ROTH conversion

Since there seem to be other people struggling with US pension funds and Roth conversions, etc. I'm setting out my circumstances and my reasoning in trying to see my way through the thicket. Converting to a Roth doesn't seem a great deal for me but it could well be that my reasoning is faulty (and of course, other people will have different circumstances).

I have $160k that I could convert to a Roth. As is, it earns 3% interest a year. This and my other income should be sufficient for my needs for the rest of my life (say, for 25 years, the approximate amount figured in the actuarial tables).

Assuming that the 160k taxed at the ordinary US rates, it would kick me up to higher tax brackets so I'd pay about 25% US tax on it, or 40k. (I don't know if it would kick me into having to pay Alternative Minimum Tax). I wouldn't pay any UK tax on this conversion. Distributions would be tax free in both jurisdictions for the rest of my life.  My dependents are all comfortable and don't particularly need an inheritance. So, how many years of tax would recoup the 40k  in tax I'd already paid.

From this fund, I'm currently taking distributions of $6800 (around 4% a year, as per RMD requirements). For my current needs, I don't need more.
 
On these distributions of $6800 I pay US tax of 15%. After the UK 'discount' of 10%, I pay UK tax of 18%, ie., yearly US tax of $1000 and UK tax of $1200. (These rates are lower than the tax rate I'd have to pay to convert to a ROTH). 

Here's where I get hung up: Assuming I stayed in the UK and paid UK tax, AND I remained in the UK 20% bracket, it would take 33 years to recoup the $40k I'd already paid.

If I died in 25 years, with the Roth conversion, I would have paid $40,000 in US tax. Without converting to a  Roth, and just paying UK tax on the yearly distribution, I would have paid $30,000 in UK tax. IRS would be $10,000 ahead. If I died earlier, I'd lose even more.

I could take out more in yearly distributions in order for it to be tax efficient. But in order to make it last 25 years, I shouldn't take out more.

What am I missing?

I'm a little unclear on paying both US & UK tax on the RMD - are you not taking a tax credit on the 1040? Or does other income come into play here.

For the basic question, it's almost like life insurance. If you live a long time and pay a lot out in premiums, the company wins; if you die soon, you win (or your beneficiaries will, sort of). Seems like you've calculated correctly using simple math; what we don't know is future tax rates, which could change the payback time. Personally, I'd rather stretch it out. Why give the IRS your money in one go? Too many unknowns for my personal comfort.

My 'large" IRA  - per the statement I got today  - stands at $124.6K, and the interest rate for the next 12 months is 3.85%. I'm almost 66, but I see no personal benefit to converting to a Roth, at least at this point in time.

It's a crap shoot.

The key to doing the ROTH is to keep the distributions such that you stay within a fairly US low tax bracket and that you avoid UK tax. Conversions are best done over several years where your taxable income is low. I plan to have a few years after I retire where I'll be living of savings and investments a I'll do ROTH conversions in those years. So doing a $160k rollover in a single year that bumps you into the 25% tax bracket is not a good strategy.

My next question might me being dumb, but why are you paying 15% US tax. Doesn't you UK tax cover any US tax liability you have on the IRA income?

My 'large" IRA  - per the statement I got today  - stands at $124.6K, and the interest rate for the next 12 months is 3.85%. I'm almost 66, but I see no personal benefit to converting to a Roth, at least at this point in time.

That's a nice interest rate in today's environment....

ROTH conversions aren't right for everyone. For US residents they work out nicely if you expect the tax rate when you take the income to be larger than when you make the conversion. For the UK resident they have the added benefit of avoiding UK taxation and if you are currently taking IRA income the conversion is a good idea if your US tax rate is less than the UK tax rate. Instead of taking the IRA distribution as income you roll it over to the ROTH. So you only pay US tax on the converted money and you take the same amount of tax free income from the ROTH.

My income for the rest of my life will be limited to my US Social Security, miniscule interest on savings, and traditional & SEP IRA distributions. We have one CD that has accumulated a significant amount of interest, and if we cashed that out, the tax hit in the UK would not be pleasant. The US tax bite (if any) won't be so bad, assuming there's still the 2 of us, because the reportable income is so small and our standard deductions & personal exemptions would whittle the taxable income down to a very small number.

