Nov
05
2008

  Roth Conversion Risk

Uh oh-- with Obama in office, I think there is a real risk that he'll try to repeal (or at least strike down parts of) The Tax Increase Prevention and Reconciliation Act of 2006. The part I'm most concerned about is the provision that both income and filing status limitations for Roth conversions of regular IRAs will expire in 2010.

It's unlikely that he will change the rules for 2009, which might be my best last chance to convert all our IRAs. Unfortunately in 2009, anyone with a status of married-filing-separately is completely ineligible to convert at any income level. And the income level for married-filing-joint is the same as for single filers, which results in a significant marriage penalty.

Now, there is certainly a good chance that our income will naturally stay below the conversion limit in 2009, especially if the downturn in the market endures and low interest rates reign. But if things pick up mid-year (I think there is a good chance the market will rise although probably not the general economy) then I may have to do some serious tax-planning.

Terry and I currently have several different IRAs with different brokerages. I might have to consider consolidating some at the brokerage I use for active trading. If I load my taxable brokerage account with long-term assets that I can hold for several years, and do all my swing trading in my IRA, then I can still earn income from trading, but the taxes will be deferred. Now, they might just be deferred until the day I do the Roth conversion, but importantly, they won't count toward the modified adjusted gross income (MAGI) limit which determines conversion eligibility.

I'll have to check to see how the balance of the IRA is taxed at the time of conversion. If the balance is taxed as ordinary income, then it doesn't matter from a capital gains perspective if I trade in my taxable account or IRA (although it may matter for the MAGI problem). I think that's the case, and if so then it makes sense to do as much (profitable) trading as possible in the IRAs--that will create a higher balance to convert. Since we can't just contribute whatever we want to the IRA, there are annual limits to our contributions (I think last year it was $5,000 per person), the only unlimited way to increase the balance is through capital gains and dividends. But I will have to balance that with gains in our taxable account, since we need some income to live off of while neither of us has any other income.

Grrr. Tax planning would be so much easier if McCain won. @#$@#% socialist Obama wants to "spread my wealth around" but I'm not going to let him. We'll see what he can squeeze out of the top 5% after they meet with their tax accountants this year and restructure their investments to avoid his punitive taxes. Now, I don't think it's going to be a problem for me to stay out of the top 5% for 2009, but his tax program isn't going to hit until 2010 anyway. And if the market is in recovery, that's when I'm going to earn my income. Except I can plan in 2009 to put the volatile stuff in my IRAs and the long-term stuff in my taxable account, so I'll be ready in 2010 to show very little taxable income. But hopefully will rack up big unrealized capital gains (to be harvested in the future when tax rates are more favorable) in my taxable account, and big realized gains in my non-taxable account. If I'm converted to Roth in 2009, then I'll truly have non-taxable gains, not just tax-deferred. Good thing I have ample experience as a personal tax accountant, otherwise I'd be even madder about the Obama win. Now I'll just plot to shuffle income around so that I get a tax BREAK instead of a tax HIT. Take that.