IRA to Roth IRA conversion question

[calicubed]

I have a quick question on whether an IRA to Roth IRA conversion is allowed when you don't currently have an income?

I'm a first year who worked before starting med school. During that time, I made sure to max out on a trad. IRA and my job's 403(b) each year...I was very frugal and continued to live like the poor college I was when I entered the work force. Also, I chose an IRA instead of a Roth because I was really focused on paying the least amount of taxes possible at that time.

Since I don't really have an income now, I was wondering if I could move 5k from an IRA to Roth IRA every year that I'm in med school and basically treat that as my only 'income'. That way I'm in the lowest tax bracket possible. My main concern is figuring out if this is even allowed or legal. I know that most of the conversion rules talk about income limits concerning high income earners, but I haven't found anyone trying to do the above.

Thanks for any help or responses!

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[Otto of the Silver-Hand]

You'll have to pay taxes owed on the amount of money you switch from tIRA to the Roth.

 

[krl7044]

Sure, you can convert your traditional IRA to Roth in pieces. There are no income limits for conversion, only for contribution to Roth directly. Discount brokerages such as Vanguard have it all automated, so you can make conversions online. All you need to do is to open a Roth IRA account, and you can make the conversion on the spot. Just make sure you declare that when filing your taxes.

 

[sazerac]

I converted a traditional IRA to a Roth IRA in a year when I had no income, and therefore could not make any additional contributions that year. You are good to go.

 

[Stroganoff]

It's the perfect time to convert to a Roth, since you can take the standard deduction + personal exemption and not pay any taxes on the conversion. I'd find out the max you can convert each year without paying a penny in taxes and knock out what you can in 2014, then 2015, until it's done.

I believe 2014 Standard Deduction is $6200, and personal exemption is $3950, so that's $10,150 that you might be able to safely convert (verify my math on how taxes work). But you're good to go on the Roth conversion! Convert it all before residency income hits.

 

[Hamhock]

I have a quick question on whether an IRA to Roth IRA conversion is allowed when you don't currently have an income?

I'm a first year who worked before starting med school. During that time, I made sure to max out on a trad. IRA and my job's 403(b) each year...I was very frugal and continued to live like the poor college I was when I entered the work force. Also, I chose an IRA instead of a Roth because I was really focused on paying the least amount of taxes possible at that time.

Since I don't really have an income now, I was wondering if I could move 5k from an IRA to Roth IRA every year that I'm in med school and basically treat that as my only 'income'. That way I'm in the lowest tax bracket possible. My main concern is figuring out if this is even allowed or legal. I know that most of the conversion rules talk about income limits concerning high income earners, but I haven't found anyone trying to do the above.

Thanks for any help or responses!

I thought one had to have an income at least equal to the Roth investment...is that not true? Is that only true for direct Roth investments and not for "conversions"?

HH

 

[sazerac]

I thought one had to have an income at least equal to the Roth investment...is that not true? Is that only true for direct Roth investments and not for "conversions"?

HH

You only need wage income that year for new contributions to your Roth / non-Roth ecosystem. Converting funds from non-Roth to Roth does not require wage income that year.

 

[The White Coat Investor]

I have a quick question on whether an IRA to Roth IRA conversion is allowed when you don't currently have an income?

I'm a first year who worked before starting med school. During that time, I made sure to max out on a trad. IRA and my job's 403(b) each year...I was very frugal and continued to live like the poor college I was when I entered the work force. Also, I chose an IRA instead of a Roth because I was really focused on paying the least amount of taxes possible at that time.

Since I don't really have an income now, I was wondering if I could move 5k from an IRA to Roth IRA every year that I'm in med school and basically treat that as my only 'income'. That way I'm in the lowest tax bracket possible. My main concern is figuring out if this is even allowed or legal. I know that most of the conversion rules talk about income limits concerning high income earners, but I haven't found anyone trying to do the above.

Thanks for any help or responses!

Yes. Med school is a great time to do Roth conversions. Good thinking. Of course, this is also probably a good time to pull money out of an IRA and use it to pay tuition....something to think about. You won't even have to pay the penalty if you use the money for education. No penalty, no tax, no student loans.....yes, you lose the benefit of compound interest on that money, but compound interest works in reverse on student loans. Pretty nice guaranteed investment. Either one is a great move, of course. Good luck with your decision.

