Comments on Help a Reader: To Convert or NotTypePad2012-10-23T18:56:55ZNAhttps://www.freemoneyfinance.com/tag:typepad.com,2003:https://www.freemoneyfinance.com/2012/11/help-a-reader-to-convert-or-not/comments/atom.xml/Bill commented on 'Help a Reader: To Convert or Not'tag:typepad.com,2003:6a00d83451bcbd69e2017d3d6b4643970c2012-11-08T19:57:51Z2012-11-09T12:28:16ZBillIt's a mistake to think that because future tax rates are uncertain that you aren't exposed to them. If you...<p>It's a mistake to think that because future tax rates are uncertain that you aren't exposed to them. If you choose to convert you are making a bet that your future rate will be higher if you choose not to convert you are betting that they will be lower. It's just the way things are. Ignoring this exposure doesn't mean it's not there. It is also possible to withdraw from an SEP without penalty prior to retirement age and contrary to what many say it is not difficult to do so. </p>
<p>Most people do quite well just hedging this uncertainty with a mixture of pretax and post tax accounts. I think that's perfectly reasonable and very simple to do. </p>
<p>One extra consideration that many people forget when they make this decision is their personal income/expense basis. Many readers of financial blogs like this one have substantial income and substantial savings rates, that is they live on a relatively small fraction of their earnings. If your retirement will come when you can safely replace your annual EXPENSES rather than your INCOME you will likely want to use a tax deferred retirement vehicle, especially when their is a wide gap between the two. </p>
<p>For example, my household income has been in the 200k annually range for the past five years. My total household expenses during that time were roughly 55k per year. I have no interest in becoming fabulously wealthy or increasing my standard of living. I will retire as soon as I can safely replace the income necessary to maintain my current standard of living. I can easily do that with 70k of gross income which at today's rates would be an average tax rate of only 14%. If tax rates stay the same my choice for converting my IRA savings into a Roth becomes, pay a marginal rate of 28-33% today or pay the average rate of 14% on my intending retirement distribution. Tax rates would have to go up a massive amount between now and my retirement to make a tax deferred option uneconomic. </p>
<p>The numbers can differ and there are more complexities to consider but generally speaking if you are going to retire with a standard of living significantly below your current income level it usually makes sense to defer the taxes.</p>Old Limey commented on 'Help a Reader: To Convert or Not'tag:typepad.com,2003:6a00d83451bcbd69e2017ee4d93b14970d2012-11-07T21:11:45Z2012-11-07T21:11:45ZOld LimeySince I retired in 1992 and made no contributions thereafter, Roth IRAs were not an option for me. My wife...<p>Since I retired in 1992 and made no contributions thereafter, Roth IRAs were not an option for me.</p>
<p>My wife and I each have large IRAs and since becoming 70 1/2 we have been making the mandatory required distributions, which for me is quite large since even though I'm now 78 my IRA is still over $3.6M. I move the required amount every December from our IRAs, have Fidelity subtract our annual State and Federal estimated tax witholdings and put the remainder into our Trust account.</p>
<p>One advantage I have found is that even if you wait to December to make your tax witholding payments, both California and the IRS treat them as if they were received in 12 equal payments throughout the year and don't charge any interest. This is so much more convenient than having to send in quarterly payments for your estimated taxes.</p>
<p>It doesn't make any sense to me to try to guess what my tax rate will be years from now. I also am invested totally in income only investments in every account we have so I also don't have to worry about the tax rates on capital gains.</p>Jim commented on 'Help a Reader: To Convert or Not'tag:typepad.com,2003:6a00d83451bcbd69e2017d3d63b7a7970c2012-11-07T20:33:56Z2012-11-07T20:33:56ZJimhttp://www.freeby50.comPersonally I would not convert. You don't have enough money in IRA right now to worry about future taxes. So...<p>Personally I would not convert. </p>
<p>You don't have enough money in IRA right now to worry about future taxes. So I wouldn't voluntarily pay taxes today on the hope you might avoid them a couple decades from now. The future is far too uncertain to be voluntarily paying taxes now. You may not retain that job for very long, the SEP contributions may be reduced in the future, you may change plans and decide against early retirement, etc. Whole lot of things can change in 20 years.</p>
<p>If you get to the point that you have a large amount piled up in the IRA account like >$500k then I'd be more concerned about your future tax bills. <br />
