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Showing posts with label tax bracket. Show all posts
Showing posts with label tax bracket. Show all posts

3 Reasons to Wait Until You Retire to Make a Roth Conversion

One of the most common Roth IRA questions I'm asked is, "Should I make a Roth conversion?" While Roth conversions can make sense at any age, depending on your particular circumstances, generally speaking, the younger you are, the more it makes sense.

Converting at a young age gives you the longest amount of time to let your money grow tax-free and, chances are your retirement account balance is lower earlier in life than as you get close to retirement, so the cost of converting may be less. Here’s the rub though, general advice is only right, in general. It does not apply to all situations and may not apply to yours. Maybe a Roth conversion would be better for you when you retire instead of while you’re young. How would you know? Well, there are
 many factors to consider, but here are three reasons why that might make sense.

1) Your Income May Be Lower
This is probably the most obvious reason you might consider waiting until you retire to make a Roth IRA conversion. When you convert an IRA, 401(k) or other eligible retirement account to a Roth IRA, you have to add the converted amount to your income for that year. If you’re already in a pretty high bracket, any income you generate from a Roth conversion is going to be taxed at that rate or even higher. Adding more income might not be very tax efficient. Consider the following example:

You and your spouse both work and together, you have $200,000 of taxable income. That puts you towards the upper edge of the 28% tax bracket. Now imagine you have $100,000 that you would like to convert to a Roth IRA. If you do so, your income will now be $300,000, pushing you out of the 28% bracket and well into the 33% tax bracket. You’ll also find that now some or all of your investment income, like interest and dividends, is subject to an additional 3.8% surtax, making your top real rate about 36.8%. Ouch. In this case, waiting until you retire and have less overall income may provide valuable tax savings.

2) Your Expenses May Be Lower
Roth IRA conversions usually don’t make sense if you have to dip into your tax-deferred retirement savings or the potentially tax-free Roth you’ve just created to (help) pay for the conversion. The math simply doesn’t add up. That means that in order to make a Roth conversion worthwhile you generally need to have enough outside money (i.e., cash in the bank, money invested in a taxable account) to pay the tax on the conversion.

The problem with that, however, is that while you are still working your expenses tend to be higher. Between the direct costs associated with your job, like commuting, the costs associated with starting and raising a family (more likely to have during your working years) and the savings you’re already diverting each year into an IRA or 401(k) - which generally does not make sense to reduce to pay for a Roth conversion), you may have little or no cash flow to save elsewhere and/or use to pay the tax on a Roth conversion.

By the time you reach retirement age, however, many of the big expenses you had while you were younger may be gone. For instance, you’re less likely to be saving or spending for a child’s education and you’re more likely to have finished paying off a mortgage. Eliminating those two expenses from a budget, alone, could free up tens of thousands of dollars in cash flow that can be re-diverted to savings and, ultimately, used to help pay the tax on a Roth IRA conversion.

3) A Change In Scenery May Be Good For You ... Tax-Wise
Oftentimes, people end up moving after they retire. Some move right away, while others wait several years. Of course, there are others that stay put and never move, but for those that do, the move - in my experience - is typically due to one of two main factors; a more comfortable climate and/or a lower cost of living. One of the biggest cost-of-living factors is taxes and, as it just so happens, many of the states that are climate-friendly for seniors are also tax-friendly for seniors. Florida and Texas come to mind as primary winners here, due to their warm weather and the fact that they have no state income tax, but those are extreme examples. You could simply move from a high-income-tax-state to a low-income-tax-state for some tax savings.

In either case, if you make a Roth IRA conversion after you move, you’re bound to lower - or eliminate entirely - the state income tax you’d owe on that conversion. In other words, you can contribute to an IRA, 401(k) or other retirement plan while you are working in a high-income-tax-state, possibly getting a deduction (check your state rules) and allow that money to grow tax-deferred until you retire. Then, when it’s time to take the money out - or make a Roth IRA conversion - you can be in a low or no tax state and minimize your tax liability. This can be such a big deal that I know of some people who moved to a state just so they wouldn’t have to pay income taxes on large Roth IRA conversions.

These are three very good reasons to wait until you retire to make a Roth conversion, but there are many reasons not to wait. Remember that when you retire, your tax-deferred retirement savings is likely to be higher than in younger years. A Roth conversion could trigger more tax on your Social Security. It could increase your Medicare Part B premiums. It could… you get the point. The decision of if, and when, to convert is complicated and varies substantially. Always make sure you’re making your decisions based on your facts and circumstances and not on some general advice. Remember, general advice is only generally right.

