Tax on Roth Conversion: Bad advice??

No. Income from TIRA-to-RIRA conversions is plain old ordinary income. No special tax treatment. It'll also increase her AGI and so could hurt any deductions and credits that depend on AGI.

Add another one to the already huge "don't take tax advice from your broker" pile.

-- Rich Carreiro snipped-for-privacy@rlcarr.com

And the other surprise I discovered last fall is that if you think you could sneak above the top of the 15% bracket because you have qualified dividend income, think again: the tax rate is 30%, not 15%!

Thanx.

And I cannot rely on the IRS.

In 2010, you can split the conversion income between 2011 and 2012. In theory this should reduce your tax because your AGI will be lower

-- and maybe that's the rep had in mind. But then again, tax rates will be higher in 2011 and 2012.

This is one of my hot buttons when it comes to financial planning. Roth conversions are not for everyone, good for some, bad for others. For those for whom the conversion makes sense, it's rarely a case where a whole conversion of all their assets in pretax IRAs is advised. You don't mention if she's single or marries, or other details that would give clues as to whether any conversion at all makes sense. I can tell you that it would take an equivalent $2M (single) or $4M (joint) to produce incomes at retirement to put one at the top of the

25% bracket in today's dollars. Few will retire in a higher bracket. I suspect even with all the talk of rates increasing, we still are missing the fact that for retirees, they need to have income to tax, and the current saving rate isn't high enough to justify the current Roth Mania. I recently guest posted an article that illustrates my thoughts on this, and I welcome comment here on this. (if there are line wrap issues on that link) As Rich replied, conversions are stacked on to income. However, conversions in 2010 may be spread over 2 years, taken as income half in '11 half in '12. That may change the story for her.

Joe

What I've discovered is that there is really no right answer as to whether to convert to Roth. Here are some of the conflicting factors-

1. The conversion makes sense if you're going to be in a higher tax bracket in later years, but there's no way to predict that. #2 and #4 below show how you can be and how you won't be.
2. One sure way of being in a higher bracket later on is if you're currently married-filing-jointly, one of you will outlive the other, and the zero, 10, and 15% brackets shrink in half the following year, so it's not too hard for a widow(er) with a moderate retirement income to be in the 25% bracket.
3. Converting now will result in what's left of your Roth IRA being tax-free to your kids. (All I can ask is whose money is it; yours or theirs? The answer may guide your decision.)
4. If you spend your final years in an Assisted Living Home because you can no longer live alone (i.e., there are two or more activities of living, or whatever it's called, that you can't do), you have a huge medical deduction. If you hit your IRA to pay for this rest-of- life care, then 90% (if AMT kicks in) or 92.5% of what you take out of the IRA is TAX-FREE (i.e., the withdrawal becomes a medical deduction, but it increases the threshhold by 7.5% to 10% beyond which medical expenses can be deducted, so that's why "only" 90%-92.5% is tax-free); this is the one argument against conversion.

So the best advice I can provide regarding Roth conversions is that it's probably either a good or bad idea. But in either case, if you do convert, convert 100% (i.e., don't convert just the amount after taxes; have enough in outside cash to pay income tax). The reason is this- suppose you're in the 25% bracket and convert $200,000. If you pay the tax from the conversion, you've gone from $200,000 in a Regular IRA to $150,000 in a Roth IRA, which is a push (i.e., $150,000 earning tax-free income is that same as $200,000 tax-deferred, earning tax-deferred income, provided the bracket remains the same). By paying the income tax from savings, you've in effect added that amount to your IRA, so in effect $50,000 more is now invested in tax-free investments.

On 3/19/10 6:57 PM, Stan K wrote: (snipped, good stuff written)

Stan. You were doing so well until this section. One can be in the 25% bracket, but have their very next dollar taxed at 28%. As for the single woman in your example, after about $90K taxed at 28%, she jumps to 33%. Knowing nothing else, my best suggestion is to convert just enough each year to top off that 25% bracket. Joe

You're right in that I assumed the 25% bracket went to infinity, and your advice is similar to advice that those who file as MFJ should use up the entire 15% bracket.

The gamble at this point though is still whether the widow(er) will be lucky enough to die while still living on his/her own, or whether (s)he will spend the last 2-6 years of his/her life paying top tax- deductible dollar to an Assisted Living Home.

Run this scenario through your tax program (2010 figures): Married filing jointly Qualified dividend income $5,000 Taxable income before Roth conversion, $68,000 (i.e., just at the top of the 15% bracket) Tax: $8,613 (tax on QDI is $0) Now add in a $5,000 Roth conversion Taxable income $73,000 Tax: $10,113 ($68,000 at bracket plus 15% of QDI) Incremental tax: $1,500 Marginal tax rate: 30% Above the level where QDI is exceeded, marginal rate drops to 25%.