2011 and 2012 tax rates

I suggest you set up a spreadsheet since words are not likely to convince you.

I start with $100K and the $35K that you'll use to pay the tax at the top rate.

It's a pretty large bet to convert that all now and assume that she has no chance to spread conversions out at 28% or less over the years, especially since the 28% bracket now ends at $171,850. She would have years of being able to top that bracket off.

Joe

The money does not grow tax free, and she wil be in at least the 28% bracket due to huge pension.

Yes, but tax free growth should make up for that.

FL is too humid.

Converting now allows money to grow tax free.

A zero tax rate would occur if converted now. And she will not need the money. so the MRD would force a taxable reinvestment.

The idea is to avoid having to make any MRD. Tax free growth should more than offset any higher taxes paid. Of course, the earlier the better. 2010 is th first year we could convert.

The investments are the same, be they in the IRA or Roth. The 403(b) stuff was converted to ETFs. At some point, I'll protect the ETFs by writing covered calls.

Yes, we did that in Dec 2006.

in the case I cited, declining tax brackets are not relevant. My sister is currently in the 28% bracket and will be in at least the 28% bracket when she retires.

The factors are length of time and whether market goes up If one assumes a lowly 5% return, the Roth comes out ahead.

If the market goes down, one can lose, but that's life.

Our returns last year were over 40% in all of our accounts. We do well in up years, and like others get hurt in down years. Of course, we will get clobbered in periods such as 2008 and 2000-2002.

Yes, indeed I filed a 4868 for 2009. The problem is you still gotta pay by April 2010, even if I need not file until October.

The decision to split appears to rest on whether my sister's taxable income would be above $375000 if we split over 2011 and 2012.

Of course, continuing to convert from the 403(b) to the Roth in 2011 and

Yes, I've got spreadsheets up the kazoo to figure this out.

That was the alternative I considered, but if we ASSuME that the market will rise, say 5%, per year, she comes out ahead. She will not be in less than 28% bracket.

Heck, even Fidelity's Roth calculator ASSuMEs 6.33% per year, last I checked.

Whilst there is a risk of loss in a given year, there is also the possibility of large increases.

Suppose we move back one year, and suppose that the income limitations on conversion had been lifted last year, then not converting last year meant that the IRA and 403(b) both grew by 40+%, resulting in even more taxes when finally converted.

Of course, I have been discussing a specific circumstance, others may not be in same circumstances, or might not have the stomach to byte the bullet.

Right. Under steady tax brackets, the Roth is always advantageous if there is a positive investment return, and disadvantageous if there is a negative investment return.

As I was curious I just ran the numbers on the following scenario:

If the investment return is 6%, the Roth comes out ahead by a mere 2.9%. If the investment return is only 5%, the Roth loses by 26%. Like I say, Roth conversion amplifies investment risk -- and not just by a little bit, but by a boatload. In the declining bracket scenario you've got a very sensitive point that you must hit in terms of investment returns.

If you're bullish, go for the Roth. No question. But what is often not discussed is the Roth is indeed a higher-risk, higher-return play.

The key point I'm getting at here is that in the declining-bracket scenario, for the Roth to work out your investment returns must not only be positive, they must be above a certain floor.

There are (at least) two other things to consider about the Roth: you're constraining more of your money to the limited set of investments available to retirement accounts (largely excluding real estate, private equity, options); and under the doomsday scenario of a national shift to a consumption tax, you're hosed.

Steve

But you're not penalized for getting your estimate wrong. You just pay interest.

For example, let's say that on 4/15/2011 it looks like you're going to go with the split on the conversion income. That's a zero effect on the 2010 tax, so you compute the rest of the return and pay any indicated balance due with the 4868. If it later becomes apparent that including all the income in 2010 is the way to go you recalculate, file, and pay the balance due.

Phil Marti VITA/TCE Volunteer

In my example I showed 10%/yr and it still takes quite a bit of time for the 35% conversion to break even. I think you may be ignoring the fact that whatever gain you assume within the Roth you should also assume on the funds used to pay the taxes. i.e. even if the market screams upward fivefold in the next decade, that $175K would also have increased.

To be fair, in most discussions on this topic I find the person thinking they'll be in a higher bracket at retirement yet not having any prospects of coming close to that. In your (sister's) scenario since she'll already be in the 28% bracket due to pension, the difference in what you've done vs anything I'd suggest is far less than for those who will be in the 10% or 15% bracket on retiring.

Had we met before you did anything, I'd have a suggestion more tailored to your goal: Break up the assets by class when converting to Roth. In other words, as best as you can, create 5-8 Roth accounts so each Roth has assets that correlation within the Roth but not so much with the others. In October '11, you'll find it unlikely that all the accounts have gains. Recharacterize the ones that show losses. This strategy would minimize the tax as you'd get the benefit of nearly two years of performance to decide which to keep and which to convert back.

Joe

This really serves to show how complex the decision is. To your last point, Take $1000, convert at 35% in 2010, you end the year (2010) with $715 ( I added 10% return.) two years later, you have $865. Same $1000, not converted in 2010, ends the year at $1100. Convert in

When I change the 2011 rate to 28% the end of 2012 balance is $958. Even though you are using the outside money to pay the tax, it needs to be accounted for.

