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Regular Ira To Roth Ira?

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I am 62 and will collect about $6K from Social Security, $1K from employment. I have saved about $400K in IRAs, mostly switched from 403b when I retired. My question is: since I am in such a low tax bracket this year, why don't I transfer lots ($8,000) from an IRA into a Roth IRA. So in 5+ years I will bea ble to have some tax free supplemental income (which could keep me in a lower tax bracket at that time. The tax consequences this year will be much less than later assuming a normally growing market. I hope this is a clear question as it is my first 403bwise offering.

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Guest Chuck Yanikoski

The important question is not whether your tax bracket is low now, relative to the past, but whether it is low now, relative to the future. The things that will affect your future income tax rate are (1) the amount of your income, and (2) the Federal (and state) tax code. If you are NOT withdrawing money from your IRAs this year, but expect to do so in the future (and of course, after age 70-1/2 you have to), then expect your income level to increase. If you believe (as I do) that sooner or later the government is going to have to resolve the deficit problem by increasing taxes again, then this, too, argues that your future tax rate is likely to be higher than it is right now.

 

If this is indeed the case, then you are right to want to roll over some of your funds to a Roth IRA. As you are probably aware, you do have to pay taxes when you do this, and the taxable income on a Roth rollover (especially on a $400,000 rollover) will push you into a much higher tax bracket, thus defeating the purpose. Your best strategy, therefore, is to establish a Roth account, then spread the rollover across several years -- determining the amount by what you can do without pushing yourself into too high a tax bracket each year.

 

Here at Still River, we also maintain that since there is always some uncertainty about future taxes, the most rational strategy is a hedging strategy, where you keep SOME money in both kinds of account. In your situation, it sounds like the lion's share should eventually be moved into the Roth account, but I would still advise you to keep some of the money in the traditional IRA (offhand, I would say maybe 20% or so).

 

One advantage of having money in both kinds of account is that you can more easily optimize your taxes over time. Imagine that five years from now you have completed your gradual rollover and you have 20% in your old IRA and 80% in a Roth IRA. Suppose further that you decide you need to withdraw $20,000 that year to cover your expenses. Finally, assume that with your other income, you are $6,000 under the top of your current Federal income tax bracket. In this scenario, your best tax strategy would probably be to take $6,000 from the traditional IRA, paying your same current marginal tax rate on that amount, then, to avoid paying anything at a higher rate, taking the other $14,000 out of the Roth account.

 

Obviously, these numbers are made up, and almost as obviously, the real numbers will change every year, depending on your other income and on changes in the tax brackets (due to legislation or to inflation adjustments). But the point is, by having some money in both kinds of account, you can play the tax game to your own best advantage. By doing all or none, you limit your options.

 

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