Regular IRA to Roth IRA conversion

[psychopengy]

I'm considering converting funds from one of my regular IRAs to one of my Roth IRAs by the end of 2023. I'll be in the lowest federal tax bracket for 2023. Not only that, my income this year is so low that I shouldn't owe any federal income tax at all for 2023. I've done a rough calculation and determined this. I'm almost certainly going to be in a higher tax bracket in the coming years, since I plan on fully retiring in about two years and starting to take social security. In the meantime I might purchase an annuity. So I thought that this might be a good time to do a conversion of at least some of my regular IRA money.

I read in an article that if my total taxable income, including the IRA withdrawal, doesn’t exceed my standard deduction, I wouldn’t owe income taxes on the conversion. Is this true? I can't find any more information about it. Please direct me to a reputable source that states this. Also, any advice about how to determine whether a conversion would be a wise move would be appreciated. Thanks for your time.

[dmertz]

"if my total taxable income, including the IRA withdrawal, doesn’t exceed my standard deduction, I wouldn’t owe income taxes on the conversion. Is this true?"

True.  The standard deduction is subtracted from your AGI in calculating your taxable income.  You would not have any income tax on Form 1040 line 16 if your taxable income on line 15 is zero.  Be aware, though, that the increase in your income from the Roth conversion could have side effects that increase your AGI by more than the amount of the Roth conversion (such as an increase in the amount of taxable Social Security benefits if you receive such benefits), so it's best to prepare a simulated tax return using the CD/download version of TurboTax to check for such things.

[fanfare]

A Roth conversion is always a good idea if your "amount you owe" is going to be zero.
Your future self will thank you.

@psychopengy 

[psychopengy]

Thank you for your reply. As it turns out, I won't have $0 taxable income. I have a small amount of business and taxable interest income, which, when added to a regular IRA withdrawal in order to fund the Roth IRA conversion, will result in a tax liability. I used a pretty accurate income tax calculator to confirm this. If I convert $19,000, which would still keep me in the 10% tax bracket, my federal income tax would be $1,062. So now I have to decide whether it's worth it to pay those taxes this year, or keep the $19,000 (or less if I want to convert less) in the regular IRA and let it grow. I'll almost certainly be in the 12% tax bracket by the time I have to pay taxes on it, either with with a Roth IRA conversion in later years, or as a part of my RMDs, which will start in about 5 years. Not sure at this point how to make this decision. Does TurboTax have advisors that consult on these matters on an hourly fee basis? Do I have to buy a TurboTax product for that? Thanks again.

[dmertz]

You'll want to convert whatever amount still results in no tax liability, which seems like it might be around $10,620.  Your decision will then be whether or not to convert more at a 10% marginal tax rate (or even a 12% marginal tax rate).

I usually consider whatever amount I convert now to be an amount I won't be distributing from my traditional retirement accounts at the tail-end of making distributions from the traditional accounts, so I consider what I expect my marginal tax rate to be then.  I also consider that the earnings on an amount not converted now will be taxable instead of nontaxable when distributed at the tail end if not converted now.  That does ignore the difference I'll have in future RMDs I'll have between converting now or not converting now, but I figure that difference is somewhat offset by being able to get more into Roth IRAs by converting more earlier instead of having to be distributed as RMDs.

I'm assuming that there would be no side-effects from an increase in AGI that would have a multiplying effect on your marginal tax rate such as an increase in the taxable amount of Social Security benefits.  Also keep in mind that the 12% tax bracket is presently scheduled to go back to 15% in 2026.

[psychopengy]

Thanks again for your reply. Good information. I did another 2023 tax return calculation to see what Roth conversion amount would result in a $0 tax liability and it was only $5,318. So if converting up to $19,000 will still keep me in the 10% tax bracket, that might make sense to do, especially, as you pointed out, the returns on that will grow tax-free in the Roth, whereas they would be taxable in the regular IRA.  And, as you said, the 12% bracket will increase to 15% in a couple of years.

Could you please clarify your statement:

"That does ignore the difference I'll have in future RMDs I'll have between converting now or not converting now, but I figure that difference is somewhat offset by being able to get more into Roth IRAs by converting more earlier instead of having to be distributed as RMDs."

I'm having a little trouble following it. Thanks again

[dmertz]

Converting now reduces your balance in traditional IRAs, so it reduces future RMDs.  By less being required to be distributed as RMDs, more of your traditional IRA funds can end up as Roth conversions if you choose to continue to do Roth conversions after RMDs begin.  For the same tax liability, reducing your RMD by some amount allows an amount equal to that reduction to be converted to Roth instead of being moved to a taxable account.