But it's now 2009, and the countdown is on toward 2010, so I would like to revive the discussion.
This thread specifically addresses the strategy of making non-deductible (due to income limits) contributions to a traditional IRA with the plan of converting to a Roth IRA in 2010. Any taxable gains at that time can be dispersed over 2 years (2011 and 2012, so due 4/15/12 and 4/15/13).
Question: I assume one can make their 2010 contributions in early 2010, and then immediately convert to a Roth? Presuming one plans for their IRA to grow over time, it appears that it makes the most sense to contribute the maximum $5000 to the traditional IRA on January 1 2010, and then initiate the conversion on January 2 2010, to minimize eventual taxable gains?
ETA: dates of taxation corrected
Message edited by: psychtobe on 2009-04-21 22:47:23 CDT
psychtobe said:This thread specifically addresses the strategy of making non-deductible (due to income limits) contributions to a traditional IRA with the plan of converting to a Roth IRA in 2010. Any taxable gains at that time can be dispersed over 2 years (2010 and 2011, so due 4/15/11 and 4/15/12).Actually, it's 2011 and 2012 taxable income, meaning the returns you file in 2012 and 2013. You're not just deferring half of the income, you're deferring half for a year and the other half for two years.
Question: I assume one can make their 2010 contributions in early 2010, and then immediately convert to a Roth?Yes.
Presuming one plans for their IRA to grow over time, it appears that it makes the most sense to contribute the maximum $5000 to the traditional IRA on January 1 2010, and then initiate the conversion on January 2 2010, to minimize eventual taxable gains?Not really. Remember, you're paying tax on all of the investment earnings of your non-IRA investments; if you don't contribute the money to an IRA, you'll still be paying tax on it.
So it depends on what you will invest in and how it will be taxed if it's not in an IRA. If it's something that generates capital gains and you're planning to hold it long enough to make them long term, then it will depend on the difference in tax rates and on the value of deferral (which depends on interest rates); you're probably better off delaying the contribution. But if you'll buy something like a bond that will generate ordinary income, you'll be paying tax on that income either way; contributing early just lets you delay the tax on that income (and, with the special 2010 rule, delay it for an extra 1 1/2 years, on average).
LH2004 said:Presuming one plans for their IRA to grow over time, it appears that it makes the most sense to contribute the maximum $5000 to the traditional IRA on January 1 2010, and then initiate the conversion on January 2 2010, to minimize eventual taxable gains?Not really. Remember, you're paying tax on all of the investment earnings of your non-IRA investments; if you don't contribute the money to an IRA, you'll still be paying tax on it.
So it depends on what you will invest in and how it will be taxed if it's not in an IRA. If it's something that generates capital gains and you're planning to hold it long enough to make them long term, then it will depend on the difference in tax rates and on the value of deferral (which depends on interest rates); you're probably better off delaying the contribution. But if you'll buy something like a bond that will generate ordinary income, you'll be paying tax on that income either way; contributing early just lets you delay the tax on that income (and, with the special 2010 rule, delay it for an extra 1 1/2 years, on average). LH - aren't you answering a slightly different question (like whether it makes sense to contribute for 2009 early vs late)? For the 2010 contribution, if I put it in a nondeductible IRA on Jan 1, 2010 and immediately convert it to a Roth, there are no earnings on which to pay tax and all the future gains are tax free under the current rules regardless of what I invest in. I can't see any advantage to holding an asset in a taxable account during some of 2010 only to contribute and convert later that year. Well, maybe if my investment is going to drop and I'll want the taxable loss, but I can always recharacterize/undo the conversion and/or possible undo the 2010 contribution and subsequently recontribute the full amount to a new account, so even then it doesn't make any sense to wait.
xerty said:LH - aren't you answering a slightly different question (like whether it makes sense to contribute for 2009 early vs late)?You're right, that's what I thought psychtobe was asking, but, rereading it, it seems clear that the question was about the timing of the 2010 contribution and conversion, which should definitely be done as soon as possible (if you have the money).
thanks LH, I thought that was the case but your reply had me scratching my head. Can you explain why a conversion in January 2010 would not count as taxable income til 2011 and 2012, meaning taxes filed 2012 and 2013?
psychtobe said: Can you explain why a conversion in January 2010 would not count as taxable income til 2011 and 2012, meaning taxes filed 2012 and 2013? Because there's a special exception for doing this in 2010 to encourage you to so. Read more here.
This is my situation.. HHI: 88K( 44k +44K) me n my wife till 2012 ( we are resident doctors. after that the HHI will increase ) No 401K or any other retirement vehicle at work.
