Dec
17
2010

  Annual Roth Conversion Started

Now that we have very little income, we're in the lowest tax bracket ever. In fact, for 2010 it appears that we will join the 50% of the population that pays no tax. After I did our preliminary tax planning, I discovered that we can actually shelter some previously earned income permanently from tax.

We actually didn't even earn enough this year to bring us up to a taxable income of zero after the standard deduction and exemptions. Fortunately, we don't have to "waste" these tax-free allowances since the government has provided a handy-dandy way for us to add previously earned but untaxed income to our AGI. I just filled out a form to convert money from our traditional IRA to a Roth IRA.

In a traditional IRA, you defer taxes on currently earned income until retirement. For example, we earned money in 2006, put it in the IRA, and didn't pay taxes on it that year. The idea is that you pay taxes when you withdraw the money in retirement.

With a Roth IRA, you deposit after-tax income. So you earn money in 2006, pay taxes in 2006, and put it in your Roth account until retirement. But unlike a traditional IRA, when you withdraw those funds from a Roth, you DON'T pay taxes on them, since you already paid taxes years ago.

Except in our case, we were ineligible to put any money in a Roth in 2006. But we've been eligible since last year, and have been making conversions.

The beauty of our situation this year, is that while technically we are paying tax on the amount we convert, our effective tax rate is zero. So by funding our traditional IRA in high-income years, we lowered our tax bill then. And now that we have exceptionally low income, we're taking our tax-deferred income and paying 0% tax on it (which believe it or not, is technically different than paying no tax on it), so it's recharacterized as after-tax income, so we won't have to pay tax when we withdraw it later in our retirement (when we're 59 or whatever the age will be in the future). Ain't it grand to be a former CPA who knows how to best exploit tax loopholes in any income situation?

Finally, after carrying the bulk of the population on our backs for so many years, we're finally on the "taking" side of the tax equation, and joining the welfare state half of the population enjoys. Obama can talk about redistributing the wealth as much as he wants, we can ride out his policies as long as necessary, keeping a low income and taking whatever wealth he wants to redistribute our way. When he's booted from office (or changes his policies to stop demonizing the wealthy), there will be plenty of time then for T to start a new venture and make some mad cash. Which we won't bother doing until we're confident it won't be confiscated and "redistributed" to others less talented or hardworking.