My 2010 Mega Roth conversion: bad idea?

[PhysicianOnFIRE]

In 2010, the income limits that restricted high earners from making Roth conversions were lifted. The limits were scheduled to be reinstated in 2011.

I converted all of our traditional IRA money, along with my large SEP-IRA to Roth.  To convert $272,000, I paid about $107,000 in federal and state income tax, split between my 2011 and 2012 tax returns.

Of course, the limits on AGI were never reinstated, but were permanently repealed, making Roth conversions available to all. I've written a longer writeup on my site here. I'm interested in hearing what some of you think about my decision. I think it looks like a mistake in hindsight, but I didn't know that the limits would be lifted, or that I might want to retire early someday, where I could make Roth conversions little by little in a lower marginal tax bracket.

Did any of you take advantage of the supposed 1-year window? Do you have any regrets? Should I?

 

 

[J.D.]

I did the same conversion in 2010 for about the same amount of money.  I have no regrets.  Another benefit is after this conversion I have zero in IRA's so i've been able to do a "backdoor Roth" conversion every year since at a zero basis.  Sure, my net worth would be higher now if I hadn't done the conversion; however, having the highest net worth possible is not my end goal.  Having the best possible retirement is.  I can't predict what future rules will be, but under the current rules I believe a large Roth IRA is the best way to achieve my goal.

[LBKCLU]

No. I never did a Roth IRA conversion as I have a 401(k) along with an SEP. Since I continue to fund my SEP each year, converting it would have defeated the very purpose that I established it.

I think for those that, at one point, had an SEP and no longer can fund it (no longer self employed or work as an independent contractor), it might make sense if they are young, have a large number of years until they retire or want to qualify to make contributions to a Backdoor Roth IRA and don't have an employer sponsored plan to roll the SEP into in order to avoid the pro rata rules.

 

 

[Hatton]

No one knows what will happen with tax policy.  I thought about doing the conversion in 2010 but elected not to.  My Sep/Ira was large enough that I could not stomach the tax hit.  When I completely retire I hope to convert small amounts over a 10 year period or so.  I read the GoCurryCracker Blog as I suspect you do which gave me the idea.  I worry about the rules changing on Roths and having to pay RMDs from the account.  You can't beat yourself up because nobody knows what Congress will do.

[PhysicianOnFIRE]

J.D. wrote:

I did the same conversion in 2010 for about the same amount of money.  I have no regrets.  Another benefit is after this conversion I have zero in IRA’s so i’ve been able to do a “backdoor Roth” conversion every year since at a zero basis.  Sure, my net worth would be higher now if I hadn’t done the conversion; however, having the highest net worth possible is not my end goal.  Having the best possible retirement is.  I can’t predict what future rules will be, but under the current rules I believe a large Roth IRA is the best way to achieve my goal.

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The ability to do the backdoor is a nice one to have.

After 2010, I had a couple years of substantial SEP-IRA contributions, then took a job as a hospital employee in 2012.  I avoid the pro-rata rule by transferring my SEP-IRA into my employer's 401(k), where the money will remain until I retire. So I'm able to do the backdoor Roths for my wife and I every year. It's a neat trick.  

[PhysicianOnFIRE]

hatton1 wrote:

No one knows what will happen with tax policy.  I thought about doing the conversion in 2010 but elected not to.  My Sep/Ira was large enough that I could not stomach the tax hit.  When I completely retire I hope to convert small amounts over a 10 year period or so.  I read the GoCurryCracker Blog as I suspect you do which gave me the idea.  I worry about the rules changing on Roths and having to pay RMDs from the account.  You can’t beat yourself up because nobody knows what Congress will do.

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I think you made the right choice. I've read GoCurryCracker as well... serial Roth conversions are in my future,  as I expect to have a 401(k) to convert in early retirement, which in 5 years will likely have a value of about double my 2010 conversion. I'll roll it over to an IRA, and the goal would be to convert it all to Roth by the time I'm 70.  I'll have 25 years to do so if I retire at 45.