If I put money in traditional IRA its makes our HHI below 52K and helps us to get at least the savers credit and saves taxes.. From what i understood, I should be able to convert my TIRA to Roth in 2010 and pay the federal taxes on that...what about the savers credit?? ( is it a part of federal tax).. are there any other taxes associated with the conversion...I hope i am understanding this conversion properly..
azygous said:HHI: 88K( 44k +44K) me n my wife till 2012 ( we are resident doctors. after that the HHI will increase ) No 401K or any other retirement vehicle at work.
If I put money in traditional IRA its makes our HHI below 52K and helps us to get at least the savers credit and saves taxes.. From what i understood, I should be able to convert my TIRA to Roth in 2010 and pay the federal taxes on that...All that changes in 2010 is that the income limit on conversions goes away (which does not matter to you, for the moment, because you're below the income limit anyway) and there is the special rule about dividing up income over 2011-2012. You are free to convert any time, if you want.
what about the savers credit?? ( is it a part of federal tax)..Eligibility for the savers' credit is based on AGI with some modifications. Assuming all of your IRA contributions have been deductible, when you convert, you will get extra taxable income equal to the full amount converted. So, if you convert, let's say, $20,000, you'll have an extra $20,000 in income that year (or spread over the next 2 years, if it's in 2010), which will count against savers' credit eligibility. You won't forfeit the credit you took in earlier years. But, if you are in a higher bracket when you convert than when you contributed, the tax on the conversion might be a bit painful.
are there any other taxes associated with the conversion...I hope i am understanding this conversion properly..You will probably also owe state and any local income tax on the conversion.
xerty said:psychtobe said: Can you explain why a conversion in January 2010 would not count as taxable income til 2011 and 2012, meaning taxes filed 2012 and 2013? Because there's a special exception for doing this in 2010 to encourage you to so. Read more here.
Got it. So if one has $45,000 of non-deductible value in an IRA, with $35,000 in basis, he can add $5000 on 1/1/10, do the conversion 1/2/10, and pay taxes on the total $10,000 in gain in years 2011 and 2012, meaning tax on $5000 owed 4/15/12, and tax on $5000 owed 4/15/13. Right? What a steal!
psychtobe said:xerty said:psychtobe said: Can you explain why a conversion in January 2010 would not count as taxable income til 2011 and 2012, meaning taxes filed 2012 and 2013? Because there's a special exception for doing this in 2010 to encourage you to so. Read more here.
Got it. So if one has $45,000 of non-deductible value in an IRA, with $35,000 in basis, he can add $5000 on 1/1/10, do the conversion 1/2/10, and pay taxes on the total $10,000 in gain in years 2011 and 2012, meaning tax on $5000 owed 4/15/12, and tax on $5000 owed 4/15/13. Right? What a steal!
That's only accurate if that person has no other IRAs.
psychtobe said:So if one has $45,000 of non-deductible value in an IRA, with $35,000 in basis, he can add $5000 on 1/1/10, do the conversion 1/2/10, and pay taxes on the total $10,000 in gain in years 2011 and 2012, meaning tax on $5000 owed 4/15/12, and tax on $5000 owed 4/15/13. Right? What a steal!Right, except:
1. "Non-deductible value" just means the total value of all your traditional IRA's (no matter how the money got there); and 2. You might need to increase withholding, or pay estimated tax, so that there is a chance that you're paying tax on the $5000 each during 2011 and 2012 instead of all on 4/15/12 and 4/15/13.
Assuming we are not "subject to backup withholding", can we delay paying the tax until 4/15/12 and 4/15/13 without penalty? Does the government charge interest and penalties by default?
XrayTed said:Assuming we are not "subject to backup withholding", can we delay paying the tax until 4/15/12 and 4/15/13 without penalty? Does the government charge interest and penalties by default?Not exactly by default, but, yes, there are penalties sometimes. To avoid the penalty, you have to have total withholding and estimated tax payments equal to whichever is the least of:
1. The current year's tax minus $1000; 2. 90% of the current year's tax; or 3. 100% of the prior year's tax (110% if AGI was over $150,000).
For this purpose, withholding counts no matter when it happens, but it's more complicated with estimated tax payments if they aren't level over the year.
Anyway, this means that if you're relying on the first test, you could have to add extra withholding or estimated taxes up to the full extra tax caused by the conversion (so, if you had $10,000 of income from the conversion in 2010, up to 35% of 1/2 of $10,000, or $1750, each year in 2011 and 2012, or more if tax rates are higher by then). If you're relying on the second, it would have to be 90% of that, or $1575. If you're relying on the third, it's nothing in the first year, but then that would potentially add an extra 110% of $1750 = $1925 on the next year's withholding, if you want to rely on that third test again that year.
Of course, if your withholding is already higher than it needs to be to satisfy these tests (even if you're already having to pay a tax bill in April rather than getting a refund), then you have some room before you have to worry about this; but that probably means that you could safely reduce your withholding, and you would (partially) lose that ability because of the conversion.
