Does Joey qualify for a Roth IRA, by using the already rolled over distribution from the old 401K?
… Yes you qualify
What is the tax due on the conversion of the roll over IRA to the roth IRA?
… Approximately $3800

 

Do you have the money to pay the tax?
… Yes - see the attached sheet.  If your 2000 payroll withholding, income and deductions are about the same for 2000, then the withholding should cover the tax due on the conversion.

 

 

Qualifying for the conversion of a traditional IRA to a Roth IRA: - Yes you qualify - see the next paragraph

 

FIRST TWO CONDITIONS MUST BE MET:
1 - modified AGI does not exceed $100,000 for a taxable year
2 - a qualified rollover contribution generally means a rollover contribution to a Roth IRA from an individual retirement plan, but only if such rollover contribution satisfies the requirements for a rollover contribution, as defined in Code Section 408(d)(3) [The ordinary and traditional roll over rules - e.g. the 60 day time period, etc.]

 

THEN ONE OF THE FOLLOWING MUST BE SATISFIED:
1 - a r/o from a traditional IRA if it is within 60 days of the distribution from the traditional IRA
2 - Trustee to Trustee transfer from a traditional IRA
3 - Transferred to a Roth if both the traditional and the Roth are maintained by the same trustee

 

The decision as to whether a Roth IRA conversion should be made should be based on three factors:

 

     (1) Is the taxpayer eligible for the conversion.

 

     (2) Do the benefits outweigh the costs.

 

     (3) Will the tax liability arising from the conversion be so large that it becomes impractical for the taxpayer to make the conversion.

 

(1) Is the taxpayer eligible for the conversion:
Resolving the first issue is straightforward: a taxpayer is eligible if he or she has adjusted gross income of less than $100,000, and, if married, files a joint return, as discussed above.

 

(2) Do the benefits outweigh the costs:
In general, the greatest benefits are available to those who will leave the money in the IRA (whether Roth or traditional) for the longest time (preferably until after death), as this maximizes both the length of time for which tax is deferred and the amount of post-conversion earnings that eventually escapes tax. Thus, for example, individuals who do not need the money contained in a traditional IRA should generally convert the IRA to a Roth IRA, as this will allow their beneficiaries to receive the amounts tax-free. On the other hand, if an individual needs or plans to make withdrawals from the IRA within a shorter period of time, such as five to ten years, it is best to continue with the traditional IRA because the short time horizon will not allow the individual to accrue enough post-conversion earnings to make up for the taxes paid on a conversion.

 

The most important factor in terms of the cost is the IRA owner's tax bracket at the time of the conversion compared to the IRA owner's tax bracket at the time he expects to take distributions, since in making a conversion, an IRA owner is choosing between current taxation on the existing balance of the IRA if the conversion is made, and taxation at the time of distribution, if the IRA remains a traditional IRA. Thus, if an individual with a traditional IRA plans to take distributions from the IRA during retirement, and if the individual expects to be in a substantially lower tax bracket at that time, the individual should probably continue with the traditional IRA. For example, if an individual is currently in the 28 percent (or higher) tax bracket, and if the individual expects to be in the 15-percent tax bracket during retirement, a conversion does not make sense because the tax rate that will be imposed on the conversion amount will be higher than the tax rate that will be imposed on withdrawals made from the traditional IRA. However, the length of time and the expected rate of return on the IRA also enter into the equation, since the tax at the time of conversion will apply only to the balance at that time, while the tax on distribution if the IRA is not converted will apply to a much greater amount, including all earnings accrued after the time the conversion would have occurred.

 

(3) ABILITY TO PAY TAX
Even a taxpayer for whom the benefits outweigh the costs will not want to make an IRA conversion if the tax liability resulting from the conversion will be so large that the taxpayer cannot pay it. Thus, an important factor in making a conversion decision is whether a taxpayer has the necessary funds to pay the tax liability. And these funds must be held outside the IRA, since if the taxpayer must use cash from inside the IRA to pay the tax owed, the cash used to pay the tax will be treated as a withdrawal and will be subject to the 10 percent penalty tax if the taxpayer is not yet age 59 1/2. <4> In addition, there will be less funds working in the IRA for the taxpayer, so the benefit of the conversion will be lessened.

 

A taxpayer who does not have the funds necessary to pay the tax liability but who can benefit from a conversion should consider converting part of the traditional IRA to a Roth IRA each year over a number of years. This technique has the effect of spreading out the taxpayer’s tax liability over a time period selected by the taxpayer.

 

                                                                                     *******

 

Does Joey qualify for a Roth IRA, by using the already rolled over distribution from the old 401K?
… Yes you qualify
What is the tax due on the conversion of the roll over IRA to the roth IRA?
… Approximately $3800

 

Do you have the money to pay the tax?
… Yes - see the attached sheet.  If your 2000 payroll withholding, income and deductions are about the same for 2000, then the withholding should cover the tax due on the conversion.

 

Is it financially profitable to make the conversion?  Yes
…  I have computed 9% annual earnings, compounded monthly for two scenarios.  One scenario is to retain the traditional IRA, pay no tax now and pay tax when the funds are withdrawn.  The second scenario is to convert to a Roth IRA now, pay the taxes now and invest the net after tax into the Roth IRA (the same circumstance as if you convert the 100% balance of the Roth, and use money from your paychecks to pay the tax.  This money could still be earning interest and therefore you have lost the opportunity to invest the money because of the tax on the conversion).  Both scenarios were initially set at a seven (7) year time period to find the result of the principal, earnings and taxes on the Traditional IRA paid upon drawing and the taxes paid on the Roth IRA "up front".  Using the assumptions listed above the following results were obtained:
  The After tax Roth IRA at the end of 7 years $17,795
  The After tax Traditional IRA at the end of 7 years $17,938.
After the initial 7 year period, the Roth IRA will continue to produce financial advantages as there will be no tax on the drawing of the Roth earnings and the continued accumulations of Traditional IRA earnings will produce ever more greater taxes.