Info for those interested in TIRA conversion to Roth

[Wonk]

I unfortunately had to spend some of my time wading through IRS paperwork to find out some definitive answers on a TIRA conversion to Roth this year.  Although I was leaning against conversion already due to the cloudiness of future tax policy, one substantial finding put the final nail in the coffin. 

This bit of info might interest those who are considering the conversion: 

I found out that if I convert TIRA funds to Roth and take distributions under SEPP (as in an early retirement), they WILL be taxed as income a second time in a Roth account. 
The only way to avoid this double taxation is to wait until age 59.5 before taking distributions.

This is incredibly significant because I plan on semi-retiring before I turn 40 and taking distributions under the SEPP rules.  Roth funds would either be subject to double taxation or locked away for another 20 years to avoid double taxation.  Not good.  By comparison, TIRA distributions will only be taxed once (upon distribution only) and the 10% early withdrawl penalty is waived if SEPP rules are adhered to.

For those in the same situation, beware the consequences of conversion this year if there is a chance you'll be retiring before age 59.5.

Source: http://www.irs.gov/publications/p590/ch ... 1000231057

[pplooker]

Very interesting.  Not at all applicable to me or most people I would imagine but it goes to show how our policies like to screw people out of their life savings I suppose.

[l82start]

is the double taxation for the contribution or just the distributions? i thought one of the benefits of the Roth is that you can remove your contribution w/o taxation, since you pay tax at the time of conversion doesn't the entire amount of the conversion become "after tax" or a contribution? why cant you just take from your initial contribution for the first part of your early retirement?

[Wonk]

is the double taxation for the contribution or just the distributions? i thought one of the benefits of the Roth is that you can remove your contribution w/o taxation, since you pay tax at the time of conversion doesn't the entire amount of the conversion become "after tax" or a contribution? why cant you just take from your initial contribution for the first part of your early retirement?

I didn't see any reference to that on the IRS page.

[l82start]

i am about as far from being an expert as someone could get... so find someone who can give you accurate info before you act,

this is where i was reading about Roth conversions http://www.bogleheads.org/wiki/Roth_IRA_conversion  it could be i am reading it wrong, or that you are attempting a more complex type of conversion .. good luck

[Wonk]

Thanks for the link.  After reading several times, I see no mention of avoidance of the double taxation on pre-59.5 withdrawls.  It's still my understanding that if one were to meet the criteria for "qualified" distributions (5+ years seasoning and 59.5 or older), you will not be taxed a second time.

However, if you withdrawl any amount prior to 59.5, it is no longer considered a qualified distribution--even if following SEPP guidelines(avoiding the 10% early withdrawl penalty)--and will therefore be taxed again as income. 

[l82start]

"You pay taxes as if you withdrew the entire amount converted, but without any penalty for early withdrawal; in return, the money will grow tax-free in the Roth IRA, and you will not pay any tax on that withdrawal if you meet the Roth IRA rules" 

this is what led me to jump to that conclusion along with these Roth IRA rules


      * Contributions are not tax-deductible.
      * There is no mandatory distribution age for the account owner, or in the case of a spousal rollover.
      * All earnings and principal are tax free (subject to some minimal conditions).
      * Contributions may be made only by those having earned income and making under a certain income; anyone can convert a Traditional IRA to a Roth.
      * Principal contributions (but not earnings) can be withdrawn at any time without penalty (subject to some minimal conditions). "

found here http://www.bogleheads.org/wiki/Roth_IRA
(again i am  not an expert) if you look down at the blue side bar under distributions at the above link you may be able to figure out from the order of distributions listed, which money is taxed on withdraw and which isn't, i dont quite get the advantage/popularity of Roth conversions if you dont get to have the benefits of a Roth once you convert... maybe someone with some expertise can explain it to us..