Again, this is a pretty minor point. The 2010 conversion is an excellent deal for a lot of people.
I think it should also be noted that for many who are considering all of this (such as myself), the top marginal tax rate is likely to rise after 2011. Again, I still think this conversion makes sense, but it is important to note that the conversion, especially if one has significant pre-tax IRA funds that will be included in the basis, will be slightly more expensive given the likely bump in the top marginal rate as the Bush tax cuts sunset.
I'm interested in finding out what strategies folks have for rolling their pre tax IRAs into 'shell' self-employed 401ks so that they don't have to include the pre tax IRAs in their basis, and thus get dinged with a potentially large tax liability (though this may still be advisable -if you can predict the future)...
This assumes that your current 401k does not allow you to 'roll in' assets from a preexisting pre-tax IRA...
LH2004 said:psychtobe said:So if one has $45,000 of non-deductible value in an IRA, with $35,000 in basis, he can add $5000 on 1/1/10, do the conversion 1/2/10, and pay taxes on the total $10,000 in gain in years 2011 and 2012, meaning tax on $5000 owed 4/15/12, and tax on $5000 owed 4/15/13. Right? What a steal!Right, except:
1. "Non-deductible value" just means the total value of all your traditional IRA's (no matter how the money got there); and 2. You might need to increase withholding, or pay estimated tax, so that there is a chance that you're paying tax on the $5000 each during 2011 and 2012 instead of all on 4/15/12 and 4/15/13.
Other than that, yes.
What ? I thought you had to pay taxes on the full value of the converted IRA, so in this example, you would owe tax on the full $45,000 when you convert your traditional (non-deductible) IRA to a Roth IRA. I'm not sure if it matter what part of this amount is the basis and what part is gains - you pay tax on the whole amount. Is that right ?
What ? I thought you had to pay taxes on the full value of the converted IRA, so in this example, you would owe tax on the full $45,000 when you convert your traditional (non-deductible) IRA to a Roth IRA. I'm not sure if it matter what part of this amount is the basis and what part is gains - you pay tax on the whole amount. Is that right ?
A traditional IRA and non-deductible IRA are not synonymous terms. There is no such thing as a non-deductible IRA. A traditional IRA can be funded with deductible contributions and/or non-deductible contributions.
If one has IRAs that have only had non-deductible contributions (post tax), only the gains will be taxed because the contributions have already been taxed. Ex. $35,000 of contributions and $10,000 of gains. Only the $10,000 will be taxed. If instead, the contributions were all deductible (pretax), the entire amount will be taxed at conversion.
It gets confusing for people who have both pre-tax and post-tax contributions. One can't pick and choose what to convert. From an IRS standpoint, it will be treated as one IRA.
SO this is what I am going to do... 2008: TIRA 5K + 5K contribution ( me n my wife )...HHI : 88K ( already did) 2009 : TIRA 5K + 5K contribution ( me n my wife )...HHI : 88K ( will do in next few months) 2010 : TIRA 5K + 5K contribution ( me n my wife )...HHI : 88K ( will do on 1/1/10)
so the total TIRA I will have in 2010 for conversion will be 30K. I wount have much gaines, may be 2% ( I just hope the value wount do down)..so the total will be ~~ 35K.
so my HHI for 2011 : 88K + 17.5K and 2012 : 88K + 17.5K
PLan for 2011 and 2012 : put money in 401 k/ 403 b/ 457 b ( not supported by employer ) instead of TIRA..
I'm just now learning about my employer's 403B plan, which is a tax-advantaged retirement savings plan similar to a 401K. Apparently having a 403B precludes me from participating in a tax-deducted tIRA (my income does not). Can 403B's - or for that matter the more standard 401k - be rolled over into a ROTH in 2010 in order to defer some
For those self-employed, you can consider paying yourself more this year (drain the business down), then in 2010 take a significant pay cut while you convert your retirement funds in 2010. Use the boosted income this year, and use some 0% AOR money as well in the mean time to survive in 2010, then comes Jan 1, 2011 and give yourself a nice big fat paycheck meanwhile drastically lowering your tax bracket for 2010 to make the conversion a lot less painful.
This is what I will be doing to convert my SEP IRA. I started funding my a new Solo 401K this year letting my SEP IRA sit as when I was building that, I was getting nice big deductions that I really needed. All in all, this method will require some sacrifice but will actually be a PROFITABLE tax venture figuring the drastic differences in taxes saved/paid.
Disclaimer: By providing links to other sites, FatWallet.com does not guarantee, approve or endorse the information or products available at these sites, nor does a link indicate any association with or endorsement by the linked site to FatWallet.com.
