Wife will take a 403b where she doesn't work anymore and roll it into an IRA. Age 47. Should we go ROTH or Traditional? The total in the account is approaching $10k. Our reportable income will be about the same or LESS than before. There is a 19 year age gap between us. If she doesn't make enough money from which to deduct IRA contributions, I don't know what to do. If we "redeem" the $10k into a regular, taxable investment account, there will be the penalty to pay, plus a tax hit, because that money will count as INCOME for the year... It will be going from V'guard VEIRX to TRP, probably their BALANCED fund. I've done my homework, with just one or two funds we are seriously interested in at Price.
Comments
Do not redeem into taxable.
For 2019 the tax table looks like this:
https://screencast.com/users/smhag/folders/Jing/media/fa939f91-3908-4dd4-b0a3-21ced8aff8a6/embed
If you can convert all $10K in the first year, great. If not, break up your conversions over time.
Roth accounts have rules that need to followed to avoid penalties, but the conversions can always be withdrawn penalty free.
Ideally, as with any kind of investment option, you like to “buy” low. While most any time is a pretty good time to convert (Traditional to Roth), if you can do it with under-appreciated (or underwater) assets, you stand to reap a larger measure of the Roth’s rewards. That in turn makes that initial tax hit look a lot less. Of course, this is to a degree based on good luck.
I did a conversion of global equity funds in March ‘09 and have never looked back. All smiles. Did another in January 2016 when most of the hype over PRPFX had faded and the fund had slid into disrepute. The hot money had left. Recent performance stunk. Caught a nice bounce with that one. No regrets. No sweat.
The third one (actually the second in sequence) in January, 2015 did not go as planned. I threw all of that conversion into a commodities fund at Oppenheimer I thought was ready for a bounce. Instead it tumbled further. Adding insult to injury, they shut the fund down while all my Roth money was still in it. At one point my “hypothetical” 10K Roth “investment“ was worth in the vicinity of 7K. Never despair. With a bit of help from Invesco/Oppenheimer’s precious metals and real estate funds, that “hypothetical” 10K Roth is now worth over $13,000 - less than 5 years after the conversion.
So, 2 out of 3 ain’t bad. And, even the one “miss” eventually turned around in time to salvage the converted amount.
So let's start with the mechanics. First, as @Gary1952 said, don't take a taxable distribution. If you're going to pay taxes, you're better off rolling it into a Roth. All its future earnings will be tax free, as opposed to taxable in a taxable account.
The law allows rollover conversions directly from a 403(b) into a Roth IRA. This eliminates one step in the conversion process. But my limited experience in helping someone do this within TIAA suggests that the 403(b) administrators may not know what they're doing. (In that case, TIAA withheld state income taxes which they were not supposed to do.)
Instead, a direct rollover to a T-IRA will preserve your options to convert or not. If you should convert the IRA (or a portion) to a Roth, don't have taxes withheld, else the amount withheld will be treated as a taxable withdrawal. In addition, the conversion moneycannot be withdrawn penalty free for five years. Because your wife is (and will continue to be) under 59½ the conversion money will be subject to the usual 10% early withdrawal tax until it becomes a qualified distribution. That happens five years after the conversion.
Here's a short column discussing these two "traps":
https://www.irahelp.com/slottreport/roth-ira-conversion-10-penalty-trap
In some states (I don't remember which state you're in), some retirement distributions (including IRA withdrawals/conversions, pension plans, etc.) can be taken state-tax-free. This feature may be age-restricted. For example, Colorado exempts $20K of retirement income (including IRA withdrawals) for people aged 55-64, and $24K for seniors. So if you're thinking about converting the money, it might make more sense for you to convert part of your T-IRA (if any) rather than part of your wife's. Not to mention that you're closer to RMDs.
Page with table of how each state treats retirement income:
https://taxna.wolterskluwer.com/whole-ball-of-tax-2018/state-retirement-taxes
That gets us to whether it even makes sense to convert (which is effectively what you're doing if you do a direct rollover to a Roth). Not enough information to reasonably comment here, especially since I don't understand what you mean by "doesn't make enough money". Generally 100% of compensation can be contributed to T-IRAs (up to contribution limits, of course).
