tIRA to Roth conversion question

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Topic Author
ilmz
Posts: 4
Joined: Wed Oct 27, 2021 7:42 am

tIRA to Roth conversion question

Post by ilmz »

Hi all,

I have a question relating to conversion of my wife's traditional IRA to Roth IRA. I am in an income bracket that precludes me from doing tIRA and got married this year. My wife currently does not work and had contributed two years' worth of money to her tIRA prior to getting married. She did not contribute anything to the tIRA this year.

Given that we will be filing taxes jointly this year, I understand that she is unable to contribute to the tIRA this year as our combined income is above the threshold to be able to utilize the tIRA (this is the case with my income alone using the limit that applies to married couples). Going forward, I would like to contribute the annual maximum to her spousal Roth IRA. However, I understand that the backdoor Roth is complicated by her existing balance in the tIRA due to the pro rata rule.

In this situation, would the sensible thing to do be to convert her tIRA to Roth this year and pay the taxes, since we will presumably be contributing to the Roth for her for the next 25+ years? Separately, given that her tax bracket was much lower when she contributed to the tIRA, by converting to Roth now when she is at a higher tax bracket due to marriage, would she actually come out worse than had she not contributed to the tIRA in the first place (since the principal amount+gains would presumably be taxed at her current, post-marriage bracket)?

Your advice would be very much appreciated.

Thanks!
SpideyIndexer
Posts: 866
Joined: Thu Apr 02, 2015 10:13 pm

Re: tIRA to Roth conversion question

Post by SpideyIndexer »

We would need more details in order to suggest "the sensible thing." The most important is your income. If your joint income puts you in a reasonably low bracket, a Roth conversion now and in future years may make sense. IMO, converting up to 22% or even 24% is a reasonable strategy, especially if you both are many years away from retirement. Depending on your joint investment income, you may want to convert up to the NIIT threshold.

Roth space has more value the longer your time horizon for assets to grow. If you are close to retirement coupled with today's high equity valuations, I would advise more caution in planning a large conversion for which you would pay a large amount of taxes.
SpideyIndexer
Posts: 866
Joined: Thu Apr 02, 2015 10:13 pm

Re: tIRA to Roth conversion question

Post by SpideyIndexer »

We would need more details in order to suggest "the sensible thing." The most important is your income. If your joint income puts you in a reasonably low bracket, a Roth conversion now and in future years may make sense. IMO, converting up to 22% or even 24% is a reasonable strategy, especially if you both are many years away from retirement. Depending on your joint investment income, you may want to convert up to the NIIT threshold.

Roth space has more value the longer your time horizon for assets to grow. If you are close to retirement coupled with today's high equity valuations, I would advise more caution in planning a large conversion for which you would pay a large amount of taxes.
DSInvestor
Posts: 11647
Joined: Sat Oct 04, 2008 11:42 am

Re: tIRA to Roth conversion question

Post by DSInvestor »

Welcome to the forum.

There is no income limit that disallows Traditional IRA contributions. However, for those who are covered by an employer sponsored retirement plan, there are income limits that may disallow the Traditional IRA deduction.

See IRS page on IRA Deduction Limits:
https://www.irs.gov/retirement-plans/ir ... ion-limits

Now that you are married filing joint tax return, are you eligible for direct Roth IRA contributions? If eligible, there is no need to do Roth conversion or to consider Backdoor into Roth IRA. The Roth IRA income limits are higher for those filing married filing jointly vs Single. For 2021 tax year, full Roth IRA is allowed if MFJ Income is under 198K vs 125K for Single filer. Direct Roth IRA contribution avoids the issue with IRA basis proration.

Here is a link to IRS Page on Roth IRA that shows the current income limits for 2020 and 2021 tax years:
https://www.irs.gov/retirement-plans/roth-iras

If your combined income on the joint tax return does not allow you to contribute directly to Roth IRA, then you would need to use the backdoor into Roth IRA.
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Topic Author
ilmz
Posts: 4
Joined: Wed Oct 27, 2021 7:42 am

Re: tIRA to Roth conversion question

Post by ilmz »

Thanks for the responses. I don't think my original post was as clear as it could be. I earn about 350k this year and expect to earn around 400k next year. My wife currently does not work. I understand under this situation my only option to contribute to IRA under my wife's name is to do a backdoor Roth (as I have done for myself for several years). Since my wife already has a traditional IRA that has a balance, I understand the pro rata rule comes into play if I try to do backdoor Roth under her name. So my question was whether I should convert the tIRA to Roth now, take a tax hit, thereby allowing me to utilize Roth IRA for her for future years to come. I am not sure if this is clearer, or if more information would be helpful. Thanks all.
SpideyIndexer
Posts: 866
Joined: Thu Apr 02, 2015 10:13 pm

Re: tIRA to Roth conversion question

Post by SpideyIndexer »

I overlooked the "25 years" of contributions and see some future income estimates. So I would recommend converting at least up to the NIIT threshold, perhaps up to the end of the 24% bracket and taking the tax hit, OR up to the limit of the tIRA assets whichever comes first. Depending on the size of the tIRA and/or tax law changes, you may need to decide on your strategy for next year. It's possible backdoor Roth contributions will become illegal for 2022; stay tuned. But that won't invalidate my suggestion which gives you some hedging against future tax rates.

In fact, if your wife's tIRA is small and you have additional tax-deferred assets (tIRA or 401(k), you may want to convert some of them up to the appropriate total amount. But it is best to first zero out the TD assets of one of you to keep open the option for future backdoor contributions, especially if the tax bill is still being negotiated.

There have been looong discussions about modelling and optimization. Bottom line is no optimization is going to be iron-clad since we don't know future rates of return nor do we know future tax codes. So one may want to diversify between Roth, TD and taxable investments.
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