Converting to a Roth IRA

[Guest gopela]

When Converting a Traditional IRA to a Roth, is there a way to have taxes withheld from the conversion proceeds?

If so, is this viewed as a distribution and therefore subject to a 10% penalty for early withdrawl?

[BPickerCPA]

You do NOT want to withhold taxes from the conversion, if you can help it. That will be considered a distribution subject to penalty.

[John G]

Using the IRA assets to pay for the taxes is not a good idea from an investment perspective. That would reduce the size of your future tax sheltered dollars, while your taxable assets are unchanged. The ideal situation is to burn off your taxable assets to maximize your tax shelter. Remember, the income from assets outside you IRA get taxed each year while the Roth is your long term tax shelter.

If you are likely to qualify for ROTH conversions the next couple of years, you can put yourself on an "installment" plan, converting a part of your IRA each year. For example, if you convert only 1/4 each year, the tax bite would be spread over four years. The drawback of this system is that you IRA assets are likely to continue to grow larger each year, so you would pay more in conversion taxes. You may be able to manage your tax bracket better in a step conversion.

Another thought, a partial conversion often gives you many of the benefits of a full conversion. The Roth part can be left untouched and become an inheritance issue since there are no mandatory distributions. This makes more sense if some (but not all) of your IRA assets will be needed earlier in retirement.

[This message has been edited by John G (edited 10-13-1999).]

[Guest Oldtimer]

John

I believe most of your comments to gopela are valid. But ---

For some, it isn't ideal to burn off taxable assets first to maximize the tax shelter of an IRA. For some, it is best to selectively use their Roth funds before exhausting their taxable assets.

And adding a bit to your comment about a partial conversion. A partial conversion is most often the optimum strategy. That is, it is better than either converting all or none of one's IRA. The question of course is, what is correct percent to convert.

[Guest Oldtimer]

John

I believe most of your comments to gopela are valid. But ---

For some, it isn't ideal to burn off taxable assets first to maximize the tax shelter of an IRA. For some, it is best to selectively use their Roth funds before exhausting their taxable assets.

And adding a bit to your comment about a partial conversion. A partial conversion is most often the optimum strategy. That is, it is better than either converting all or none of one's IRA. The question of course is, what is correct percent to convert.

[John G]

I can not think of many likely circumstance where you want to utilize Roth IRA funds BEFORE you consume non-retirement assets or regular IRA assets. Perhaps you could construct a case with lumpy withdrawals, major changes in tax rates, problem liquidation non-roth investments, or estate planning issues.

The income stream to retirees is often a complex mix of lump sum benefits, pension, thrift plans, 401K, social security, etc. These vary in terms of their $$ magnitude, when they kick-in, how much control you have over the timing and their tax status. It is very common for retirees to utilize this mix over a 15 to 30+ yr time span, especially when you consider the surviving spouse options. Given the high flexibility (no forced distributions), tax shelter features, and inheritance options of a Roth I still think the most common conclusion is to tap your other options before you utilize your Roth assets.

That is a generalization. I would like to see some examples to support other conclusions.

[This message has been edited by John G (edited 10-14-1999).]