Taxes on Roth Conversion

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Topic Author
glamourzolt
Posts: 15
Joined: Wed Sep 25, 2019 3:53 pm

Taxes on Roth Conversion

Post by glamourzolt »

I am 61 years old and in process of a Roth conversion. Does it matter if I use money from my taxable account or traditional IRA.

My analysis says that is doesn't matter since I am over 59 1/2.

Is this correct?
livesoft
Posts: 85971
Joined: Thu Mar 01, 2007 7:00 pm

Re: Taxes on Roth Conversion

Post by livesoft »

If "matter" means paying more taxes or not, then Yes, it probably does matter. One can do two different "What if?" tax returns today with each scenario and see what I mean.

This is because traditional IRA withdrawals are taxed differently than both return of capital (not taxed) from a taxable account and realized long-term capital gains (from a taxable account).
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cas
Posts: 2245
Joined: Wed Apr 26, 2017 8:41 am

Re: Taxes on Roth Conversion

Post by cas »

Depends.

If you pay out of taxable, you get to move the whole converted amount from tIRA to Roth IRA, where it can compound tax-free. If you pay taxes out of tIRA, the amount that makes it into the Roth is reduced correspondingly.

If you can pay the taxes out of cash from your taxable account or out of a dividend stream from your taxable account, then that effectively means you just were able to "contribute" that amount (the amount you paid in taxes) to the Roth, eliminating the taxable account tax drag (due to dividends/interest) on the taxes-paid amount of money as long as it remains in Roth.

If you were going to have to raise the cash in the taxable account by liquidating appreciated assets, incurring tax, then the calculation becomes more complex.
Exchme
Posts: 1323
Joined: Sun Sep 06, 2020 3:00 pm

Re: Taxes on Roth Conversion

Post by Exchme »

livesoft wrote: Thu Jul 29, 2021 8:48 am If "matter" means paying more taxes or not, then Yes, it probably does matter. One can do two different "What if?" tax returns today with each scenario and see what I mean.

This is because traditional IRA withdrawals are taxed differently than both return of capital (not taxed) from a taxable account and realized long-term capital gains (from a taxable account).
Another way to put it is that since you should stay within your chosen tax bracket for your Roth conversion, you can do a bigger conversion by paying taxes out of your taxable account.
cas wrote: Thu Jul 29, 2021 9:22 am
If you were going to have to raise the cash in the taxable account by liquidating appreciated assets, incurring tax, then the calculation becomes more complex.
Yes, OP needs to look ahead with some planning software, to make sure he is doing a reasonable amount of conversions and dodging traps in the tax code now and in the future.

I like to recommend that people start with i-orp.com (use the Extended Input button partway down the page) as a quick, easy to use and valuable starting point. The tax package in i-orp is reasonable, but has some gaps (e.g. the program uses current year income for medicare IRMAA taxes instead of a 2 year look back). Remember to use the same stock/ bond asset allocation in all account types or you will accidentally be mixing the benefits of a Roth conversion with the benefits of holding more stock and won't learn anything useful from it.

If you love spreadsheets and want great flexibility, try the Retiree Portfolio Model (RPM) available at the Wiki at this site. The new beta version has an awesome new feature of keeping your overall portfolio stock/bond allocation constant while varying the stocks/bonds in the different types of accounts (you generally should keep your bonds in traditional IRA to slow that account's growth and leave your stocks in taxable and Roth to maximize their growth). That new feature allows a better analysis of Roth conversions which gives much different answers for the optimum amount to convert (in my case much smaller benefits to doing Roth conversions). The main weaknesses are it is entirely manual and it is not strong on handling capital gains taxes when you sell from taxable. Look for a thread from author BigFoot48 to get the beta with the new feature.

The portfolio tool with the best tax package I've seen is Pralana Gold ($99 1st yr, $49 updates, requires Excel). It takes care of all tax nuances I've run into. With a lot of manual fiddling, you can approximate the new RPM feature of portfolio level asset allocation. It's a locked spreadsheet, so no adding formulas, and sometimes you want to do things that its internal optimizer fights you about, but it has a lot of built-in flexibility, so you can usually get where you want to go.
Topic Author
glamourzolt
Posts: 15
Joined: Wed Sep 25, 2019 3:53 pm

Re: Taxes on Roth Conversion

Post by glamourzolt »

Thanks for the responses.

I purchased Pralana Gold based on bogleheads.org recommendations about a month ago and recently entered my data. The results confirmed my thoughts - convert up to the next tax bracket and at the same time use taxable account first to cover expenses.

The challenge is "what stock and when to convert stock held in my current traditional IRA"? to minimize tax burden.
chemocean
Posts: 1561
Joined: Mon Dec 19, 2016 8:45 pm

Re: Taxes on Roth Conversion

Post by chemocean »

If you are keeping your asset allocation constant (buying the same investment in the Roth account as you sold in your Traditional IRA), the market timing only affects taxes paid per share and not total return of investment. I have been all waiting all year (2021) for the "correction" to pay less taxes per share (same dollar amount for more shares converted in a downturn). Butgot antsy and been converting quarterly. Back to dollar cost averaging for tax timing.
Topic Author
glamourzolt
Posts: 15
Joined: Wed Sep 25, 2019 3:53 pm

Re: Taxes on Roth Conversion

Post by glamourzolt »

I have also been waiting for the correction but like "chemocean", I have been converting when it makes sense (I.e. quarterly).
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