The Journal of Financial Planning had a great article on this topic and I took a snapshot while it was available on line:

Joe

I was trying to point out that "being in the 35% tax bracket" does not mean that her "regular income" gets taxed at 35%. In fact, with the conversion her regular income is still taxed in brackets of 28% or less, per the link above.

As joetaxpayer keeps mentioning, a complete, fair analysis requires one also to consider what would happen to the money used to pay the taxes on the conversion. In other words, you say your sister will never need the money in the Roth, but you are ignoring that, by converting, she is poorer by some $175k (= 35%*500k) in her non-Roth accounts. Hence her taxable account grows less (compared to not converting) because it has $175k less in it. When you take this into account, then you will find that the projected growth rate of the Roth IRA or Trad IRA is irrelevant. Instead, what matters most is the expected tax rate when withdrawing the money. The general rule (well discussed on the internet) is: If one expects to be in a higher tax bracket in retirement, then convert. If not, do not. There are other pros and cons regarding converting, but this is generally considered to be the controlling one.

I continue to bear in mind that, for those with high incomes, this year, 2010, may be a rare window of opportunity to convert to Roths.

The effective tax rate would be a lot less than 35% anyway. In this case, I have used Excel to test the scenarios. Only if the market goes down is the all at once scenario inferior, but if I thought that would occur, I might sell all in the IRA and 403(b) and move the cash to the Roth and then dollar cost average back in,

The time it takes to make up for the tax difference is not relevant in my sister's case:

1. Unless some disaster occurs, she will never need the money.
2. She, or her heirs, will eventually see a profit.
3. My crystal ball forecasts the the markets will up, maybe substantially, by Oct 2011.
4. I am gradually converting stuff in her taxable account to ETFs so I can write covered calls to protect on the downside, not to mention, if any, locking in long-term losses to carry forward. And, if we postpone taxes until 2011 and 2012, that allows ETF sales to be taxed at long-term rates.
5. During all of this the Roth is gleefully growing tax free.

I started this thread to merely ask about tax rates, not to justify what I did.

My sister's circumstances are special:

1. Retiring with a huge pension putting her in at least the 28% bracket.
2. Not needing the funds, unless something really weird happens.
3. Having the ability to pay the taxes from other funds.

My ability to manage the funds is due to at least the following (I no longer use a monkey to assist me!):

1. I studied for a PhD in economics. I never finished as I got side-tracked by going into computers. Tho, I did teach economics at a university for 1 year.

1. I then joined the CMSBE (Center for Mathematical Studies in Business and Economics) of the Graduate School of Business of the University of Chicago, where I also worked with CRSP (Center for Research in Security Prices). Alas, my knowledge is not reflected by my investment results

So my sister's circumstances and my background make this a very non-typical situation.

Obviously, taking the action I took takes a strong stomach.

The advantage of converting all at once means that things grow tax free in the Roth, no matter when the taxes are paid.

Delaying taxes to 2011 and 2012 allows the funds in the taxable account to grow. I'm not sure that splitting over 2011 and 2012 will keep us under the $375000 threshold for the higher tax bracket.

If we do decide to pay the taxes in 2010, I have to decide whether to sell the taxable funds before the 2010 distributions. But I would not sit on such a large cash pile, so I would re-invest in ETFs, perhaps using covered calls, resulting in some short-term gains/losses in 2011. If we do not pay the tax until 2011 and 2012, the gains could be taxed at long-term rates.

I understand you are not going to undo what you have done. But for the archives and hence other readers, I think it is reasonable to point out that the premise on which you at least partly have based your decision, and which you keep re-stating, is false.

The growth rate is irrelevant. The tax rates while employed and in retirement are among the top criteria to consider for determining the feasibility of converting.

Option 1. Keeping money in Traditional IRA, hence saving all the taxes you would have payed on the conversion: Keeping money P (for "principal") in Trad IRA at tax rate Temployed letting it grow by G over the years; withdrawing at tax rate Tretired; also keeping money P*Temployed invested that you would have paid when converting; gets you at retirement:

PG(1 - Tretired) + P*Temployed*G PG (1 +Temployed - Tretired)

Option 2. Converting to Roth IRA gets you at retirement: PG

Hence G affects both options 1. and 2. the same way, and tax rates need to be given priority in making this decision.

When 1. and 2. are very close, a third option is to do some of each.

The money does grow tax-free in the 403(b) but distributions are taxable.

Basically what I'm saying is to look at the numbers, do some calculations, and figure out whether the lump-sum tax now is worth it. I was just trying to give an example of the type of analysis. It might very well make sense just because she'll be in the 28% tax bracket at retirement, but would probably not be if she was in the 10 to 15%.

Sorry, that is wrong. I'm done with this thread as I onlywanted to know what would be the tax rates.

No. There is NO money in the 403(b). All contributions are immediately converted to the Roth.

Again, I've looked at the numbers. And the lower tax rate is not relevant because one cannot invest tax free, not to mention that it is safe to expect that there will be no withdrawals.

The tax hit will be the estate tax.