The 12% bracket that @bee mentioned calls to mind another consideration: 0% capital gains. If you keep your total taxable income under $78,750 (sic), then you cap gains are taxed at 0% by the IRS. Note that this limit is slightly different from the $78, 950 limit for the 12% ordinary income tax bracket (MFJ).
Too many considerations and too little information to comment intelligently about your conversion decision (which would be informational in any case and not constitute advice, as with all of this post).
https://irs.gov/retirement-plans/retirement-plans-faqs-regarding-iras-rollovers-and-roth-conversions
https://irahelp.com/slottreport/5-year-forever-clock
..we talked w our advisor and several persons who known each uchnabout tax before starting
You can have 401k /sepIRA /pensions at same time as long as we don't contribute more than certain amount per yr
About 15s year til retirement probably best route to go w sep IRA in our situations
.whether pay tax now or later it's always a question..just we can save money now for capital income and reinvest without worrying about tax maybe a good choice
The only requirements for contributing to a Roth are that you have compensation and that your MAGI does not exceed certain values. A SEP reduces your MAGI (see #5 in this Kiplinger piece). So if you met the MAGI requirement before starting the SEP, you should be able to meet the MAGI requirement now; the SEP just makes it easier.
The other requirement is that you have compensation. The SEP limits your contributions to 25% of your business' profits (that's 20% after counting the SEP contribution as a profit-reducing expense). So you've still got 80% of the business profits as income. That income could be used to contribute to the Roth.
Hence the confusion. Why stop contributing to a Roth IRA?
(My tax guy explained the procedure and percentages and steps and nonsense and crapola and bullshit re: exactly what kind of mathematical formula the IRS uses to let me get at that $7,000 total in non-deductible (and zero tax owed) contributions. Clearly, some Martian with 8 brain cells and both male and female genitalia and no experience at all on planet Earth came up with that idiotic gobbledigook.... Now that I'm of age, I COULD take out the non-taxable amount without penalty. But it can't be done simply by taking the $7,000.00, since that's the non-taxable total amount in the account. The IRS requires that it be done over time, in order to preserve the tax-free status of that full amount. M-I-C... K-E-Y....... M-O-U-S-E.)
So, I'm hearing great things from you all about the Roth.
Is it not possible to convert the 403b DIRECTLY and TOTALLY into a Roth? Maybe that IS possible, but for some arcane reason, should not be done? Because the conversion (of whatever amount) triggers a taxable event?
Note: together, we will be WAY below the 12% tax bracket's income limit. PLENTY of room, there. BUT: maybe converting the 403b entirely in a single year might be the difference between owing no tax at all, and owing SOME tax.
I'm re-reading my entry, here. I'm going to just finish here. I'm only going to add this, which is the same thing I've volunteered to say to some customer rage and aggravation agents (aka "customer service") on the phone, just today, in fact: NOTHING should be THIS complicated.
Despite the fact that the rollover conversion is taxable, withholding is not supposed to be mandatory. You don't want taxes withheld, since it's better to move the whole amount into the IRA. A risk (based on experience) is that the (former) employer may withhold taxes even if you instruct the employer not to. This can be remedied by contributing the withheld amount yourself into the Roth IRA and declaring it a 60 day rollover conversion. So it's possible for taxes to be "accidentally" withheld, but that's something you can deal with.
It looks like any employer match that's part of a taxable 403(b) distribution is exempt from Hawaii income tax. So it might even be to your benefit to do the conversion directly from the 403(b). If you were to first rollover the money into a T-IRA and then convert, I think you'd lose the "employer-match" quality to some of the money, and Hawaii would tax the whole conversion.
That's assuming I'm reading the Hawaii income tax rules correctly, and I've merely glanced at them.