- By Jeffrey Levine and Jared Trexler

Slott Report Mailbag: What Part of My Lump Sum Distribution is an Eligible Rollover Distribution?

This week's Slott Report Mailbag looks at retirement plan distributions and moving money to tax-free territory. We dissect these two issues below, and remember, if you have a question make sure to email us at [email protected]  As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.


Enjoy your articles greatly.
IRA and retirement planning questions
Send questions to [email protected]

My question is, say I am 63, receiving Social Security and a pension. My wife is 5 years younger. We both had company 401(k)s.

When she retires, I figure her Social Security, 401(k) distributions and pension may throw us to the 25% tax bracket.

What I want to do is take $30,000 distributions from my 401(k), figuring to use about $10,000 of it. I want to throw the excess $20,000 into my existing Roth IRA so that I have some more tax-free income in the future when we may be at the 25% tax bracket.

Is this allowed and are there any limits?


Rich McBride

You can convert any amount of your 401(k) distribution to a Roth IRA. There are no dollar limits on the amount of money that can be converted to a Roth IRA nor are there any income limits that would prevent you from doing a conversion. The amount converted will be taxable. It is considered ordinary income and can push you into a higher tax bracket. It can also affect your deductions, credits, exemptions and phase-outs. If, after doing your tax return for 2013, you decide that the conversion is no longer what you want to do, you can undo (recharacterize) all or some of the converted amount up to October 15, 2014.


A pension plan participant has been receiving monthly payments during 2013.

The pension plan is terminating and the participant has been offered a lump-sum cash out option. She wishes to elect this option (with spousal consent) and roll the lump sum to an IRA (non-Roth).

Question: What portion of the lump sum is an eligible rollover distribution?
a. All but the full normally computed required minimum distribution?
b. (a) but reduced (not below $0) by the sum of the monthly pension payments received?
c. Other?

Question: Will the amount rolled over be subject to a second minimum required distribution in 2013?

Thank you.

The amount that’s eligible for rollover is the full amount minus any required minimum distribution (RMD) of the pension plan for 2013 that she hasn’t taken yet. Assuming she’s age 70 ½ or older this year, she doesn’t have to take a second RMD from the IRA on the pension rollover amount.

- By Joe Cicchinelli and Jared Trexler

Accelerating the Sale of Appreciated Capital Gain Property: A Strategy Worth Considering

As you are now no doubt aware, there are any number of ways which you might pay more in taxes for 2013 than you will this year (in case you missed it, click here to read my article on 10 of those ways). One of those many ways is when you sell long-term capital gain property. Common types of capital gain property are stocks, bonds, mutual funds and real estate. To be considered “long-term,” you must have held the investment for more than one year.

Currently, the maximum rate you will pay on the sale of most long-term capital gain property is 15% of the gain. Next year, that’s scheduled to jump to 20% (a 33% hike), and if your unfortunate enough to get hit with the new 3.8% health care surtax as well, you could pay up to 23.8%, which is almost 60% more in tax than you would ever have to pay this year!

One of the nice things about investing though is that you can, in some ways, control your tax liability. For instance, suppose you purchased $10,000 of XYZ Corp. in your regular brokerage account several years ago. Now that stock has appreciated in value and is worth $20,000. How much tax do you owe? You might be tempted to say $1,500 (15% times your $10,000 total gain), but that wouldn’t necessarily be the case. In fact, it would only be the case if you chose to sell your investment. That’s because during the time you own a capital investment, such as a stock, bond, real estate, etc., gains and losses are generally deferred.

Most people - including most CPAs - try to put off paying taxes for as long as possible, and usually that’s a good thing. After all, isn’t that the reason so many of us contribute to a traditional IRA, 401(k) or similar type of tax-deferred account? As a result, people often hold onto investments for long periods of time. In fact, sometimes people are so averse to paying tax that they hold onto an investment long after they should, perhaps incurring investment losses that far exceed any tax they would have paid.

If, however, there was ever a time to sell appreciated property before you otherwise intended to, it could very well be now. Why not sell your long-held investment now and lock in the low 15% rate still in effect through the end of this year? Sure, you will be paying taxes before you have to, but you could be paying them at a significantly lower rate than you would in the future. In some sense, it’s
very similar to a Roth IRA conversion, where you pay taxes on your retirement account sooner than you would otherwise have to, but with the idea of locking in today’s “low” tax rates in the process.

