:50:42 AM »
How likely is it that your income will go up into the next tax bracket?  If it is, you are probably better off converting now.

With the laws as they are, it is much better to have a Roth IRA vs a traditional IRA.  But, the laws can and do change.  A future congress, hungry for money, may significantly change the rules pertaining to Roth IRAs, especially if there is a dire need for cash (Medicare funding for baby boomers maybe?).  Also, marginal tax rates have fluctuated wildly in the past.  Will tax rates for up dramatically in the future?  If they do, you are likely to benefit from converting now.

I don't like the idea of converting IRA money when you are in a relatively high tax bracket.  But given the above, and how young you are, I would seriously consider doing the conversion now.  If you are invested in stock, one thing you may want to consider is waiting until later in the year.  The markets are pretty jittery and you may have a lower amount to convert if a bear market develops in 2016.  I have no crystal ball but I think odds are higher for a bear market than a bull market.

I am assuming that you have cash available to pay the taxes for the conversion.  If not, I would not convert until you do.  There is no point in taking the tax money also out of your IRA.

signhere

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Re: Confirming now is time for Roth IRA conversion
« Reply #3 on: January 08, 2016, 06:27:16 AM »
How likely is it that your income will go up into the next tax bracket?  If it is, you are probably better off converting now.

With the laws as they are, it is much better to have a Roth IRA vs a traditional IRA.  But, the laws can and do change.  A future congress, hungry for money, may significantly change the rules pertaining to Roth IRAs, especially if there is a dire need for cash (Medicare funding for baby boomers maybe?).  Also, marginal tax rates have fluctuated wildly in the past.  Will tax rates for up dramatically in the future?  If they do, you are likely to benefit from converting now.

I don't like the idea of converting IRA money when you are in a relatively high tax bracket.  But given the above, and how young you are, I would seriously consider doing the conversion now.  If you are invested in stock, one thing you may want to consider is waiting until later in the year.  The markets are pretty jittery and you may have a lower amount to convert if a bear market develops in 2016.  I have no crystal ball but I think odds are higher for a bear market than a bull market.

I am assuming that you have cash available to pay the taxes for the conversion.  If not, I would not convert until you do.  There is no point in taking the tax money also out of your IRA.

Thanks for the replies.

I the cash and would come out of pocket to pay the tax now if I convert. I also think it is unlikely that I move up into the higher tax bracket at any point in the future.

I guess I'm confused because tax free growth/withdrawal seems like the no brainer most important benefit to me, and therefore that the Roth should be an easy decision. Unless I'm missing something I view it as paying tax on ~$600  (my gains over the last 3 years) now vs a tax free withdrawal on a sum that will probably be 150k at a minimum assuming I pump in the max every year. What am I missing?

fa

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Re: Confirming now is time for Roth IRA conversion
« Reply #4 on: January 08, 2016, 06:41:32 AM »
I guess I'm confused because tax free growth/withdrawal seems like the no brainer most important benefit to me, and therefore that the Roth should be an easy decision. Unless I'm missing something I view it as paying tax on ~$600  (my gains over the last 3 years) now vs a tax free withdrawal on a sum that will probably be 150k at a minimum assuming I pump in the max every year. What am I missing?

A Roth conversion at a 33% marginal tax rate means effectively your principal is reduced by 1/3 overnight.  Given the enormous effect of compounding interest over a long time, you are giving up a lot of interest/dividends by converting.  Especially given your long time horizon.  Since nobody knows the returns on investment over the next 40 years, you cannot calculate it, but the effect is rather huge.  That is the flip side of the coin in my view.

signhere

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Re: Confirming now is time for Roth IRA conversion
« Reply #5 on: January 08, 2016, 06:57:19 AM »
I guess I'm confused because tax free growth/withdrawal seems like the no brainer most important benefit to me, and therefore that the Roth should be an easy decision. Unless I'm missing something I view it as paying tax on ~$600  (my gains over the last 3 years) now vs a tax free withdrawal on a sum that will probably be 150k at a minimum assuming I pump in the max every year. What am I missing?