With todays tax rates a single retired person can have about $1M in IRA accounts, use a 4% withdrawal rate pulling out ~$40k a year and still be in the 15% fed tax bracket. Taxes will likely change in 20 years but its far too far away to guess how. </p>
<p>Also note that Roths are not the only way to access retirement funds during early retirement without penalty. You can withdrawal money from a IRA or 401k before age 60 without incurring a penalty. You have to use substantially equal periodic payments also known as 72t.</p>Adam commented on 'Help a Reader: To Convert or Not'tag:typepad.com,2003:6a00d83451bcbd69e2017d3d62aa4a970c2012-11-07T18:24:11Z2012-11-07T18:24:11ZAdamThank you everyone. Great feedback so far so please keep it coming. To answer a few questions, yes I can...<p>Thank you everyone. Great feedback so far so please keep it coming.</p>
<p>To answer a few questions, yes I can pay the tax out of pocket so that it does not come out of the lump sum. Financial advisors agree this is the way to go.</p>
<p>My tax bracket will likely not change much in the future as far as salary goes but I agree with the points made above, I should only convert whatever I can while still maintaining my current levels.</p>
<p>I also agree that it's good to have a mix of Roth/non-Roth money. My hope is that I continue to work for this small business so that I can continue to get these big SEP checks every year. If I do that plus $5k per year in my Roth then I should be fine for early retirement. I just know that rules are supposed to change and I read somewhere that if you are considering a conversion then do it in 2012. </p>Steve commented on 'Help a Reader: To Convert or Not'tag:typepad.com,2003:6a00d83451bcbd69e2017d3d629a81970c2012-11-07T18:16:17Z2012-11-07T18:16:17ZSteveAlways hard to know whether converting or not makes sense until after the fact. Lots of good advice above. But...<p>Always hard to know whether converting or not makes sense until after the fact. Lots of good advice above. </p>
<p>But if you do convert, at the end of the year figure out exactly how much you can convert that will fall in your current bracket and only convert that much, then do it again the next year.</p>
<p>This is a constant consideration of mine b/c my income fluctuates wildly and just doing these sort of conversions the years I fall in the 15% bracket for the amount that will fit into the bracket has saved me much over the years, given I'm more often in a higher bracket.</p>retirebyforty commented on 'Help a Reader: To Convert or Not'tag:typepad.com,2003:6a00d83451bcbd69e2017c333393b8970b2012-11-07T17:10:00Z2012-11-07T17:30:03Zretirebyfortyhttp://retireby40.orgI'm with Kurt. Make sure you have money in both Roth and Traditional IRA. I sounds like you're still young...<p>I'm with Kurt. Make sure you have money in both Roth and Traditional IRA. I sounds like you're still young so it's probably worth it to convert to Roth this year. I'm not sure if you can pay tax out of pocket like that. Don't they take the tax out of the lump sum when you convert?</p>Luis commented on 'Help a Reader: To Convert or Not'tag:typepad.com,2003:6a00d83451bcbd69e2017c33337bb4970b2012-11-07T16:57:35Z2012-11-07T17:30:03ZLuisDoesn't matter what the tax rates are in the future. Funding your early retirement without incurring fees and taxes is...<p>Doesn't matter what the tax rates are in the future. Funding your early retirement without incurring fees and taxes is your hurdle. A Roth IRA is the only way you can withdraw funds (contributions) penalty free and of any worries for rules and/or tax penalties. Yes you want a mix of Roth/traditional IRAs for when you are in your 60's, do that, but we are talking about setting yourself for retirement in your 50's.</p>
<p>The whole point of an advisor would be to help you do "the conversion up to the point that it doesn’t push you into a substantially higher tax bracket." </p>Kurt @ Money Counselor commented on 'Help a Reader: To Convert or Not'tag:typepad.com,2003:6a00d83451bcbd69e2017c3333050a970b2012-11-07T15:47:30Z2012-11-07T17:30:03ZKurt @ Money Counselorhttp://mymoneycounselor.comIn my opinion, it's futile and therefore pointless to attempt to factor into decisions such as the one posed tax...<p>In my opinion, it's futile and therefore pointless to attempt to factor into decisions such as the one posed tax rates decades in the future. No one--not even a FINRA fee-only advisor--can reliably predict the future, particularly 20+ years down the road. My suggestion in such situations is to save yourself some time and stress, simply acknowledge that the future is impossible to forecast, and spread your eggs among different baskets. Rather than betting on higher future tax rates (arguing for Roth) or lower future tax rates (arguing against Roth), split retirement money evenly among Roths and tax-deferred accounts. Then forget about future tax rates and go take a relaxing hike in the woods!