 

[QofQuimica]

Question about how to pay the income tax due on traditional-to-Roth IRA conversions:

I'll be converting about $16,000 and estimate that I'll owe about $4000 in taxes on that. Obviously, I don't want to lose 25% of my savings by withholding those tax dollars from my IRA funds! But what is the best way to prepare for the additional tax burden if I don't withhold from the IRA? It seems like the options are either to keep aside an extra $4000 that I will owe the IRS when I pay my 2014 taxes, or to make an ES payment for $4000 in January. From my perspective, either method will basically result in my getting a $4000 bill in January (or shortly thereafter depending on exactly when I file), so it's kind of six of one and half a dozen of the other to me. But does anyone think there's a benefit to making an ES payment rather than just paying it when I actually file my taxes?

 

[NICUfello]

Question about how to pay the income tax due on traditional-to-Roth IRA conversions:

I'll be converting about $16,000 and estimate that I'll owe about $4000 in taxes on that. Obviously, I don't want to lose 25% of my savings by withholding those tax dollars from my IRA funds! But what is the best way to prepare for the additional tax burden if I don't withhold from the IRA? It seems like the options are either to keep aside an extra $4000 that I will owe the IRS when I pay my 2014 taxes, or to make an ES payment for $4000 in January. From my perspective, either method will basically result in my getting a $4000 bill in January (or shortly thereafter depending on exactly when I file), so it's kind of six of one and half a dozen of the other to me. But does anyone think there's a benefit to making an ES payment rather than just paying it when I actually file my taxes?

I have $13000 in a 401A. Basically same position as you.

What would happen if you DON"T convert your 16k like I am planning on?

Say it grows..you are 65..and yes it will be higher taxes... vs paying 4K now?

Just thinking out loud..not making a suggestion...

 

[krl7044]

It is not a lot of money to worry about, but given that taxes probably will increase, and you will most likely accumulate a large sum of money in tax-deferred accounts, converting now is a good idea.

However, you need to really plan this out better. I like to think of three ways to diversify tax liability. After-tax, Roth and pre-tax. As long as you hit all three (with an understanding that the pre-tax will be the biggest one), any additions that you can make to your Roth bucket now will be an advantage down the road (especially if the taxes increase).

 

[Silent Cool]

Question about how to pay the income tax due on traditional-to-Roth IRA conversions:

I'll be converting about $16,000 and estimate that I'll owe about $4000 in taxes on that. Obviously, I don't want to lose 25% of my savings by withholding those tax dollars from my IRA funds! But what is the best way to prepare for the additional tax burden if I don't withhold from the IRA? It seems like the options are either to keep aside an extra $4000 that I will owe the IRS when I pay my 2014 taxes, or to make an ES payment for $4000 in January. From my perspective, either method will basically result in my getting a $4000 bill in January (or shortly thereafter depending on exactly when I file), so it's kind of six of one and half a dozen of the other to me. But does anyone think there's a benefit to making an ES payment rather than just paying it when I actually file my taxes?

You could always do a tax extension and file in October. You can request a tax extension for free through TurboTax.

 

[QofQuimica]

I have $13000 in a 401A. Basically same position as you.

What would happen if you DON"T convert your 16k like I am planning on?

Say it grows..you are 65..and yes it will be higher taxes... vs paying 4K now?

Just thinking out loud..not making a suggestion...

Nope, I can't leave it in the traditional IRA, or it will cause pro rata problems next calendar year when I go to do my first back door Roth. Plus, I'll be in a higher tax bracket next year than this year, so I really don't want to postpone the conversion.

You could always do a tax extension and file in October. You can request a tax extension for free through TurboTax.

What would be the benefit of doing that? Other than just not having to pay my taxes right away, which, meh. I'd just as soon file on time and be done with it unless there's some advantage to waiting that I'm not aware of.

 

[Silent Cool]

Nope, I can't leave it in the traditional IRA, or it will cause pro rata problems next calendar year when I go to do my first back door Roth. Plus, I'll be in a higher tax bracket next year than this year, so I really don't want to postpone the conversion.