Again, assuming married filing jointly, for the next few years we will have no US tax liability, even when I start RMDs in 2019 (April 1 of the year after I turn 70-1/2). The RMD amount plus interest income will remain less than our exemptions + standard deduction. Since my US tax rate is likely to always be less than my UK tax rate, I suppose it might make sense to roll the distributions into a Roth, again assuming that we don't need the income for living expenses.

Right now, I'm in the "I'll think about that tomorrow" mode.

Again, assuming married filing jointly, for the next few years we will have no US tax liability, even when I start RMDs in 2019 (April 1 of the year after I turn 70-1/2). The RMD amount plus interest income will remain less than our exemptions + standard deduction. Since my US tax rate is likely to always be less than my UK tax rate, I suppose it might make sense to roll the distributions into a Roth, again assuming that we don't need the income for living expenses.

Right now, I'm in the "I'll think about that tomorrow" mode.

The ROTH conversion is only a "conduit". You will take your living expenses from the ROTH rather than the IRA so that you avoid UK taxation. It sounds as if you have very little US income other than the IRA distributions; the US SS is only UK taxable. So you can use your US exemptions and deductions to off set the IRA to ROTH rollover and you'll pay little to no tax and then be able to take the same amount out of the ROTH and pay no US or UK tax on the distributions.

By this way of thinking....I am wondering if it might be in my best interest to start moving some of my TSP money over to my Vanguard Roth.....moving as much as I can each year and paying 15% tax on it and still avoid bumping up over the 15% bracket.

The ROTH conversion is only a "conduit". You will take your living expenses from the ROTH rather than the IRA so that you avoid UK taxation. It sounds as if you have very little US income other than the IRA distributions; the US SS is only UK taxable. So you can use your US exemptions and deductions to off set the IRA to ROTH rollover and you'll pay little to no tax and then be able to take the same amount out of the ROTH and pay no US or UK tax on the distributions.

Ok, trying to figure all this out, as converting my 457 plan to a Roth IRA is still on my very long to do list, I think?
Right now I am 48 years old, moving to the UK in mid October. I have about 100k in my 457 plan, along with my pension. I am a year & a half into my retirement & I am not dependent on any monies from the 457 plan, I just rely on my pension for income.
What happens if I move the whole amount from a 457 to a Roth right now while I am still in the US? Or would I better off doing a small amount each year after moving to the UK? Or converting the whole amount after I move to the UK?
I did not realize that I would get taxed when I convert it to a Roth.
 
Sorry to probably be asking probably very obvious questions, I am trying to make sense of all of this 

If you convert the 457b to the ROTH you'll loose the immediate penalty free access to the money. You will only be able to get the IRA to ROTH conversion amounts out penalty free after waiting 5 years. So liquidity needs to be factored into your plan. Also, I'm not sure how 457 plans are taxed in the UK. They are not specifically included as pensions and might come under "Other Income". I just don't know. I won't need early access to my 457b money if I move back to the UK so I'm going to roll it into an IRA just so I'm sure I can maintain the tax deferral of both US and UK taxes. If you had no US taxable income you could do regular IRA to ROTH rollovers up to the 10% tax limit and pay 10% tax on the amount the standard deduction and exemption of $9850...The 10% bracket stops at around $18k so the tax bill would be about $815 or 4.5%. If you kept the rollover to $9850 there'd be no tax at all.

You need to guess your present and future tax rates to see if the IRA to ROTH conversion is a good idea. So if you will be moving to the UK and you think your UK tax rate will be greater than your US tax rate then the ROTH conversion is a good thing to do. Next you have to be sensible in how you do the conversion for US tax purposes, so do them in years where you'll have low US taxable income and take them in amounts that keep you in the 0%, 10% or 15% tax brackets depending on how much money you want to rollover.

