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Roth conversion

IRA Distribution Pro-Rata Rule

How does the pro-rata rule for IRA distributions work? Can it cause problems as I implement the back-door Roth conversion strategy?

A new way to fund your Roth IRA

As you plan and save for your retirement, it’s nice to have multiple types of taxation for your income sources. You may have a pension, Social Security, and a traditional IRA, all of which are taxed to some degree or another.  Adding to this list you might have a Roth IRA which generally will provide you with tax-free income in retirement. The problem with the Roth IRA is that you have some strict limits on the amounts that you can contribute, and typical Roth Conversion strategies are costly and complicated. With the recent pronouncement from the IRS in Notice 2014-54, there is a brand new, sanctioned method, to fund your Roth IRA.

Be Careful When Converting

When converting from a 401(k), traditional IRA, 403(b), SIMPLE IRA, SEP or 457(b) to a Roth IRA there are some important tax considerations to keep in mind. First, converting from a tax deferred plan to a tax free plan it’s not always the best idea. Generally, it’s going to make sense to convert if the tax payer believes that he or she will be in a higher income tax bracket in retirement. For example, John, age 28 has a 401(k) and recently left his employer. He’s currently in the 15% bracket but expects to be in the 28% bracket or higher in retirement. It may make sense for John to convert his 401(k) to his Roth IRA. This makes sense for John because when he converts from a pre-tax, employer sponsored plan like the 401(k) it’s money that has not yet been taxed. If he converts while in the 15% […]

An Unexpected Result From Roth Conversion – Increased Medicare Premiums

Many folks took advantage of the one-time opportunity in 2010 to convert funds from traditional IRAs to Roth IRAs and subsequently spread the tax over the following two years, 2011 and 2012.  This was a very good option for some folks who wanted to do the conversion and reduce future tax costs.  However (and there’s always a however in life!), with the coming of 2013, many of these same folks are experiencing an unexpected result of the conversions: a significant increase in Medicare Part B premiums. Beginning after 2003, Medicare Part B premiums have been partly determined by income – primarily higher income.  For 2013, the increased Part B premium begins for single folks with incomes above $85,000, married couples above $170,000.  The income used to calculate the Part B premium is always based on the most recent tax return, which in this case would be the 2011 tax return. […]

Taking Distributions from Your IRA In Kind

When you take a distribution from your IRA, whether to put the funds in a taxable account or to convert it to a Roth IRA, you have the option of taking the distribution “in kind” or in cash. In cash means that you sell the holding in the account or simply take distribution of cash that already exists in the account. This is the most common method of taking distributions, and it is definitely the simplest way to go about receiving and dealing with a distribution.  Cash is cash, it has only one value – therefore the tax owed on the distribution, whether a complete distribution or a conversion to a Roth account. On the other hand, if you choose to use the “in kind” option, you might just save some tax on the overall transaction.  The reason this is true is due to the fact that the amount reported […]

The Difference Between IRA Contributions and Rollovers

Often there is confusion about what constitutes a “contribution” and a “rollover” into an IRA.  This post is intended to clear up the difference. While both activities are technically contributions, there’s a major difference between the two.  The most significant of the differences is that with a regular annual contribution there are several limits imposed that can be quite restrictive. Annual Contribution Limits For an annual contribution to a traditional IRA or a Roth IRA, you are limited to the lesser of $5,000 or your actual earned income for the year.  If you have no earned income, you’re not allowed to make an annual contribution to an IRA.  Above that amount, if you happen to be 50 years old or better, you can add $1,000 more to your annual contribution (2012 figures). Astute readers will point out that there is the option for a spouse to make a spousal IRA […]

Pre-Death Planning: Roth Conversion

Image via Wikipedia Financial planning often requires us to face our own certain demise – something that we often don’t want to do, but still a certainty that we all must face. Among the things that we want to do when planning for the inevitable would be to make certain that our surviving loved ones have access to adequate monetary resources to support themselves, in the most cost-effective manner.  Another thing that we hope to accomplish is to make the transition as easy as possible for our loved ones.  One way to do this is to convert a good portion of your IRA or other tax-deferred funds to a Roth IRA account.  Here’s why: By converting to a Roth account, you will make the funds in that account available to your heirs totally tax free. Granted, your estate will also be smaller by the amount of tax that you paid […]

If You Converted to Roth in 2010 – You Have About 50 Days Left to Recharacterize

Image via Wikipedia For those of you who took advantage of the one-time opportunity in 2010 to convert IRA funds to Roth IRA accounts, spreading the tax over the following two years (2011 and 2012), you are faced with a decision-point:  if you have reason to recharacterize the conversion, you have to do this by October 18, 2011. Why might you want to recharacterize? Here’s a ferinstance: If you converted $10,000 from your IRA account on December 31, 2010 into your Roth IRA and invested it in the S&P 500, that $10,000 converted is now worth approximately $8,997 (using a recent price). If you are in the 25% bracket, you will owe $2,500 on the conversion, which equates to 27.79% in taxes on the conversion.  If your chosen investments did worse than the S&P 500 (and you know some of them probably did), your effective tax will be even higher. […]

NonDeductible IRA Contributions: Good or Bad Idea?