Short answer - you can do a direct 403(b) to Roth IRA rollover/conversion. The only downside I know of is a small risk and can be handled. There may be an upside to doing the direct rollover/conversion.
That’s what I did with my 403(b) - which was already with TRP. Price was most helpful in facilitating that rollover. The funds I was invested in stayed the same. No money moved. Just a bit of paperwork. Later, I diversified away from Price into some other houses by doing simple IRA Transfers. Paperwork for an IRA transfer takes less than 15 minutes. Pretty basic. Just mail it in.
Changing from a 403(b) designation to IRA status would seem the important first step. Later, deciding which portions of the IRA to convert to Roths and how to time those conversions requires more foresight and planning on your part. The whole chunk doesn’t have to be converted at once. I found it simplest and most convenient to convert 100% of my holdings at different houses in 3 different years. It also allows you to pick the most opportune investments to convert at different times.
PS - In a 403 plan the employer controls it. In an IRA you have control. Big difference.
Just some ideas FWIW
Depends on the definition of “communicate.” With T. Rowe when withdrawing tax-sheltered funds online a pop-up appears stating that Michigan requires “mandatory withholding” and that a specified percentage will be withheld. Unlike Federal withholding, you do not have the option to “decline” at that time.
That’s the “default” option. However, Michigan also allows taxpayers to “opt-out” of mandatory withholding in advance by submitting form W-4P to the custodian ahead of time. I send in a new one every January 1 to custodians where I expect to take IRA withdrawals during the year. Doing that, I’ve had no trouble taking distributions free of withholding. As a safeguard, I first deposit the proceeds into a non-retirement account with the same custodian. This, I believe, would make any later corrections, if needed, easier to transact. Don’t put too much faith in what the custodian says over the phone beforehand. The knowledge level varies greatly. It’s best to dot the “i”s and cross the “t”s in advance.
Re Roth Conversions. My best recollection is that all 4 firms where I did in-house conversions (Traditional to Roth) had a check-off box in the paperwork allowing one to decline Federal withholding on the amount being converted. There were no problems.
I’ll be forever grateful to the front office folks at D&C and Oakmark. I phoned both on Friday March 6, 2009 to inquire about a Roth conversion. The stock market was plummeting - as it had been for over a year. Both advised me to download the paperwork, which I completed over the weekend, and provided instruction. I called the PO and was informed the documents could be delivered on March 10 if I got them to the post office by 1:00 Monday the 9th. On the 9th a terrible snowstorm hit our area in the early morning hours. I remember driving 10 miles over barely passable roads to get the documents to the nearest post office by 1:00. But it worked. Both firms received the documents on Tuesday, March 9 and effected the Roth conversion at that day’s close. As it turned out, the market bottomed Monday, the 9th. Tuesday the Dow bounced around 300 points. So my conversion missed the absolute market bottom by 1 day.
(Note: I tend to think of those 2 conversions a being just 1, as they occurred together on the same date. And I’ve long since co-mingled / transferred those accounts.)
Roth. It's affordable to switch at this point; any income she has going forward (and she's only 46), you will probably be able to afford to stick into the Roth; it gives you an aspect of wealth diversity and financial control that no other instrument does.
Wifey and I both have Rollover IRA's, she has a Roth, and a taxable account [read: deferred, deferred, exempt, taxable]. I have a DB pension, both on SS and now we're 71 and 70 both subject to RMDs. Both working part time. The Roth gives me additional flexibility with management.
good luck and so it goes,
peace,
rono
For withdrawals at Fidelity, be they from a taxable account or from a T-IRA, the account owner decides from a drop down menu whether or not to have any federal or state taxes withheld; and if withholding is chosen, at what percentage amount.
Very nice and straight forward.
Here’s form W-4P https://www.michigan.gov/documents/taxes/4924_365368_7.pdf
Here’s a clarification of Michigan's law. Note that it specifically notes that IRAs are treated the same as “pensions” within the purview of the law. What are retirement and pension benefits? - https://www.michigan.gov/taxes/0,4676,7-238-43513-397990--,00.html
Thank you for your added information.