What would be the benefit of doing that? Other than just not having to pay my taxes right away, which, meh. I'd just as soon file on time and be done with it unless there's some advantage to waiting that I'm not aware of.

It sounds like you are worried about paying 4K. You can more easily pay the 4K with your earned income if you simply file a tax extension.

Also, what is an ES payment?

 

[QofQuimica]

It sounds like you are worried about paying 4K. You can more easily pay the 4K with your earned income if you simply file a tax extension.

Also, what is an ES payment?

No, not worried about paying the $4000. I can afford to pay it on time. The question is, do I need to make an estimated (ES) payment for it versus just paying it when I pay my taxes in, say, Feb.

There is a separate 1040-ES for people who have 1099-MISC income and don't get income tax withheld from their paychecks. The IRS does not permit you to pay no taxes all year; what you do in that case is send in quarterly ES payments. I had to do that for a few years, and it's kind of a PITA, but not the end of the world.

 

[Silent Cool]

No, not worried about paying the $4000. I can afford to pay it on time. The question is, do I need to make an estimated (ES) payment for it versus just paying it when I pay my taxes in, say, Feb.

There is a separate 1040-ES for people who have 1099-MISC income and don't get income tax withheld from their paychecks. The IRS does not permit you to pay no taxes all year; what you do in that case is send in quarterly ES payments. I had to do that for a few years, and it's kind of a PITA, but not the end of the world.

Ah, got it--you're a 1099. In that case I'm not sure. I would recommend the TurboTax forums--they are free and I'm sure that someone on there has had the same question before. It's called TurboTax AnswerXchange:

https://ttlc.intuit.com/

As an addendum, I think that you can avoid paying quarterly taxes as a 1099 but there is a penalty/fee/add'l tax, etc.. (from what I understand) though I'm not sure how much/what % it is.

 

[QofQuimica]

Ah, got it--you're a 1099. In that case I'm not sure. I would recommend the TurboTax forums--they are free and I'm sure that someone on there has had the same question before. It's called TurboTax AnswerXchange:

https://ttlc.intuit.com/

I'm actually not getting a 1099-MISC from my current job; I work for the gub'ment now, and they most certainly take their cut out of each and every one of my paychecks. So it's not like I'm not having a substantial amount of income tax withheld each month. I imagine, however, that I will get a 1099-MISC from my brokerage for my traditional-to-Roth conversion in the amount of ~$16,000 of income. But not having ever done such a conversion in the past, I don't know this for sure. Nor do I know whether people who do traditional-to-Roth conversions typically make an ES payment for them. Hence my question.

 

[NICUfello]

Nope, I can't leave it in the traditional IRA, or it will cause pro rata problems next calendar year when I go to do my first back door Roth. Plus, I'll be in a higher tax bracket next year than this year, so I really don't want to postpone the conversion.

Got it. Didn't realize that my 401A leaving the money in there, would harm the backdoor Roth in Jan.

Means I gotta do something about it too....

Bullocks was hoping not to do the conversion.

 

[QofQuimica]

Got it. Didn't realize that my 401A leaving the money in there, would harm the backdoor Roth in Jan.

Means I gotta do something about it too....

Bullocks was hoping not to do the conversion.

I don't know whether you have to or not. I've never had a 401a and am not familiar with the rules. In my case, I had a pre-tax pension fund that was going to start earning nothing once I separated from my residency. So I rolled the money out of the pension and into a traditional IRA. I definitely do need to convert that money from the traditional IRA to my Roth this year if I want to be able to back door Roth next year without running afoul of pro rata, or else convert the entire ~$22,000 next year and pay even higher taxes since I'll be in a higher tax bracket in 2015. But I don't know if you have the same issue with a 401a plan. You should ask someone who actually knows what they're doing.

 

[ThoracicGuy]

Got it. Didn't realize that my 401A leaving the money in there, would harm the backdoor Roth in Jan.

Means I gotta do something about it too....

Bullocks was hoping not to do the conversion.

If the 401a is anything like the 401k, those monies are hidden from the pro rata calculation for the backdoor roth. Also, you can have tIRA monies at the time of the conversion, they just have to be moved or all converted by Dec 31st of the tax year of conversion for the pro rata rule.

