401K conversion to Roth IRA advice

[govtec]

It's that time of the year folks, get your IRA deposits in or miss out on 1 years worth of contribution. Well, actually you do have until April 15, 2011 before the real deadline is here.

I think I know the answer to this question but I just want to run this by the fine folks on this forum. In January of this year, I rolled over a portion of my employer 401K plan into a Traditional IRA account and then proceeded to do a conversion from Traditional IRA to Roth IRA account. So this was all completed in 2010.

Can I still contribute another $5K into the Roth IRA account in 2010 and still be considered within the contribution limit? I did a little bit of research and a lot of people was saying a conversion should not be counted as a contribution. Any tax accountant here to confirm if this is a true statement? Thanks

[ideliver]

conversions are not contributions...BTW it makes no sense to me why the government wants to limit my post tax savings???

[kyleb350]

The first thing I would do is say "Would ya look at that?"

[scollins]

Originally Posted by ideliver

conversions are not contributions...BTW it makes no sense to me why the government wants to limit my post tax savings???

Because the money in the ROTH grows tax free. So the government wants to limit how much "tax free money" you might build up.

That is why the ROTH conversion makes sense: Pay the known taxes now on $50,000, and don't pay ANY taxes on it in 30 years when it has grown to $225,000 (5% annual rate of return). Let's say that $50,000 conversion is at the 28% tax bracket. You will pay $14,000 in taxes (28% of $50,000) in 2010. In 30 years, your net "effective tax rate" is now $14,000/$225,000 = 6.2%.

The way this government is bleeding cash right now, who knows what kind of tax rates we might have on a $225,000 nugget.....

[double_j]

Don't forget to pay taxes on the conversion.

[govtec]

Originally Posted by double_j

Don't forget to pay taxes on the conversion.

Yes sir

[Repsol]

I'm new to the investment stuff, but is this something I should be doing? Converting part of my 401K to a Roth?

[BTM]

If you foresee taxes going up in the future, put your retirement funds in a Roth IRA. You will pay taxes on 401k/403b and IRA withdrawals, but Roth IRA withdrawals are tax free.

[scollins]

Originally Posted by BTM

If you foresee taxes going up in the future...

How can they not? I foresee large tax increases along with large spending cuts. That is the only way (other than printing money, which just causes other, more significant problems) that this country can get its finances back in order. Obviously we've delayed that call for 2 more years, but at some point, someone is going to have to pay the piper. Anyone under 60....... that's means you!

[BTM]

Originally Posted by scollins

How can they not?

Well that's just it...it's not at all a sure thing, and it's actually been trending slightly negative in recent history. Not to say I don't agree with you.



There is also the issue of what bracket you're currently in - a Roth IRA contribution does not lower your taxable income. So the higher the tax bracket you are in, the less advantageous (with an arbitrary future tax rate held constant) it is over a traditional IRA, where you contribute pre-tax.

Just things to think about, everyone's situation is different. My retirement is a Roth IRA, FWIW.

*Got the graph from a blog, and didn't check it's accuracy, but it does mirror a similar chart I did for a class a few years back, so I believe it to be fairly correct*

[scollins]

Originally Posted by BTM

Well that's just it...it's not at all a sure thing, and it's actually been trending slightly negative in recent history. Not to say I don't agree with you.


There is also the issue of what bracket you're currently in - a Roth IRA contribution does not lower your taxable income. So the higher the tax bracket you are in, the less advantageous (with an arbitrary future tax rate held constant) it is over a traditional IRA, where you contribute pre-tax.

Just things to think about, everyone's situation is different. My retirement is a Roth IRA, FWIW.

*Got the graph from a blog, and didn't check it's accuracy, but it does mirror a similar chart I did for a class a few years back, so I believe it to be fairly correct*

Those are just graphs of historical tax rates, but it doesn't necessarily correlate to government spending. So while tax rates are at a near historical low, our spending is at historical highs. That is unsustainable, and it is to such a degree that simply increase taxes or lower spending won't be enough, it will require both actions.

And then you've got the AGI limits on ROTH contributions, so the "wealthy" ($167,000-ish plus) can't even contribute to a ROTH. And the ROTH contribution limits for the rest of us aren't all that high either. But as far as I know, there are no AGI limits on ROTH conversions.

So I think the best option is a combination of IRA and ROTH. I've actually got an IRA, ROTH IRA, 529 Plan and a 401(k). Soon, we'll open a SEP IRA for the wife too. Good grief....

[ideliver]

Originally Posted by scollins

Because the money in the ROTH grows tax free. So the government wants to limit how much "tax free money" you might build up.

That is why the ROTH conversion makes sense: Pay the known taxes now on $50,000, and don't pay ANY taxes on it in 30 years when it has grown to $225,000 (5% annual rate of return). Let's say that $50,000 conversion is at the 28% tax bracket. You will pay $14,000 in taxes (28% of $50,000) in 2010. In 30 years, your net "effective tax rate" is now $14,000/$225,000 = 6.2%.

The way this government is bleeding cash right now, who knows what kind of tax rates we might have on a $225,000 nugget.....

this is my gripe...what difference does it make to the government what I do with my money after I have earned it and paid my initial income tax...

it's because they want to tax it again if I spend it (sales tax) or tax it again if I invest it (capital gains and dividens)...and tax it again if I die (estate tax)

This is one of the reasons that I am leary of converting to a ROTH...nothing (except to goodwill of congress) keeps them from changing the rules and making distributions taxable in the future...

Just like those of us that saved money will be means tested in the future and will get reduced social security payments...(which also is taxable...)