10

Jurisdiction is US/Oregon

I retired in 2014. In 2015 I am drawing on cash and investments held in a taxable account, and don't foresee needing to tap my IRAs for several years. Thus I am in the enviable position of having more deductions (mortgage, property Tax, medical insurance, etc) than taxable income for 2015.

Can I use this deduction excess to effect a "tax-free" conversion of some IRA funds to a Roth? From my reading I see that converted funds are taxed as ordinary income, so it seems I should be able to determine my total deductions and convert just enough to ensure that my tax liability is zero or slightly positive, while "using up" all my deductions.

I'm already aware of the following

  • Any funds converted cannot be withdrawn from the Roth for 5 years without incurring a penalty
  • The conversion must occur by 12/31/2015 (not 4/15/2016)

Are there any other gotchas that I should be aware of?

12

Yes. A most emphatic yes.

I suggest you look at your 2014 return and project what 2015 will look like. I'd convert enough to "top off" the 15% bracket. Note, if you overshoot it, and in April 2016, see that you are say $5K into the 25% rate, you can just recharacterize the amount you went over and nail the bracket to the dollar.

If you have the time and patience, you can convert into 2 different Roth accounts. One account for one asset class, say large cap stocks/funds, the other, cash/bonds. In April, keep the account that outperformed, and only recharacterize the lagger. Roth Roulette is my name for this strategy. It's risk free, and has the potential to boost the value of your conversions.

Edit - To be clear, you are permitted to recharacterize (undo) any or all of the converted amount. You actually have until tax time (4/15 or so) plus the 6 month extension. You can recharacterize for any reason -

  • Your converted assets dropped in value, why pay 15% on $20K (say) when the stock current value is $10K (ouch).
  • You overshot the target bracket and want to nail your "taxable income" number dead on.
  • You don't have the funds to pay the tax and don't want to cash out more IRA money to pay it.
  • You are retired, collecting Social Security, and find the conversion puts you in a Phantom Tax Bracket
  • You just changed your mind. (I mean this literally. No reason is required by the IRS, just paperwork.)

A personal anecdote - I manage my mother in law's money. She is well under the 25% bracket cutoff. Each year I convert, and each April, recharacterize just enough to be at the top of the 15% bracket. Over $100K has been shifted from Traditional IRA to Roth by now. Taxed at 15% so her daughters will 'not' pay 25% when they withdraw. $10K in tax saved from uncle sam, for my effort of filling out paper twice a year for 12 years now. Well worth my effort.

  • 3
    I favorited the question, but I really wanted to favorite this answer. – Nathan L Oct 7 '15 at 20:04
  • Thanks, Nathan! There's my smile for the day. Much appreciated. – JoeTaxpayer Oct 7 '15 at 20:51
3

Answering for just the US part, yes, you should be able to do this and it's a good strategy. The only additional gotcha I can think of is that if you've made after-tax contributions to your traditional IRA, you need to prorate the conversion, you can't just convert all the pre-tax or all the after-tax.

I'm not familiar with Oregon personal income tax so there may be additional gotchas there.

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