Image by Sean MacEntee via Flickr If you find yourself in the position of having too high of an income to make a deductible contribution to your IRA for the year ($110,000 for joint filers in 2011, $66,000 for Single and Head of Household), you may be wondering if it’s a good idea to make a non-deductible contribution to your IRA. There are two opposing camps on this issue, and the deciding factor is how you’re intending to use the funds in the near term. It’s a Good Idea If you’re intending to convert your IRA to a Roth and your income is too high to just make the contribution directly to the Roth account, the non-deductible IRA may be the right choice for you.  This way you’re effectively working around the income limitations of the Roth contribution ($179,000 for joint filers in 2011 or $122,000 for single or head […]

More Clarification on Rollovers and Transfers

2/19/2014 update: This rule has been updated to allow only one rollover for ALL IRAs per year. See the article The One-Rollover-Per-Year Rule: Revised for more information. I’m compelled to provide an additional update to the posts I’ve provided in the past in the article Running Afoul of One Rollover Per Year Rule and its follow-up More on the One-Rollover-Per-Year Rule.  This is primarily to provide clarity to a portion of this rule that I personally was unclear on when the articles were originally written. The rule is that you are restricted to one IRA rollover in a 12-month period.  So let’s define a few things for the purpose of this discussion: Rollover – this is when you move money from one IRA to another, first taking possession of the funds prior to depositing the funds into the new (or the same old) account.  You have 60 days to complete this process.  […]

Tax Bill Higher Than You Expected?

Now that you’ve (hopefully) filed your return for 2010, you may have noticed that the bill was higher than you expected.  This may be due to some subtle changes to the tax law that affected your return for this year.  Listed below are some of the changes that you may have been impacted by: Social Security taxation: Especially if you had unusual income taxed in 2010, such as a Roth Conversion, you could be subject to as much as 85% taxation of your Social Security benefit. Alternative Minimum Tax: If you’ve been impacted by this, not only are your ordinary income tax items taxed at a higher rate, but your capital gains and dividends could be taxed at a rate higher than 15% as well.  This happens for folks with incomes between $150,000 and $439,800 (or $112,500 and $302,300 for singles) as the AMT exemption phaseout occurs. Image via Wikipedia […]

The Roth Recharacterization

After all the hoopla around Roth conversions in 2010, now is the time to consider whether or not a recharacterization is in your future.  So what is a recharacterization, and how does it work? Recharacterization is the “backing out” of your Roth conversion.  In other words, you can literally make the conversion as if it had never been done at all, with your money back in the traditional IRA where it started. Why would you want to do that?  Here’s an example: let’s say you converted $100,000 to a Roth IRA in 2010 and you are ready to pay the tax on your 2010 return (you elected out of the spread to 2011 and 2012).  Except that now, your investment in the Roth IRA has dropped in value to only $50,000 – and you still owe tax on the conversion of $100,000!  Yikes – that’s just totally wrong! Recharacterization can […]

Staging Your Roth IRA Conversion

So you have a substantial IRA (or several IRAs), and you’ve retired.  For the first time since you started your career, you’re in a low tax bracket.  You’re not age 70½ just yet, so you don’t need to concern yourself with Required Minimum Distributions (RMDs). But then again, maybe you should concern yourself with those Required Minimum distributions…? Think about it – you’re in a good place, tax-wise, and your IRA money is bound to continue to grow over time.  You are getting along just fine with your pension, Social Security, and other investment income.  This is the perfect time to strategically reduce your future tax bite. Staging the Roth IRA Conversion Let’s say for example that your taxable income puts you in one of the lowest tax brackets… say 15% or 25%. You have some “headroom” left in the bracket to spare, meaning that you could realize some additional […]

A Good Reason to Not Convert to Roth

While there are many reasons that it may be in your best interest to pay tax and convert funds from a traditional IRA to a Roth IRA, there are a few situations that you might want to keep in mind as you consider converting. I covered Three Reasons You May Not Want to Convert to a Roth IRA in an earlier article, and here we’ll be talking about another – the probability of paying medical expenses from your traditional IRA. Under current tax law, you are allowed to deduct medical expenses to the extent that the expenses exceed 7.5% of your Adjusted Gross Income (AGI).  In effect, if you utilized IRA distributions to pay for these medical expenses, everything above 7.5% of your AGI can be tax free after deduction.  This is much better than paying up to 35% on a Roth conversion and then using those funds later at […]

Running Afoul of the One-Rollover-Per-Year Rule (and How to Fix It)

2/19/2014 update: This rule has been updated to allow only one rollover for ALL IRAs per year. See the article The One-Rollover-Per-Year Rule: Revised for more information. In case you’re not aware of it, there is a strict rule that the IRS applies with regard to IRA rollovers:  you are allowed to roll funds over from an IRA using the 60-day rule only once during each 12-month period.  FYI: Trustee-to-trustee transfers are not considered rollovers for this rule. Here’s an example of what could happen:  Early in the year, you withdraw some money from your IRA to help you catch up on some bills.  Then, you receive a bonus a little later in the year, within the 60-day period from your withdrawal, so you deposit those funds back into the same IRA. Then, later in the year, you want to take another short-term distribution from your IRA, and once again you have […]

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