Roth IRA Conversion Strategy – Fill Out the Bracket

One strategy to consider as you think about making Roth IRA conversions is the idea of “filling out the bracket”.  With this strategy, you consider your income level and what bracket you’re in, and if it makes sense, convert enough of your IRA or QRP to effectively use up the remainder of the tax rate bracket that you’re in.

Of course, this mostly makes sense in the lowest brackets, but for some folks with potentially high incomes it may be appropriate at higher brackets.  Your feeling on this also depends on what you think will happen with tax rates as you get to the point where you’re ready to retire – and if you’re like me, you’ve got to believe that tax rates are on the rise.

The following table illustrates the highest income you could have within each tax bracket, using the rates for a Single taxpayer and a Married Taxpayer, using only the Standard Deduction for 2009, with only one exemption for the Single taxpayer and two for the Married Taxpayer.  Add $3,650 to the figure for each additional exemption claimed, and add the difference of your itemized deductions above the standard.

Also, if you happen to claim the standard deduction and have real estate taxes paid in the tax year, you can deduct up to $500 for those (in addition to the standard).  Plus if you’ve bought a car in the tax year, the sales tax on that purchase can be deducted above and beyond the standard deduction as well.

To use the above table, calculate your income – from wages, salaries, tips, dividends, interest, short-term capital gains, rental income, etc..  Figure out which bracket you fit into, based on the table.  Subtract your income amount from the amount for your applicable bracket:  the remainder is how much you could convert to a Roth IRA while remaining in that tax bracket.

As an example, let’s say you’re single, with no dependents.  Your total income for the year will be $30,000.  When we go to the table we see that you’re in the 15% bracket, and that you could convert up to $13,300 to a Roth IRA without bumping yourself up above the 15% bracket.  The tax on that conversion would be $1,995.

For another example, let’s say you’re married, and your household income is also $30,000.  According to the table, you’re in the 10% bracket, and you could convert as much as $5,400 without going above the 10% bracket.  Plus if you have two kids who are dependents, the additional exemptions would increase that number by an additional $7,300 ($3,650 per dependent exemption) to a total of $12,700.

Now, you might be saying to yourself, that’s all well and good, but how many families of four have the wherewithall to undertake a Roth conversion in those circumstances?  After all, that would be an additional tax of $1,270!  You’re right, it’s not terribly practical for folks in those particular circumstances – but consider someone who is semi-retired, who has very little earned income beyond some interest and dividends.  How about a married individual, with part-time work earnings of $10,000?  This individual could convert as much as $8,700 to a Roth IRA – and owe no income tax at all!

As I’ve mentioned before, unless you’re very, very competent with income taxes, please, do yourself a favor and run any plans of this nature past a tax professional.  It’s well worth the cost – you don’t want to make mistakes on this sort of thing!  And if you rely on a box as your tax advisor, don’t expect the box to represent your interests before the IRS.

I can learn from you, you can learn from me - please leave your comments and links!

Jim Blankenship, CFP®, EA, is an expert in personal retirement, IRAs, and tax issues, with more than 20 years of experience in the industry.  . Read more from this author