NOTE: this conversation is not fully in line with this post subject,except to the point of current and/or future taxation regarding the tax status of retirement monies, as to how variations exist within state jurisdictions, aside from whatever personal taxable status may exist at the federal level.
A few pieces of info from 2012 regarding the "new pension tax" in Michigan. Hank, the below item 1 is part of what did cause confusion, from wording within the new tax code, with some pertinent wording in bold by me.
--- 1. Payers Subject to the New Withholding Rules, Michigan (note: there was a last minute scramble to provide payers with withholding instructions for the new calendar year 2012, as the Michigan Supreme Court had just ruled on the Constitutional status of taxing pensions for a narrow portion of the population (read, those born between 1946-1952
)
Only those subject to Michigan jurisdiction are required to withhold Michigan income tax under the new rules. Other payers need not withhold, even though the payee resides in Michigan.
The Withholding Guide refers to the pension “administrator” as the person responsible for withholding. If the administrator is registered with Michigan Department of Treasury only for reasons other than withholding, the administrator must register again as a “pension administrator.” It is not entirely clear whether an administrator who administers payments to one person from more than one plan would have to aggregate the payments for withholding purposes. Analogy to federal law would indicate that aggregation is allowed but not required.
Mandatory Use of the MI W-4P
As mentioned above, the State of Michigan's current position is that an administrator must withhold at the prescribed rate unless the participant provides different instructions on a MI W-4P. We understand that a number of payers are disregarding that position and are continuing to use their own version of the W-4P.
Next for item 2, is a short reply to friends and family at the time (2012) asking what the hell is going on with this new pension tax. Do not imply I retain a bias favoring one political party over another. This is not the case. However, at the time; this form of tax legislation was a strange path for a Republican controlled state government. Thus, the words to help identify the pathway of the legislation for those asking the questions of me (as in, who the hell promoted and favored this legislation?).
--- 2.
I had several email exchanges with legislators, including the Lt. Governor and the state Treasurer during the beginning of this process.
The tax came to birth when the Republicans decided to reduce some business taxes.
The overview:
1. Reduce some business taxes and companies will hire more people and/or new companies will move to Michigan.
2. Michigan's budget is required to be balanced.
3. So, if one is reducing business taxes by $1.6 billion dollars, this needs to be offset from some other source.
4. Thus, the tax the pensions came to be as a source to recover the lose revenue to the state.
The legislation was introduced by a Republican, the final passage was supported by enough Republicans, with the exception of a tie vote in the MI senate, with the tie breaking vote being cast by the Lt. Governor and signed by Gov. Snyder.
The legislation was challenged in court as unconstitutional and eventually traveled to the MI Supreme court for a final decision. The court at the time was Republican dominated. The legislation was passed with a 4-3 vote as not violating the constitution.
Summary: many republicans were not in favor of this tax, but enough voted in favor to set up the tie breaking vote by the Lt. Governor and of course, favored by Gov. Snyder.
My main points in email exchanges (my opinions,2011) with legislators from both political parties were:
1. that whatever amounts would be taken away from retirees in tax, would be monies not spent locally to support those businesses.
2. the tax was targeted at a specific group (baby boomers) does violate tax code by age discrimination
3. those voting in favor are targeting their own retired parents and/or grandparents...duh!
4. a number of Michigan residents will indeed retire to a state that does not tax pensions......this has take place to some extent, so the tax money is forever gone from Michigan, as these "snow birds" stay long enough in another state to claim residence in that state as a taxpayer; although they may return to Michigan during the warmer months. (2019 update, this indeed has taken place in larger numbers; so Michigan has lost this tax base from pension monies)
This link takes you to the legislation path:
https://votesmart.org/bill/13363/35098/tax-exemption-and-pension-bill#.XgiijGYyeM_
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Lastly, Hank; wife and I both receive defined pensions from payers not domiciled in Michigan. We have taxes "only" withheld from 1 pension for federal taxes, so as to not "hit" the federal underpayment penalty box at tax time. No Michigan taxes are withheld from either pension. Generally, we pay the remainder of federal and state taxes owed when filing taxes in the next year, without underpayment penalty. As noted in my previous post, Fidelity only asks; for my IRA RMD, as to whether I choose to have any federal or state tax deducted (tell us how much or none).