 

[ThoracicGuy]

I don't know whether you have to or not. I've never had a 401a and am not familiar with the rules. In my case, I had a pre-tax pension fund that was going to start earning nothing once I separated from my residency. So I rolled the money out of the pension and into a traditional IRA. I definitely do need to convert that money from the traditional IRA to my Roth this year if I want to be able to back door Roth next year without running afoul of pro rata, or else convert the entire ~$22,000 next year and pay even higher taxes since I'll be in a higher tax bracket in 2015. But I don't know if you have the same issue with a 401a plan. You should ask someone who actually knows what they're doing.

I see you work for the government. Are you eligible for the TSP plan? If so, you can transfer your tIRA into the TSP and not have to worry about the tax hit. If you do the tax hit, don't pay the taxes from the tIRA, use your own money from your taxable account to pay for it... Keep as much money in the IRA bracket as possible. And if you aren't doing the backdoor until 2015 calendar year, then you have until Dec 31, 2015 to have the tIRA moved to avoid pro rata taxes.

 

[Anonymous007]

you lose the benefit of compound interest on that money, but compound interest works in reverse on student loans. Pretty nice guaranteed investment.

It's my understanding that the interest on student loans only capitalizes once (right before repayment), and that the interest you pay each day after that is only calculated from the initial principle plus capitalized interest accrued up to repayment. This seems different to me than compounding interest, and in this setting favorable to it.

 

[QofQuimica]

I see you work for the government. Are you eligible for the TSP plan? If so, you can transfer your tIRA into the TSP and not have to worry about the tax hit. If you do the tax hit, don't pay the taxes from the tIRA, use your own money from your taxable account to pay for it... Keep as much money in the IRA bracket as possible. And if you aren't doing the backdoor until 2015 calendar year, then you have until Dec 31, 2015 to have the tIRA moved to avoid pro rata taxes.

No, I'm a state employee, not federal, so no TSP. And again, I don't want to wait until 2015 to convert, because I'll be in a higher tax bracket next year. Definitely won't use the IRA funds to withhold taxes, but still just trying to figure out if I need to make an ES payment....

 

[dpmd]

No, I'm a state employee, not federal, so no TSP. And again, I don't want to wait until 2015 to convert, because I'll be in a higher tax bracket next year. Definitely won't use the IRA funds to withhold taxes, but still just trying to figure out if I need to make an ES payment....

I would say it is probably worth making the estimated payment if you think you might end up with underpayment penalties. Not sure how this would get factored in for this conversion, but if you owe that much (because your withholding is set appropriately and you aren't getting a big refund) they might have an issue. Wait, are you the one who put 0 on the w-4? If so, I wouldn't worry about it.

 

[QofQuimica]

I would say it is probably worth making the estimated payment if you think you might end up with underpayment penalties. Not sure how this would get factored in for this conversion, but if you owe that much (because your withholding is set appropriately and you aren't getting a big refund) they might have an issue. Wait, are you the one who put 0 on the w-4? If so, I wouldn't worry about it.

No, that was the lady who had almost a million dollars worth of debt plus the sick husband, and they lived in an expensive city.

I think I'm going to talk to an accountant. I have no idea if I'm going to have an issue or not regarding penalties.

 

[dpmd]

No, that was the lady who had almost a million dollars worth of debt plus the sick husband, and they lived in an expensive city.

I think I'm going to talk to an accountant. I have no idea if I'm going to have an issue or not regarding penalties.

Ok. Yeah. Not a bad idea to ask. I got screwed in residency one year when they decided they weren't going to let us participate in the deferred comp plan and decided it was a retroactive thing so they refunded what we had put in and made us subject to social security instead. Since I always fill out my w4 so I owe some or have a minimal refund that extra tax liability made me have to pay penalties. It wasn't much, but it still sucked.

 

[The White Coat Investor]

It's my understanding that the interest on student loans only capitalizes once (right before repayment), and that the interest you pay each day after that is only calculated from the initial principle plus capitalized interest accrued up to repayment. This seems different to me than compounding interest, and in this setting favorable to it.

Different loans, different terms. But yes, if the interest is calculated on some sum smaller than the entire principal + interest owed, you'll be better off than if it were.