A Roth conversion at a 33% marginal tax rate means effectively your principal is reduced by 1/3 overnight.  Given the enormous effect of compounding interest over a long time, you are giving up a lot of interest/dividends by converting.  Especially given your long time horizon.  Since nobody knows the returns on investment over the next 40 years, you cannot calculate it, but the effect is rather huge.  That is the flip side of the coin in my view.

Interesting.. I thought I would only be taxed on my income/market gains, which were very minimal. I didn't realize the entire sum would be taxed. Big difference!

maizeman

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Re: Confirming now is time for Roth IRA conversion
« Reply #6 on: January 08, 2016, 07:23:12 AM »
You probably ran into a lot of the discussions of the "mega-backdoor roth" which is where you contribute money to a 401k which is neither tax deductible nor designated as Roth contributions. In that case if you roll those contributions over into a Roth IRA you only owe taxes on the investment gains because the original contribution was already post-tax money.

Tjat

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Re: Confirming now is time for Roth IRA conversion
« Reply #7 on: January 08, 2016, 09:33:49 AM »
Did you mean you started contributing to traditional IRA (your post says 401k) and are considering whether to convert into roth? If so, and that's correct as you mention a 401k in your last line, I think it depends on if your traditional IRA contributions were deductible or non-deductible contributions.

If non-deductible, converting is an easy yes.

if deductible, it depends on if your income is increasing to a point at which you can no longer make deductible IRA contributions and plan to pursue back-door roth contributions. If that's the plan, I'd convert now. If you plan to continue making deductible tIRA contributions, I would suggest stay that course. Generally pre-tax makes out in the long run, so I would advise sticking with those if you can.

http://www.madfientist.com/traditional-ira-vs-roth-ira/


signhere

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Re: Confirming now is time for Roth IRA conversion
« Reply #8 on: January 08, 2016, 09:47:46 AM »
Did you mean you started contributing to traditional IRA (your post says 401k) and are considering whether to convert into roth? If so, and that's correct as you mention a 401k in your last line, I think it depends on if your traditional IRA contributions were deductible or non-deductible contributions.

If non-deductible, converting is an easy yes.

if deductible, it depends on if your income is increasing to a point at which you can no longer make deductible IRA contributions and plan to pursue back-door roth contributions. If that's the plan, I'd convert now. If you plan to continue making deductible tIRA contributions, I would suggest stay that course. Generally pre-tax makes out in the long run, so I would advise sticking with those if you can.

http://www.madfientist.com/traditional-ira-vs-roth-ira/

 Yes, I have 16k in my traditional IRA and 120k in my 401k. I'm considering converting the 16k. All of the 16k was funded Post tax and while my income was 200kish. I assume it's an easy yes then (sorry not sure what deductible vs non means!)
« Last Edit: January 08, 2016, 09:52:16 AM by signhere »

Tjat

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Re: Confirming now is time for Roth IRA conversion
« Reply #9 on: January 08, 2016, 11:47:37 AM »
Yes, I have 16k in my traditional IRA and 120k in my 401k. I'm considering converting the 16k. All of the 16k was funded Post tax and while my income was 200kish. I assume it's an easy yes then (sorry not sure what deductible vs non means!)

Got it. In that case, my opinion is that converting to Roth makes sense. By deductible, I meant that up until a certain income threshold, you're allowed to deduct tIRA (traditional IRA) contributions from your taxes (up to the limit, currently 5,500 not including any potential "catchup" contributions). With non-deductible tIRA contributions, there's really no point of keeping money in the traditional account as there are no tax benefits to your earnings. A rIRA will allow you to withdraw all funds (contributions + earnings) tax free when you're old enough.

In your case, the only cost of converting now is you will have to count your tIRA earnings as income. Going forward, you can do what's called a "back-door Roth" by making a non-deductible tIRA contribution and converting to a Roth. There is some debate as to how long you should wait to convert. Technically, you can do it the next day, but some argue that the IRS may not like this (yet they have never commented/acted on it).