I'll definitely fill the 15% bracket if there's any space, and probably the 25% brackets.  I'll definitely be doing some projections to explore the tax consequences each year. One nice thing is you can overconvert, then recharacterize the overage.  Some people will convert different asset classes, with the plan to recharacterize the lot(s) that performed poorly.

[WealthyDoc]

I did the same thing but have no regrets.  I ran a financial analysis based on any reasonable assumptions I could come up with and I estimate it will save me $250k over my lifetime.  I ran the numbers through fidelity and got the same answer.  My CPA then did his own analysis and got the same result.  Granted the future is uncertain but it always is.  There is nothing like tax-free growth combined with tax-free withdrawal!  I plan to spend it all when I want (no required withdrawals at present) or pass it on to my dependents.  The general idea is I would rather pay tax now when the amount is smaller than when it will (I hope due to investing)be bigger in the future.  Even if the tax rate percentages are the same I would come out ahead.  Coming up with that cash to pay the tax was also like a forced prepayment that caused me to invest more that year.  I also continue with "backdoor" Roths for as long as we are allowed to.

 

[jfoxcpacfp]

We did the 2-step Roth conversion for several clients in 2010. It has been a very good decision for them. As for ongoing conversions, I convert chunks of my own IRA and for some clients whenever the market corrects. We’re all paying taxes in a high bracket, but on less income and it works very well. Given that you get a mulligan until the extended deadline of the following year, I cannot imagine why more people do not do this. You are effectively moving the taxes you pay on the conversion into your Roth IRA.

[DarrVao777]

LBKCLU wrote:

it might make sense if they are young, have a large number of years until they retire or want to qualify to make contributions to a Backdoor Roth IRA and don’t have an employer sponsored plan to roll the SEP into in order to avoid the pro rata rules.

 

 

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This was basically my situation. I (may have stupidly) converted my $50K SEP-IRA into a Roth IRA (despite residing in the 39.6% marginal bracket) since I'm young, plan to work 30+ years (for now), and wanted to make contributions to a backdoor Roth IRA but have a lousy employer sponsored plan that would not accept SEP-IRA rollovers.

[jfoxcpacfp]

DarrVao777 wrote:

LBKCLU wrote:

it might make sense if they are young, have a large number of years until they retire or want to qualify to make contributions to a Backdoor Roth IRA and don’t have an employer sponsored plan to roll the SEP into in order to avoid the pro rata rules.

 

 

Click to expand…

This was basically my situation. I (may have stupidly) converted my $50K SEP-IRA into a Roth IRA (despite residing in the 39.6% marginal bracket) since I’m young, plan to work 30+ years (for now), and wanted to make contributions to a backdoor Roth IRA but have a lousy employer sponsored plan that would not accept SEP-IRA rollovers.

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Probably not stupid over the long term. Taxes aren't that bad on "only" $50k and you'll overcome them. Unless, that is, you had to use part of your IRA to pay the tax bill. Don't know your tax bracket, etc. of course, but my guess is that you made a good decision, given your age (just guessing around 35).

Of course, if you did the conversion in 2015 or 2016, you still have time to recharacterize. But I wouldn't be too hasty to do that. Suck it up and pay the taxes and go forward with an appropriately diversified equity mutual fund portfolio.

[AlexxT]

I think it's not enough of a difference to obsess about in your case , but the difference between a Roth and a regular IRA is primarily one of tax arbitrage: If the effective tax rate on the IRA withdrawals will be higher than your marginal rate now, then pay the tax now.  If your effective rate on withdrawal will be lower in retirement, then pay the tax later.   There's a small caveat there, in that you get more of "your" money in a Roth than in an IRA, because all the Roth money is working for you tax free, whereas in an IRA some of that money and growth will belong to the government, but if you run the numbers, for almost all of us, conversion only makes sense if your tax rate is lower now than it will be after 70 1/2.   Of course, the advantage of no required withdrawals, tax diversification, and psychological advantages might be worth something to you as well.

[GXA]

I did the same as Physician on Fire and with a similar amount.  Given where the market was then, it will be nice to not have any capital gains taxes on the growth.