[Wonk]

"You pay taxes as if you withdrew the entire amount converted, but without any penalty for early withdrawal; in return, the money will grow tax-free in the Roth IRA, and you will not pay any tax on that withdrawal if you meet the Roth IRA rules" 

this is what led me to jump to that conclusion along with these Roth IRA rules


      * Contributions are not tax-deductible.
      * There is no mandatory distribution age for the account owner, or in the case of a spousal rollover.
      * All earnings and principal are tax free (subject to some minimal conditions).
      * Contributions may be made only by those having earned income and making under a certain income; anyone can convert a Traditional IRA to a Roth.
      * Principal contributions (but not earnings) can be withdrawn at any time without penalty (subject to some minimal conditions). "

found here http://www.bogleheads.org/wiki/Roth_IRA
(again i am  not an expert) if you look down at the blue side bar under distributions at the above link you may be able to figure out from the order of distributions listed, which money is taxed on withdraw and which isn't, i dont quite get the advantage/popularity of Roth conversions if you dont get to have the benefits of a Roth once you convert... maybe someone with some expertise can explain it to us..

Here are the key phrases for me:

"if you meet the Roth IRA rules"

"subject to some minimal conditions"

The Roth IRA rules and minimal conditions stipulate that you must wait until age 59.5 to begin qualified distributions (although there is no mandatory forced withdrawl).  There may be a chance that you can withdraw contributions only before 59.5 with no double tax, but that leaves the remaining capital gains held hostage in Roth until age 59.5.  Even under the latter scenario (which is best case from what I can tell) I still don't like the idea of holding money hostage for 20+ years under the threat of additional taxation. 

As mentioned, I already didn't like the thought of paying taxes on conversion and reducing basis in my investments for the promise of not paying taxes later (which can be rescinded).  Now I'm 200% sure I won't make the conversion.  Unfortunately, I think there'll be a lot of people who won't do the same due diligence and find they'll have a rude awakening come withdrawl time. 

[l82start]

that sounds right to me, the price you pay for the tax free earnings is committing to the 59 + 5 for the earnings and the ability to remove your after tax contributions any time is why there is no yearly income tax write off..
in a traditional you cant remove your money (with some exceptions) in return for that you get the yearly write off, tax free growth and a chance of being in a lower tax bracket at retirement..

i suspect the risk of the rules changing applies to both types of IRA, taxes being higher at retirement and right offs being reduced or taxes being applied to Roth distributions.. i cant predict what will happen, so i agree with you there doesn't seem to be much point  in converting, (especially if you know you are likely to hit a double tax because of withdraw needs).... unless maybe if you have a large portfolio/windfall and doing the conversion creates more tax deferred  space (i dont know if it would, i haven't had the need to figure that out yet) then it might be worth the gamble/cost....

[Wonk]

For those reading this thread, here's more information on SEPP (not SEP IRA) rules & eligibility to avoid the 10% early withdrawl penalty:

http://www.investopedia.com/articles/re ... p?viewed=1

[Wonk]

Ok, I think I need a stiff drink.  Here's an old article that suggests SEPP can be used with Roth IRA's as long as the 5 year seasoning has been reached:

http://www.brill.com/features/401k05013.html

Leave it to the U.S. to complicate everything.  I can only wonder what horrible diseases would be cured by now if our 1.3 million accountants were using their intelligence for something more productive to society.

[MediumTex]

I can only wonder what horrible diseases would be cured by now if our 1.3 million accountants were using their intelligence for something more productive to society.

Don't forget the lawyers.  Arguably, their work (i.e., making up arbitrary rules and then charging a fortune to fight over them) is even more pointless than that of the accountants.

[Wonk]

I can only wonder what horrible diseases would be cured by now if our 1.3 million accountants were using their intelligence for something more productive to society.

Don't forget the lawyers.  Arguably, their work (i.e., making up arbitrary rules and then charging a fortune to fight over them) is even more pointless than that of the accountants.

I tried to get a figure for the amount of tax attorneys but couldn't find one.  Suffice to say maybe 2 million souls dedicating their working lives to perpetuating the "square wheels" tax setup?