What if you really like a stock and don’t want to be without it? No problem. You could sell your XYZ stock at 10:00 AM tomorrow to lock in the current 15% long-term capital gains rate and buy it back one minute later at 10:01 AM. You might be thinking to yourself right now, “Isn’t there some sort of rule stopping me from doing that? Don’t I have to wait more than 30 days or something like that?” If this thought is running through your mind, you’re probably thinking about the “wash sale” rule.

Fortunately, in our example, the wash sale rule doesn’t apply. The wash sale rule deals with losses, but here, we’re talking about selling investments with a gain. When/if you repurchase the same investment, your new cost basis will be the amount you paid when you repurchased it. Any future gain could still be taxed with the 20% rate - 23.8% with the surtax - but the tax would only apply to the gain above your new, higher basis.

Should you choose to take advantage of this strategy, I have one additional suggestion. Consider using non-investment money, such as money in a savings or money market account, to pay the tax. You’re probably not making much in the way of interest on those funds these days and this way, if you decide to reinvest your funds, you’re not reducing the amount to be invested by the tax you voluntarily chose to accelerate paying. You should not, however, leave yourself without enough money to meet your ongoing expenses and cover yourself in the event of an emergency.

Of course, like most planning strategies, this idea is not for everyone. Here are four groups of people who should probably not “sell early” to lock in today’s cheaper tax rates.

#1 - You expect to be in the lowest brackets in the future
If you expect your income to decrease substantially in the future, you may not want to sell your long-term capital gain property now. Although the maximum rate you could pay on the gain is 20%, plus an additional 3.8% for the health care surtax, if your income is fairly modest, you might owe as little as 10%.

#2 -You’re terminally ill
It’s hard to write about stuff like this, but it’s also an important consideration. If you are very ill and probably won’t sell your investment before you pass, you’re probably better off holding onto it. Capital assets receive what’s known as a “step-up in basis” after death. This means that whatever the value is on your date of death, that’s your heir’s new basis. So let’s assume you bought a building in 1950 for $50,000 and now it’s worth $2,000,000. If you sell the property before year-end you’re looking at close to a $300,000 tax bill. That’s better than it would be next year, but, on the other hand, assuming it’s still worth the same $2,000,000 at the time of your death, your heir could sell it for that price and pay no income tax whatsoever.

#3 - You’re never going to sell
This is really kind of an extension of #2. If you plan to hold your investment forever, there’s no point in selling now. Remember, if you never sell a capital investment, you’ll never trigger the capital gains tax, no matter how much gain you have. Plus, as noted above, when you ultimately pass those assets to your heirs, they will get a step-up in basis and may be able to sell the property on their own with little or no tax consequence.

#4 - You’re going to give it away to charity
When most people think about making charitable contributions, they usually think about donating cash or putting it on their credit card. You can, however, donate capital assets, such as stock, which in some cases may be a better move. When you donate capital assets to a charity, you don’t have to pay tax on any of the gain, plus, you get to take a charitable deduction for the full value of your investment (subject to the overall charitable contribution limits). For example, let’s say you bought ABC stock for $10,000 in 1990 and now it’s worth $110,000. If you donate that stock to charity, you’ll avoid the $15,000 ($100,000 gain x 15%) capital gains tax you would have owed had you sold the stock, plus you’ll get a $110,000 charitable contribution deduction (subject to the overall limits). The cherry on top is that for the charity, the $110,000 in stock is an equivalent donation to $110,000 since qualified charities don’t pay any income tax, including the capital gains tax on appreciated investments.

A Final Word
If you’re not one of these people, you should probably check with your tax or financial professional to see if there are other factors that may make this strategy favorable or not. Remember though, in order to lock in today’s low rates, you’ve got to sell by December 31st, so don’t wait too long, or this opportunity might pass you by.

Article Highlights:
  • Currently, the maximum rate you will pay on the sale of most long-term capital gain property is 15% of the gain. Next year, that’s scheduled to jump to 20% (a 33% hike)
  • Use non-investment money, such as money in a savings or money market account, to pay the tax
  • Selling capital gain property is not for everyone, like if you are expecting to be in a lower tax bracket in the future, if you are terminally ill, if you are never going to sell or if you are going to give it to charity

-By Jeff Levine and Jared Trexler