So this is Tom from Chantilly.
Is that how you pronounce that?
Yeah I guess.
Chantilly VA - Virginia.
So Tommy, he writes in to us, he goes, "Hey, not sure if this is the correct way to submit
a podcast question, but here goes nothing.
It is my understanding with the new tax law that it does not allow you to perform a conversion
over to a Roth IRA and then re-characterize a portion or all of it at a later date.
What is the best strategy of maximizing your Roth conversion amount in any given year while
not moving yourself into the next higher tax bracket?"
Good question, Tom.
I've got a few different answers for you, but I'm sure, Al, you've got the standard.
Yeah, I do have the standard.
(laughs) The standard is, first of all Tom, that's correct.
And this is with this new tax law, you can no longer re-characterize.
That's not true for 2017.
So if you had a Roth conversion that you did in 2017, you can re-characterize all the way
up to October 15th, 2018, which is right around the corner.
So you got a few more days to do that.
But going forward, that's a correct answer.
So what's the best strategy?
Generally we're going to tell people to wait later in the year, when their income is more
certain, because that's right - when you do a Roth conversion it's what we call irrevocable.
You can't change your mind anymore.
So you might want to wait till November and December when you have more certainty on your
income, and you can calculate your tax bracket with more clarity and make sure you do the
right amount.
This also requires that you spend a little time in November or December trying to figure
this out.
That's the standard.
So what have you got in addition to that?
Well it depends, Tom, on what your income looks like.
If it's W2 type income, you work for an employer, it's not variable, you get a 1 to 6% increase
cost of living or something like that.
Take a look at last year's tax return, and then you just put in your cost of living wages
in there, and then if you have interest or dividends or other type of income, it might
get a little bit more complex.
But if it's just a straightforward tax return, here's what I would do.
Look at what line 43 says on your tax return for last year.
That's going to be your taxable income.
Then I'm going to look at the tax tables, and I'm going to say, "well how much room
do I have in that particular tax bracket that I want to convert?"
So there's three different strategies I'm going to give you.
I'm going to say the best time to convert Alan, and you know this, is the beginning
of the year - if you know the amount.
So let's say I had $20,000 worth of room in my tax bracket last year, I might convert
$17,000.
A little bit lower, but I'm still going to convert in January.
And so explain why is it better at the beginning of the year?
Because I want to have that time for the dollars to grow.
Yeah, tax free.
Why not?
You get another year.
Do it in January instead of December.
Exactly.
Let's say the market performs 6% in a year.
Well if I'm in my Roth IRA January 1, all of that 6% grew in my Roth IRA starting Jan
1.
If I waited until December, well that 6% is already happened, per se.
So I'm only going to have that little bit of growth within the Roth.
The second way to do this is dollar cost average into the Roth IRA.
So let's say you wanted to put $12,000 in the Roth IRA?
Put $1,000 per month as a conversion into your Roth IRA.
So then you can kind of gauge things throughout the year and adjust as necessary.
So as the market is volatile, you're going to take advantage of better pricing as markets
go down, as you dollar cost average into the Roth.
Now those Roths are at a lower price.
Sometimes you might time it wrong, prices are high.
It will all even out, in most cases, in your favor.
So you could do it that way, just dollar cost average in.
But again, it does take a little bit of work to look at what your line 43 was last year,
how much that you want to convert, and then you can kind of do it slowly there.
The third way is to barbell it.
$20,000 is the number again, I'm going to convert $10,000 in January, and then I'm going
to wait until November to see where I fall, check my W2s or my paycheck stubs, and say,
OK well, maybe it's not $20,000 it's closer to $15,000 and then I would convert the additional
$5,000 at that point.
I'm trying to take advantage of the time value of money to get the money into the Roth as
soon as possible.
So there's a couple of different ways.
The most conservative way is to wait until the end of the year to find out exactly what
your paycheck is going to be and then convert it, like, December 15th.
All right.
So I agree with all three of those strategies with one caveat.
And that is, you can't really look at last year's line 43, because the tax law is different.
So you start there, correct.
But then you've got to look at what's going to be different.
For example, if you're married and you got two exemptions last year, that was about $8,000.
That's gone.
So right off the bat, you lost $8,000.
Itemized deductions, let's say you got $30,000 of itemized deductions last year.
And when you look at the new rule that says you can only deduct $10,000 for state taxes
and property taxes, you might be below the standard deduction, which is $24,000 for a
couple.
So maybe you lost $6,000 there.
So add those two together, that's $14,000 of less deductions.
You would add that's the line 43 to get your current year amount, and then you gotta go
to the current year tables which are a lot more generous.
Like for a married couple, $315,000 of taxable income is the 24% tax bracket.
Last year in that income level you were probably in a 35% bracket when you counted alternative minimum tax. Right.