ROTH IRA Conversions
With 2010 approaching and with it the opportunity to convert traditional to Roth IRAs, I think ESPlanner should have some automation built in to help make decisions. Will doing a conversion increase future income? Should the taxes be paid in 2010, or in 2011 and 2012, as I understand the current law allows? Even if full automation is not practical, some sort of guidance would be appreciated.
By the way, I tried this with my current situation, using a suggestion I found from Larry to include no traditional IRA money in my scenario, figure the value of my IRAs in 2010 and include that as a taxable receipt in 2010, and deposit that amount into Roth IRAs in 2010. The result was a halving of my consumption for 2009 and 2010! After thinking about it, that makes sense - the program is preparing for the huge tax amount I'd have to pay in 2010, and if I were to deposit the entire value of my traditional IRA into the Roth I would have to pay those taxes out of current income. So somehow I need to figure out how much of the IRA distribution to hold back for paying taxes, rather than depositing the entire amount into the Roth. This gets more complicated if I want to spread the burden into 2011 and 2012. So you can see why I think some automated assistance would be helpful.
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lynnsgrubb at aol.com wrote:
Do you know how the taxes on a Roth conversion in 2010 will be calculated? Will it be:
1. Calculate the tax in 2010 on the amount of the conversion, but spread the payment over 2011-2012; or
2. Apportion the conversion amount over 2011 and 2012 and pay tax on the two apportioned amounts. This approach could lower the effective tax rate by reducing the amounts in higher brackets.
I cannot find anything online that is clear on this point.
Lynn
Lynn,
You can start by looking at form 8606:
http://www.irs.gov/pub/irs-pdf/f8606.pdf
Which does the tax calculations for conversions in 2008. Not much help for 2010 and 2011 but it will get you started. Frequently the IRS has future information up well in advance, but you may be a little early for that.
I've found a couple of articles discussing the conversion process. The clearest with decent examples was (IMHO):
http://www.money-zine.com/Financial-Planning/Retirement/2010-Roth-IRA-Co...
You can always go back to the original enabling legislation, signed in May of 2006 by Dubya but I can't seem to find an online copy anywhere convenient. I thought everything that got passed into law was in the public domain (more or less) and was online.
Best,
Dick Munroe
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The money-zine article referenced by Dick seems to indicate that option (2) - do the conversion in 2010 but report the income in 2011 and 2012 - is the correct one. Note particularly this sentence: "So the 2010 conversion amount may be included as taxable income in 2011 and 2012 - helping to spread out the tax bite."
I can't figure out how I would model this in esplanner. If I shpw my Roth IRA balance jumping up by the value of my regular IRA in 2010, that money has to come from somewhere - I would assume from current income. I can split the amount of the IRA into 2 taxable special receipts in 2011 and 2012, but since I funded the Roth IRA in 2010, that income has no place to go. The best I can think to do is approximate the situation by having 2 special, taxable receipts in 2011 and 2012 and funding the Roth in those years.
All the more reason, I think, that ESPlanner should be modified to handle these conversions.
I am under the impression that the answer is your alternative (2), Lynn, but do not know for certain. I have not been able to find many details, either. Perhaps the IRS is still figuring out the rules.
Jim A
The money-zine article referenced by Dick seems to indicate that option (2) - do the conversion in 2010 but report the income in 2011 and 2012 - is the correct one. Note particularly this sentence: "So the 2010 conversion amount may be included as taxable income in 2011 and 2012 - helping to spread out the tax bite."
I can't figure out how I would model this in esplanner. If I shpw my Roth IRA balance jumping up by the value of my regular IRA in 2010, that money has to come from somewhere - I would assume from current income. I can split the amount of the IRA into 2 taxable special receipts in 2011 and 2012, but since I funded the Roth IRA in 2010, that income has no place to go. The best I can think to do is approximate the situation by having 2 special, taxable receipts in 2011 and 2012 and funding the Roth in those years.
All the more reason, I think, that ESPlanner should be modified to handle these conversions.
I am under the impression that the answer is your alternative (2), Lynn, but do not know for certain. I have not been able to find many details, either. Perhaps the IRS is still figuring out the rules.
Jim A
Do you know how the taxes on a Roth conversion in 2010 will be calculated? Will it be:
1. Calculate the tax in 2010 on the amount of the conversion, but spread the payment over 2011-2012; or
2. Apportion the conversion amount over 2011 and 2012 and pay tax on the two apportioned amounts. This approach could lower the effective tax rate by reducing the amounts in higher brackets.
I cannot find anything online that is clear on this point.
Lynn
There is another issue with Esplanner's handling of Roth conversions that I pointed out to Larry in an email. One of the large benefits of a Roth is the ability to pass assets to a spouse or children after your death. The inherited Roth IRA remains tax-exempt and for your spouse at least, free of required minimum distributions. The longer the expected life of the Roth, the greater the benefit to your family. However, Esplanner spends down all retirement accounts during your lifetime even if regular assets are available. So it understates the benefit of a Roth conversion perhaps significantly if the life span of the Roth might be long.
All this is in no way a criticism of Esplanner, which I regard as an indispensable tool.
This topic seems to have died, but I would like to bring it back to life. A few days ago Vanguard posted an article about conversions to a Roth, which can be found here:
https://personal.vanguard.com/us/VanguardViewsArticleSecure?ArticleJSP=/...
It seems to say that you can make a conversion in 2010, but pay the taxes as if the money was received in 2011 and 2012. In addition, it says that paying the taxes out of the money taken from the IRA is "not a good idea" - I would assume that that is because the held back funds would be considered to be a premature withdrawal from the regular IRA.
So let's say that I have $100K in an IRA and convert it to a Roth in 2010. I would take $100K from the IRA and deposit the entire amount into a Roth IRA. Then, in 2011, I would add an additional $50K to my income to pay taxes on. I'd do the same in 2012.
I am not sure I can model this in ESPLanner. In 2010 I could have a nontaxable special receipt of $100K (or whatever I figure my IRA will be worth then) that I would indicate is to be deposited into a Roth IRA. (I'd just keep a zero balance in my regular IRA.) In each of 2011 and 2012, I could record taxable, special receipts of $50K, but then I've got an extra $100K, less taxes, in my assets. I suppose I could enter offsetting special expenditures if I could figure out how much to make them for.
Can anyone help? Or do we need a Roth IRA conversion feature to be added to ESPlanner?
I think the offsetting Special Expenditures is the best work-around for now in the treatment you just outlined.
I also think we need a Roth conversion function added. This would be hugely helpful.It is going to be a very common question asked and the software isn't handling it well.