IRA conversion

[chamberlain94]

Hello, I’m considering starting to convert my 401(k) to Roth IRA and want to check if I’m missing anything.

Current situation: Male, 40, married, no kids. I’m a UK/US dual national and my wife is US citizen on 5 year track to ILR.

I spent about 16 years in US accuring almost $300,000 in a 401(k). While I am still employed by the same global company in the UK, I am no longer a US employee so it’s a bit like my 401(k) is with a former employer.

My general plan is:
- roll over my 401(k) to a traditional IRA with Schwab, with whom I already have a Roth IRA, brokerage account and investment current account
- each year, convert an amount from traditional to Roth equal to the standard deduction from married filing jointly. Currently $29,200. Our combined income in the UK is about £100,000. We use the foreign earned income exclusion and are far below the $240,000 threshold, so we have essentially zero US tax liability. I could adjust the conversion amount down to account for modest interest, dividend or capital gains from my brokerage and current account.

- after about 11 years the full amount would have been converted and I would have paid no 10% penalty or ordinary income tax
- after 5 years, the conversions (but not gains) would be available to withdraw with no penalty or tax should I wish to access the funds.

- at retirement age, any withdrawals would be tax free (whereas if I left the money in 401(k) my withdrawals would be taxable)

I’m evaluating my options for transferring relatively large sums of money from US to UK, with the view that any expenses I can cover with $s instead of from my pay in £s allows me to salary sacrifice more to my SIPP or other sal sac schemes (benefitting from 42% tax and 2% NI). SIPP currently stands at about £22,000 after 2 years of contributions (8% ss from me, 8% match).

I would also consider extra payments to my mortgage/ lump sum at renewal. Currently £213,000, 23 years left, 3 years left at 2.01%. Expect to be close to 60% LTV by renewal.

Thanks for any advice or feedback on my plan.

 

[fredindallas]

@chamberlain94 solid plan

 

[robert1849]

@chamberlain94 Apologies if I'm stating the obvious, but if you reside outside the US when you retire, your pension may be taxable despite it's ROTH standing in the U.S.

 

[chamberlain94]

@robert1849 From what I’ve read the tax treaty between the US and UK means that the UK would not tax me on distributions from a Roth IRA.

 

[robert1849]

@chamberlain94 You're probably right and I hope you are right. If there is any doubt, check it out. It would be most unpleasant to find out otherwise.

 

[s1blue]

@chamberlain94 Does the uk not tax the distribution pulled from the 401k to the Roth Ira? Can't you only transfer $7000 ($8000 if over 50) into a Roth each year? I want to do the same as think but I thought I needed to wait until fully stop work and my income is $0 so I can could do it with minimal uk tax hit. I'm not sure I'm following how this works if you're still earning £100k in uk per year?

 

[chamberlain94]

@s1blue From my current understanding, a conversion is considered an inter-pension transfer and not taxable in UK under treaty. A conversion is not subject to Roth contribution limits so my only restriction is staying in the US tax free allowance

 

[s1blue]

@chamberlain94 So you're saying that:

a) UK won't tax the conversion from 401k/IRA to Roth since its just shifting money from one pension pot to another in HMRC view?

b) USA will tax the transfer since 401k/IRA is pre-tax contributions and Roth IRA is post tax so they'll tax the conversion. (expected)

But what I don't get is this. Surely the USA when they tax you they tax you on world wide income so won't your tax be based on 100k GBP income + your $29k USA income from the conversion and so you'll own USA tax on 100k + 29k?

This is why I was going to wait until I fully retire so my UK income is 0 (living off savings accounts first few years) and thus USA would only tax me on the $29k conversion?

 

[chamberlain94]

@s1blue Because I am using the Foreign Earned Income Exclusion (FEIE). So my UK income is excluded as far as the US is concerned. (I pay tax on it to the UK).

 

[s1blue]

@chamberlain94 I use the same so you're saying because we pay MORE tax than the USA would have charged us on the 100k GBP income (way more!) thus UK doesn't see the $29k as income as its just one pension "pot" moving to another pension "pot" and then US will only tax the $29k since the 100k GBP we've paid tons of UK tax on and the FEIE has more than written off any USA tax owed for that year (with some FEIE carried over into future years even)...

If so - then damn - I need to start doing this fast!!

 

[chamberlain94]

@s1blue Actually the difference in tax rates doesn’t really make a difference with the FEIE. If you were using the Foreign Tax Credit, then yes, the fact that you had paid a higher rate of tax on UK income than you would have done on the same income in the US may mean that the credit would cover some of the tax due on the conversion. Remember that a tax credit does not reduce your taxable income (which cannot be reduced below zero), but directly reduces tax owed.

All I can say is, I used H&R block for taxes last year. I had tens of thousands of dollars of UK income (line 1h on form 1040) which I excluded (shown on line 8 as negative the value on line 1h)

I then had a few thousand dollars of capital gains income, which I paid no tax on since I claimed the standard deduction.

Honestly this sentence in Pub 54 is super ambiguous.

“If you qualify for and claim the foreign earned income exclusion, the foreign housing exclusion, or both, must figure the tax on your remaining non-excluded income using the tax rates that would have applied had you not claimed the exclusion(s). “

 

[s1blue]

@chamberlain94 One other question though - does any IRA (say Fidelity) allow you to do large conversions from its IRA to one of its Roth IRA's each year? Like I say I've been moving $8k per year from general savings to my Fidelity IRA and then rolling it right into a Roth IRA but I've not looked at just converting large chunks of my 401k/IRA directly into the Roth?