Earlier this year, I wrote about getting started on the Roth IRA conversion ladder. The first rung has been taken. This week, I completed the first of 7 conversions.
For those of you not in the know, I have some money, but it’s in all the wrong places. I’m 47 years young, 3 years retired with a modest income from various investments. The problem is, that the bigger chunk of these investments are tied up in my 401(k) (Luxury problem, I admit).
Based on today’s budget, five years prior to the age of 59 (and a half), my after tax investment accounts will run dry . There will be plenty in my 401(k) when that time comes but it would invoke all sorts of penalties getting to it. The Roth IRA Conversion ladder offers a solution to this problem.
What’s a Roth IRA Conversion Ladder?
Money converted from an IRA/401(k) to a Roth IRA can be accessed 5 years after deposit, penalty free. The catch: when converting from a 401(k)/IRA you owe regular income tax on the amount converted. Hence, you spread it out over a number of years, leaving your tax-bracket low and freeing up enough each year (starting 5 years from now) to cover your expenses.
This week I climbed the first rung of my conversion ladder. I should be done for this year. There are variations on how this is done for others, but here is the process I went through.
Step 1: Open a Roth IRA account. In my case I opened it with TD Ameritrade. The process was painless, all online and there was no deadline on when I was supposed to put money in. Pleasant surprise: when I did put my money in they threw in an extra $100.
I have two 401(k)s, both from previous employers, both with another investment firm. The plan was to convert part of my oldest 401(k) but, it turns out, that plan doesn’t allow a partial rollover. This is why it might be different for others; much depends on the plan’s rules which can vary wildly. Two 401(k)s with the same firm, different rules for rollovers on each.
Step 2: Call your plan administrator to start the rollover. In my case this would be for $40,000. This amount would keep me in the 15% tax bracket, which is important as I incur long term capital gains on my after tax accounts. Long term capital gains taxes in the 10% and 15% tax bracket are ZERO!!!
I called my 401(k) manager and requested a direct rollover to a Roth IRA at TD Ameritrade. First hiccup, this didn’t work as my Roth IRA was opened at a different entity. I might have gotten away with it, but the 401(k) administrator would not submit the proper tax papers when converting to another broker. As a matter of fact, they really just write you a check. What you do with it, is up to you. The advise I got, was to simply open an IRA with TD Ameritrade, convert to it, and subsequently convert that to the Roth IRA. Taking that route, TD Ameritrade will submit all the right paperwork with Uncle Sam.
All seems cumbersome, but it really only takes 10 minutes to open an IRA.
The check was made out to “TD Ameritrade IRA, FBO: Mr MI10″, which means I was able to simply forward the check onto TD Ameritrade (don’t even need to endorse it, as its made out to them).
Tip: Check with your broker, mine allows to scan checks up to $25,000 though their mobile app. That could skip one of the snail mail steps.
IMPORTANT: The check has to be deposited within 60 days. If not, you will incur penalties!!
Step 3: Transfer the money from the IRA to the Roth IRA. For this I had to fill out an old fashioned form that I downloaded from TD Ameritrade. In it, you specify the amount, the accounts involved and how you want to handle the taxes.
In my case I instructed TD Ameritrade to NOT withhold any taxes. I will handle my own taxes come January. Letting them withhold would mean an automatic 20% (I believe) withholding, which you btw. have to replenish from your own funds back into the Roth IRA.
I was able to scan in the form and submit it to them via their messaging system (online). The only other alternative is snail mail or fax (Yes, banks too, still use faxes).
All of this was done within a matter of days. The biggest delay being the shipping of the check via snail mail. If you stick with one broker, it can probably be all done within a day.
Done for 2017
So there you have it, the first run of the ladder (in my case I plan on 7 to 8 rungs). Next year it will simply be rinse and repeat.
If you’re considering doing something similar, pay careful attention to the tax consequences. The money you convert to a Roth IRA is considered part of your Adjusted Gross Income (AGI). You will have to pay taxes over it, but beyond that, it can also impact credits/eligibility for social programs and in our case the Affordable Care Act. Due to this conversion I may have to pay back some of the credits for our healthcare. In our case it also puts us very close to the top of the 15% tax bracket. Once I get over, I have to pay capital gains over my other investments.
I’ll keep you updated when tax time comes around and let you know how well (or not) I planned.
Good luck reaching your financial goals.