If you convert the 457b to the ROTH you'll loose the immediate penalty free access to the money. You will only be able to get the IRA to ROTH conversion amounts out penalty free after waiting 5 years. So liquidity needs to be factored into your plan. Also, I'm not sure how 457 plans are taxed in the UK. They are not specifically included as pensions and might come under "Other Income". I just don't know. I won't need early access to my 457b money if I move back to the UK so I'm going to roll it into an IRA just so I'm sure I can maintain the tax deferral of both US and UK taxes. If you had no US taxable income you could do regular IRA to ROTH rollovers up to the 10% tax limit and pay 10% tax on the amount the standard deduction and exemption of $9850...The 10% bracket stops at around $18k so the tax bill would be about $815 or 4.5%. If you kept the rollover to $9850 there'd be no tax at all.

You need to guess your present and future tax rates to see if the IRA to ROTH conversion is a good idea. So if you will be moving to the UK and you think your UK tax rate will be greater than your US tax rate then the ROTH conversion is a good thing to do. Next you have to be sensible in how you do the conversion for US tax purposes, so do them in years where you'll have low US taxable income and take them in amounts that keep you in the 0%, 10% or 15% tax brackets depending on how much money you want to rollover.

I googled my way around the internet & I more or less have figured my tax brackets for the US/UK. I think I have figured out what I need to do about this conversion! Thank you for your advice Nun, now I have to start making calls and get this sorted and off my To Do List 

If you are a US citizen living in the UK, taxed on an arising basis and taking income from an IRA then the IRA to ROTH rollover is a great idea. If you take money directly from the IRA then you will have to deal with both US and UK tax. If instead you roll the IRA money over to a ROTH and the take the same amount out of the ROTH you will only pay US tax. This will save you some effort in tax filing and will save you money if your UK tax bill would have been larger than the US bill.

By this way of thinking....I am wondering if it might be in my best interest to start moving some of my TSP money over to my Vanguard Roth.....moving as much as I can each year and paying 15% tax on it and still avoid bumping up over the 15% bracket.

After recent threads on this topic here I have also decided to speed up our ROTH rollovers before moving back to the UK.

Again, assuming married filing jointly, for the next few years we will have no US tax liability, even when I start RMDs in 2019 (April 1 of the year after I turn 70-1/2). The RMD amount plus interest income will remain less than our exemptions + standard deduction. Since my US tax rate is likely to always be less than my UK tax rate, I suppose it might make sense to roll the distributions into a Roth, again assuming that we don't need the income for living expenses.

Right now, I'm in the "I'll think about that tomorrow" mode.

Just an FYI.  Once you start taking RMD's you cannot roll these over to a ROTH.  You can still do ROTH conversions once you are over age 70.5, but only after you have taken an RMD into a taxable account.  At least that is how I understand it.

durhamlad, I will be the first to admit I know zilch about ROTH IRAs and what can or cannot be rolled over. Frankly at my age, I've pretty well passed the planning stage. I suspect I will stick to my original plan of taking my small 2 small SEPs as lump sums, and the RMDs at the appropriate time. I'll pay UK tax, but it's not enough to overly concern me.

I suppose I could roll the small SEPs into a ROTH, but as we will still be under the US taxable income threshold, there seems to be no point in doing that aside from the future interest being tax free in the US.

My finances are not complicated, thankfully.

I suppose I could roll the small SEPs into a ROTH, but as we will still be under the US taxable income threshold, there seems to be no point in doing that aside from the future interest being tax free in the US.

My finances are not complicated, thankfully.

The ROTH rollover is good if you want to avoid UK tax. If a US citizen lived in the UK off US SS and some IRA distributions which was their only US income they'd be able to rollover an amount equal to their exemptions and deductions and avoid US and UK tax. If they were single they'd pay UK tax on the SS and be able to convert almost $10k tax free.....

After recent threads on this topic here I have also decided to speed up our ROTH rollovers before moving back to the UK.

Just an FYI.  Once you start taking RMD's you cannot roll these over to a ROTH.  You can still do ROTH conversions once you are over age 70.5, but only after you have taken an RMD into a taxable account.  At least that is how I understand it.

This is true. Once you are over 70.5 you have to take RMDs from the IRA and must take them as income before you can do a ROTH rollover.

Where you make the ROTH rollovers doesn't matter as the UK won't tax them wherever you live and the US will tax them wherever you live. However, when you make the rollovers is important as you have to balance the amount of US taxable income you have and the time you have until you reach 70.5 and RMDs start.