Potential strategy for cicumventing the $100K MAGI limit for Roth conversions?

[Guest rkal66]

You have a conventional IRA and a Roth IRA. You are over age 59.5. All of your income is from withdrawals from your trad IRA. You also want to convert part of your traditional IRA to a roth IRA each year.

Problem: In a given year, you have high expenses and need to withdraw an amount from your traditional IRA such that you go over the $100K MAGI limit for conversion to a Roth. You will not be able to do any conversion that year.

Potential solution: Withdraw some of your living expenses from your existing Roth so that your MAGI stays under $100K. Then covert the amount you withdrew from the Roth, plus more, from your trad IRA to your roth.

Will this strategy work? It seems like anyone with an existing Roth could get around the $100K MAGI limit using this strategy.

[mbozek]

What does the taxpayer achieve by following this strategy? It seems that the taxpayer is substituting funds which are exempt from tax in a Roth IRA for funds in a deductible IRA which will be taxed at the taxpayer's marginal income tax rate. Whether the taxpayer removes the funds from the IRA to pay for current expenses so as not to reduce the amount in the Roth IRA or uses the IRA funds to replace the funds withdrawn from the Roth IRA the taxapyer will incure the same amount of tax on the withdrawal of the IRA funds. Its a wash.

[Guest rkal66]

There is no tax benefit to this strategy. It is simply a way to get around the $100K MAGI limit on transfers from an IRA to a Roth. Here's an example. A taxpayer wishes to convert $50K from his trad IRA to his Roth.

Case 1:

$130K withdrawn from trad IRA to meet expenses. $20K in deductions. MAGI = 110K. Taxpayer not eligible to convert any funds from trad IRA to Roth. Roth balance unchanged.

Case 2:

Withdraw $110K from trad IRA and $20K from Roth to meet expenses. MAGI is now less than $100K. Convert $70K from traditional IRA to Roth. Roth balance increases by the desired $50K.

[mbozek]

In case 2 If the taxpayer is married he will be in the 28% fed bracket for taxable income in excess of $114,650 (110 + 70 = 180k- 20 deduction and 10 exemptions = 150k taxable income). In case 1 if taxpayer filing joint return did not withdraw 75k from IRA to fund roth he would only be in 25% fed tax bracket for amounts withdrawn from IRA (110-20 -10 = 80k). Withdrawing 70k in IRA funds to replace roth withdrawal in Case 2 will cost him $1060 in extra tax (3% x (150,000-114,650)) because additional 70k withdrawal pushes him into higher tax bracket.

In addition taking the additonal 70 k from the taxable IRA will result in a loss of 3% of the itemized deductions because the taxpayers agi will be above 139,500 resulting in additional tax of $600 plus the 1060.

[Guest rkal66]

Thanks for your replies mbozek. You are reading more into the question than was intended. I am not looking for the lowest cost approach, or trying to minimize taxes. I am just wondering if this strategy is acceptable to the IRS. The goal is only to convert some funds to a Roth when otherwise you would exceed the MAGI limit.

Depending on your situation, it is sometimes beneficial to convert to a Roth even if you pay 28% in taxes. You may be able to minimize the effect of the MRD later. You might also benefit from taxes on SS income, or even be able to better utilize medical deductions when you have the flexibility of using the Roth to tailor your AGI.

[mbozek]

The IRS welcomes the opportunity to collect more taxes than it would collect if the taxpayer received less taxable income. But I dont know any financial planners who would recommend that a taxpayer increase his taxable income in a current year in order to increase the possiblilty of being able to avoid taxes in a future year because of the loss of income due to the time value of money, e.g, the $1660 that is paid in extra taxes would be worth $2457 in 10 years if it earned 4% on an after tax basis and $3637 in 20 years. Besides MRD is taxable as ordinary income whereas the tax money saved can be invested in a capital asset which will be taxed at a maximum rate of 15%.

[Guest rkal66]

One of the assumptions here is that all of your income comes from your IRAs, so you can't really invest in a 15% capital asset. And any gain in the Roth is not taxed at all.

I have a friend who has worked this very carfully on a spreadsheet and in some cases it is better to increase you income now, rather than in future years. This is particularly true when your MRD puts you in a high bracket, or you have high medical expenses. The actual results--like all financial planning--is very sensitive to your assumptions about rates and inflation, etc.

But my real question is: is this a legal way to get around the MAGI rules for conversion?

[BPickerCPA]

My first reaction from your example is where do you get $20,000 of deductions FOR MAGI. There are not a lot of deductions that fit in that category. If you're thinking of itemized deductions, you're way off base.

My second reaction is, why not just borrow the money for expenses for one year, do the conversion, and take a double withdrawal the second year and pay off the loan.

But to answer you simple question, as long as all taxable income is reported, any method used to keep taxable MAGI under $100K is permitted.

[John G]

Spounds like too much smoke and mirrors to me.

I would suggest that you use a local accountant and run the numbers for him. I see no advantage to your plan.

You might want to wait a few years to see if they change the Roth conversion rules.