Author Topic: Opening a Roth IRA as a future conversion vessel?  (Read 1662 times)

The Pigeon

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Opening a Roth IRA as a future conversion vessel?
« on: September 22, 2015, 07:56:32 PM »
Hi, I'm hoping some of you can guide me with the idea of opening a Roth IRA as a "vessel" for future Traditional-IRA conversions?

This would be the last year in which I can open a Roth, because I will not have any earned income next year, thanks to having FIREd in June. :-D

I've read a number of articles about doing the Roth conversion ladder, and most address the strategy as a way to provide income. I don't need to access the income, but it occurred to me that there might be some tax benefits by converting small portions of the tIRA over the years into the Roth (and cost-averaging the tax bill), rather than just withdrawing (when the time comes) from the tIRA and paying taxes at whatever tax bracket rate I happen to be in at the time. Or perhaps it would more of a headache than an advantage, and generate too much paperwork to move small amounts yearly out of the tIRA into the Roth? I may not need to access the money in the IRA as income for a long time.

I don't know what my income will be in future years, it depends on how my taxable accounts do, so it's hard to forecast any future-tax bracket projections.

This is likely a dumb question or not very well thought out... I'm not sure I can articulate it more clearly. I hope it may elicit some insight.

Thanks,
The Pigeon.




terran

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Re: Opening a Roth IRA as a future conversion vessel?
« Reply #1 on: September 22, 2015, 08:18:05 PM »
You shouldn't have any problem opening a roth later for conversions with or without earned income, so that isn't really a factor, but it might be worth opening one now to get the clock started on the 5 year rule related to when the roth was opened. This one applies whether or not you're over 59 1/2, so while you might be eligible for penalty free withdrawals because you're over 59 1/2, the roth has to have been open for 5 years. If you're under 59 1/2 then the conversion still needs to "age" 5 years, so this may not matter in that case. Here's an excellent post on all that: https://www.kitces.com/blog/understanding-the-two-5-year-rules-for-roth-ira-contributions-and-conversions/

Even if you don't need the money for quite some time it can be a great idea to start conversions as soon as possible to use up as much of the lower tax brackets as you can. How much you want to convert (and at what tax brackets) depends on how much money you have in traditional IRAs, but you basically want to try to balance it so you convert up to the bracket you're going to be pushed into once you hit 70 1/2 and have social security and RMDs (required minimum distributions) from your IRA.

One other factor that needs to be considered now is any Affordable Care Act subsidies you might be eligible for. While the advice used to be to convert at least to the top of the 15% tax bracket, you may now want to convert much less than that if it will allow you to more than make up for the additional taxes you'll eventually pay with the ACA subsidies you could receive.


MDM

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Re: Opening a Roth IRA as a future conversion vessel?
« Reply #2 on: September 22, 2015, 10:47:36 PM »
You shouldn't have any problem opening a roth later for conversions with or without earned income, so that isn't really a factor, but it might be worth opening one now to get the clock started on the 5 year rule related to when the roth was opened. This one applies whether or not you're over 59 1/2, so while you might be eligible for penalty free withdrawals because you're over 59 1/2, the roth has to have been open for 5 years. If you're under 59 1/2 then the conversion still needs to "age" 5 years, so this may not matter in that case. Here's an excellent post on all that: https://www.kitces.com/blog/understanding-the-two-5-year-rules-for-roth-ira-contributions-and-conversions/

Even if you don't need the money for quite some time it can be a great idea to start conversions as soon as possible to use up as much of the lower tax brackets as you can. How much you want to convert (and at what tax brackets) depends on how much money you have in traditional IRAs, but you basically want to try to balance it so you convert up to the bracket you're going to be pushed into once you hit 70 1/2 and have social security and RMDs (required minimum distributions) from your IRA.

One other factor that needs to be considered now is any Affordable Care Act subsidies you might be eligible for. While the advice used to be to convert at least to the top of the 15% tax bracket, you may now want to convert much less than that if it will allow you to more than make up for the additional taxes you'll eventually pay with the ACA subsidies you could receive.
^Good advice.

To put more precision on the numbers (accuracy will still depend on your guesses for investment returns), you could do some work with www.i-orp.com.  It will consider Roth conversion options and at least some ACA considerations.