Convert now or later?
December 6, 2009 5:26 PM Subscribe
Should I wait to convert my Traditional IRA to a Roth?
I've got a Traditional IRA that I'd like to convert to a Roth, especially since I've got the savings to do so now. I'm 28, single and have no dependents. I'l need to split the conversion over 2 years to stay within my tax bracket, so I've been planning to convert 1/2 this month, and then 1/2 in January 2010.
However, when I called to get the paperwork to do so, the guy I spoke with strongly implied that it was a Very Bad Idea not to wait and do the whole conversion in January (even though they can't officially give advice). I am very aware that 2010 conversions will be allowed to split the tax payments over the following two years. But since I have the cash in hand now, why would I wait?
My main concerns are:
- I don't like the idea of that amount hanging over me for the next two years, especially since I don't know now if my income (or taxes themselves) will be higher in 2011.
- I suppose I could put the money I'd spend on the conversion towards funding the Roth further now, but I'm nervous about not having enough future savings to make the tax payments later. Similarly, the gains seem fairly small if I instead put that money in a CD for a year or two, given that current rates are only around 2%
- It's possible that I'll apply to grad school during the next year or two, and I wouldn't want earmarked savings to lower my loan eligibility.
I've got a Traditional IRA that I'd like to convert to a Roth, especially since I've got the savings to do so now. I'm 28, single and have no dependents. I'l need to split the conversion over 2 years to stay within my tax bracket, so I've been planning to convert 1/2 this month, and then 1/2 in January 2010.
However, when I called to get the paperwork to do so, the guy I spoke with strongly implied that it was a Very Bad Idea not to wait and do the whole conversion in January (even though they can't officially give advice). I am very aware that 2010 conversions will be allowed to split the tax payments over the following two years. But since I have the cash in hand now, why would I wait?
My main concerns are:
- I don't like the idea of that amount hanging over me for the next two years, especially since I don't know now if my income (or taxes themselves) will be higher in 2011.
- I suppose I could put the money I'd spend on the conversion towards funding the Roth further now, but I'm nervous about not having enough future savings to make the tax payments later. Similarly, the gains seem fairly small if I instead put that money in a CD for a year or two, given that current rates are only around 2%
- It's possible that I'll apply to grad school during the next year or two, and I wouldn't want earmarked savings to lower my loan eligibility.
Setting aside impact on cash flow, it's pretty simple: you should convert to a Roth if you expect to be in a higher tax bracket when you take the money out than you are when you put it in.
posted by alms at 5:55 PM on December 6, 2009
posted by alms at 5:55 PM on December 6, 2009
I just did this three days ago and I am your age in your exact situation (not married, no dependents). Ignore what the guy says and run the tax implications for both options, like alms said.
While yes, if you wait to do the whole thing, you can split the tax payments over two years, you'll effectively be doing the same thing by doing it your way, and there's no benefit that I can see to doing it his way. Did you ask him his reasons for implying what he did?
posted by peanut_mcgillicuty at 6:00 PM on December 6, 2009
While yes, if you wait to do the whole thing, you can split the tax payments over two years, you'll effectively be doing the same thing by doing it your way, and there's no benefit that I can see to doing it his way. Did you ask him his reasons for implying what he did?
posted by peanut_mcgillicuty at 6:00 PM on December 6, 2009
So, my mom's lawyer who is handling her estate said something (and I wish I could have written it down) that basically next calendar year you'll be able to split up your IRA, let them appreciate and then use that appreciated value (the gains) to offset the costs of converting to a Roth. Please note, I don't understand this at all but I'm trying to understand it and I haven't been able to find a source who can explain this in plain english but... maybe this will help you figure out what the deal is or maybe this will help someone who reads this thread and knows more about this stuff to chime in. Please post back if you figure this out. :)
posted by amanda at 11:06 AM on December 7, 2009
posted by amanda at 11:06 AM on December 7, 2009
The reason that he advocates converting in January is that money spent in the future costs less than money spent today. Let's say that your tax owed will be $1000. You will have to pay that as $500 in April 2010, $250 in April 2012 and $250 in April 2013 if you do half now and half next year. If you convert it all in January, you would owe $500 in April 2012 and $500 in April 2013. In essence, this means that you are being offered an interest-free loan on the first $500 for 2.5 years by the government.
If your concern about deferring your tax obligation is that you are afraid you will spend the money, you should lock it up in a CD or bond. As you point out, at current interest rates you only make $30 on your $500 -- so the savings are not vast. If you will draw the money from your future earnings, inflation is likely be at least 2% over the next three years so the $500 in 2013 will be less money in real dollar terms. Again, this is more of a factor the more money you are talking about.
However, your arguments are sound and the amount of money you would save may be low enough that you would just as soon pay it down now. The particularly compelling reason would be if your marginal tax rate increases significantly, that would completely eliminate the value of deferring your taxes.
As an aside, "it's pretty simple: you should convert to a Roth if you expect to be in a higher tax bracket when you take the money out than you are when you put it in." is a significant oversimplification. If that condition is true, you should certainly convert, but even if your tax rate will be higher you may still be much better off in a Roth, especially if the amount of time until retirement is long. The value of never being taxed on your gains is huge if you don't anticipate accessing the money for 30 years.
posted by Lame_username at 11:42 AM on December 7, 2009
If your concern about deferring your tax obligation is that you are afraid you will spend the money, you should lock it up in a CD or bond. As you point out, at current interest rates you only make $30 on your $500 -- so the savings are not vast. If you will draw the money from your future earnings, inflation is likely be at least 2% over the next three years so the $500 in 2013 will be less money in real dollar terms. Again, this is more of a factor the more money you are talking about.
However, your arguments are sound and the amount of money you would save may be low enough that you would just as soon pay it down now. The particularly compelling reason would be if your marginal tax rate increases significantly, that would completely eliminate the value of deferring your taxes.
As an aside, "it's pretty simple: you should convert to a Roth if you expect to be in a higher tax bracket when you take the money out than you are when you put it in." is a significant oversimplification. If that condition is true, you should certainly convert, but even if your tax rate will be higher you may still be much better off in a Roth, especially if the amount of time until retirement is long. The value of never being taxed on your gains is huge if you don't anticipate accessing the money for 30 years.
posted by Lame_username at 11:42 AM on December 7, 2009
This thread is closed to new comments.
posted by a robot made out of meat at 5:37 PM on December 6, 2009