Take care,
Catch
Do you have any guidance how to live comfortably in Hawaii and worried free/free of debts? heard housing and living expenses there one of highest in world
Of course you cannot beat the scenery though
I always dream of retire in paradise like Hawaii or Santa Monica in Cali [very expensive]
may need to settle for other more affordable beaches places in Alabama or Texas/Florida
thankyou
At least for Michigan employers, "Every Michigan employer who is required to withhold federal income tax under the Internal Revenue Code must be registered for and withhold Michigan income tax."
This is the concern I was voicing. Direct Roth rollovers from 403(b)s to Roth IRAs are not subject to mandatory federal withholding. But some employer administrators get this wrong and withhold at the state level anyway, viewing the state withholding as mandatory.
With respect to whether employer (public or private) pensions (including defined contribution plans) are subject to taxation based on age in Michigan vs. IRA taxation rules, all I can say is: good luck! That looks like a full employment act for Michigan CPAs.
Thanks for the added info. Appears the courts have weighed in on Michigan’s pension tax recently - particularly on which providers (in our case IRA custodians) are required to withhold the tax. Thus far, all my distributions have come out of TRP, so I can’t comment on any other investment manager. As recently as mid-summer the mandatory withholding appeared to be in effect. Would another institution address Michigan’s law in the same manner? Perhaps not. Is this a reason to leave T Rowe Price? No.
I store the same annual letter to TRP on my computer. After updating date, I print and mail it to TRP along with a new W4-P (available on the internet) and a copy of a recent statement each January 1. Preparing all of this takes about 5 minutes (less time than I’ve spent composing this post). While a 55-cent stamp will work, I prefer to add tracking (via priority mail). So my annual cost is $7.35.
The above is overkill. It’s likely the opt-out would continue into the next year without an update. And one could save $6.80 by not using priority mail. To their credit, Price does an excellent job maintaining one’s records. Call with any tax related question and they’re likely to produce the needed documentation. So I’ll forgive what appears now to be their excessive caution on the pension tax withholding issue.
@Crash - These issues aren’t as complicated as they sound. Invest in the vehicle that will allow you maximum after tax return and also allow you the greatest flexibility in managing your assets.
Thank you for your time and observations.
This whole pension tax process (May 2011 - Jan. 2012) was a 3 ring, government circus event, to the max; including the last minute rush to provide legal language to the CPA's, etc. Michigan's newly elected governor is a Democrat, while the legislature is Republican for the most part. Removal of the "pension" tax were campaign words by some, but state revenue is state revenue and I doubt this action will take place. The legislators that were in place in 2011 are now term limited away. The political parties remain split on many items, not unlike at the national level. Though Michigan's roads/bridges,etc. are in need of major repairs, Republican's at all levels, including the citizens will not agree/find a monetary path for repairs (IMO). When I query to friends/family who I know are strong Republican's about this circumstance, the overwhelming response is a "hell no, we're not paying any more gas or other tax for repairs". When I ask them how often do they plan to replace the aging shingles on their house, if ever; I get a stare and can hear the wheels turning inside their heads.
So, they and everyone else will "pay" (no taxes for road repairs) in the form of new wheels and tires, and repairs to vehicle suspensions.
What a wonderful, divided world in which we live; as common sense gets thrown out of the window of politics.
Have a pleasant remainder.
Catch
I'm a cheapskate: first class mail (55¢) + certified mail ($3.50) + electronic return receipt ($1.60) = $5.65. Just proof of delivery, not tracking. Same for IRS. I figure that if it doesn't get there, it doesn't matter where it gets lost.
https://www.usps.com/ship/insurance-extra-services.htm
https://faq.usps.com/s/article/How-is-Return-Receipt-Used