</p>John S @ Frugal Rules commented on 'Help a Reader: To Convert or Not'tag:typepad.com,2003:6a00d83451bcbd69e2017c3332e626970b2012-11-07T15:27:48Z2012-11-07T17:30:03ZJohn S @ Frugal Ruleshttp://www.frugalrules.comTypically I would say that it would be better to convert it to a Roth. But, as you pointed out,...<p>Typically I would say that it would be better to convert it to a Roth. But, as you pointed out, who knows what's going to happen with taxes. Added to that is the value of tax diversification between retirement accounts. That said, I'd probably stay with the SEP.</p>Adam commented on 'Help a Reader: To Convert or Not'tag:typepad.com,2003:6a00d83451bcbd69e2017ee4d69e60970d2012-11-07T15:10:09Z2012-11-07T17:30:03ZAdamThanks for the feedback and hopefully there is more to come. I anticipate having the same job for the next...<p>Thanks for the feedback and hopefully there is more to come. I anticipate having the same job for the next few years at least so hopefully I will continue to receive $20k per year from my boss for the SEP and I will continue to contribute $5k into my Roth. So I would still build up that non-Roth amount pretty quickly.</p>
<p>The debate for me is really just, pay taxes now or pay taxes later? And if it's now will it be less than I would in my early 60s when I may need the money? All uncertainties and yes I have spoken to a financial advisor that I trust and basically he gave me the pros and cons and said it's up to me. Here was his response...</p>
<p>There is no question that in general the Roth IRA is a great tax savings vehicle. The question to ask yourself is: am I willing to pay tax out-of-pocket now (a certainty) based on an expectation that my tax rates will be higher when I want to distribute the money (some uncertainty)? Your distribution time frame would either be in your 60’s or maybe even starting in your 70’s when you are required to distribute from an IRA by law. Ultimately, it requires a guess about tax rates 30-40 years from now – a lot of uncertainty, although income tax rates are certainly low now on a historical basis. <br />
<br />
There is additional uncertainty regarding the value of the portfolio. You will pay tax based on the value as of a set date. There is a potential the portfolio could go down at least for a while, which would mean that you could have paid less in tax. Of course, this is unknowable – but I did want to relay the types of uncertainty involved in the conversion. There is a potential to reverse the conversion in the case of market loss, but it would require a substantial amount of paperwork.<br />
<br />
There is a fair likelihood that your tax rate would be at least 20% at 30-40 years in the future. There is also some benefit in having the flexibility to make future distributions according to your needs and not according to IRS minimum required distribution rules. If you agree this is the case, we would suggest doing the conversion up to the point that it doesn’t push you into a substantially higher tax bracket.</p>Ivy commented on 'Help a Reader: To Convert or Not'tag:typepad.com,2003:6a00d83451bcbd69e2017d3d6081b9970c2012-11-07T12:41:51Z2012-11-07T17:30:03ZIvyI agree that having Roth will help with early retirement, but on the other side it is better to have...<p>I agree that having Roth will help with early retirement, but on the other side it is better to have a balance of Roth/non-Roth to protect against future tax uncertainty, and it may make more sense to leave these $60k to start building the non-Roth portion, while putting your own contributions in Roth.</p>
<p>We have a mix of Roth/non-Roth - we did a big conversion a few years ago, though the non-Roth part is still larger. Next year I'll be getting a lump sum payment for cancelled company pension, so I was facing the same dilemma, but decided in favor of not converting. As we do have some Roth and I am a good 15-20 years away from potential early retirement, I can work towards the mix I need without taking the hit now.</p>
<p>If you do decide to convert, do you think you'll have a low income year in near future (non-paid parental leave, sabbatical, etc), because you could try to time it and convert then for lower tax payment. You could also covert in portions over a few years to minimize the burden if that will seriously hurt your emergency budget</p>Luis commented on 'Help a Reader: To Convert or Not'tag:typepad.com,2003:6a00d83451bcbd69e2017d3d604b76970c2012-11-07T12:05:33Z2012-11-07T17:30:03ZLuisThe fact that your goal is to retire early bodes well for converting to a Roth. The uncertainty here is...<p>The fact that your goal is to retire early bodes well for converting to a Roth. The uncertainty here is how and the answer is carefully. The tax implication is huge, therefore you should seek professional guidance to minimize any pitfalls and maximize gain. Yes it will cost you in services but better to insure you get this right. Go to FINRA and select a fee only advisor in your local area.</p>